The future of virtual pay
The world is moving toward cashless payments. It has been moving in this direction for at least the past couple of decades, with the good old plastic debit/credit card facilitating the transition on the consumer side. However, this humble servant of the electronic payment revolution is facing extinction in today’s Internet-driven world.
The rapid development of Internet-based services and the meteoric rise of smartphones has enabled the creation of a new type of payment solutions centred around virtual pay. And while online services such as e-commerce, digital distribution and streaming has been reliant on online payments for a while now, virtual pay has over the past few years, has been expanding its reach to physical vendors, as well.
With the help of near-field communication (NFC) technology and cloud computing, many companies have been able to develop mobile payment solutions that allow users to use their mobile devices to pay for goods and services at stores, restaurants and other establishments. Leading handset makers such as Apple and Samsung have made their proprietary payment systems an integral part of their respective smartphone and smartwatch offerings. Meanwhile, Google has developed its own payment system for Android devices.
Then there are mobile services, such as WeChat Pay and Alipay in China, which offer similar options to its users, while Japan’s mobile messaging company Line also has a mobile payment business. In the West, social media giant Facebook has been exploring mobile payments through its messaging services Messenger and WhatsApp, while Square, the other company of Twitter co-founder Jack Dorsey, has built its entire business around mobile payments.
So where do cryptocurrencies fit in all of this? Well, while the aforementioned services eliminate the need for physical credit or debit cards for everyday transactions, they typically rely on the digital representations of those cards. This is why they need to work with credit and debit card providers such as Visa and MasterCard.
Cryptocurrencies, in contrast, don’t bother such things. All you need to make a Bitcoin payment is a crypto wallet, some Bitcoin in it and the recipient’s crypto wallet address. By design, cryptocurrencies are the biggest threat to credit card companies.
At the moment, there are a number of issues that prevent cryptocurrencies from becoming a mainstream medium of exchange and a major player in virtual pay. Crypto critics often point to their price volatility, scalability problems and the lack of adoption among merchants and businesses. While all those present valid concerns, it is worth noting that these concerns are actively being addressed by developers.
Scalability has in recent years become the main focus of the Bitcoin community, with developers exploring different ways to scale the Bitcoin network to increase its transaction capacity. This sparked a heated debate that culminated in August 2017, when a subset of the Bitcoin community, which wanted to solve the problem by increasing block sizes, initiated a hard fork that led to the creation of the Bitcoin Cash (BCH) cryptocurrency. Meanwhile, work on the legacy Bitcoin network has been centred around the Segregated Witness soft fork, which has enabled the creation of ‘second layer’ scalability solutions for the Bitcoin protocol.
The most prominent of those solutions is the Lightning Network, a Layer 2 payment protocol that enables the creation of bi-directional payment channels between two parties, for example, a merchant and a customer. A payment channel can facilitate numerous transactions between the parties, without the need for these transactions to be recorded on the blockchain. Last month, Lightning Labs, one of the teams developing the LN protocol, released a ‘Loop Out’ feature aimed at improving the usability of the network.
The Lightning Network has also been implemented by other cryptocurrency protocols such as Litecoin (LTC) and Stellar Lumens (XLM). Meanwhile, other blockchain protocols are working on similar technologies. For example, Ethereum, the second most popular blockchain network, is developing its own off-chain payment solution called the Raiden Network, which enables near instant transactions and works with ERC20 compatible tokens, as well as Ether.
A common criticism doubters level at cryptocurrencies are that they are not backed by a central authority like a central bank or a government. But the whole point of public blockchains like Bitcoin is that they do not need such backing to operate. The governing mechanism are their consensus algorithms, which allow these networks to be decentralised and trustless by nature.
These are not just buzzwords, but a key part of blockchain’s core proposition. A good example of how decentralisation can lead to more secure transactions is the double spending problem, which occurs when the same digital currency is spent twice. In a centralised payment system, solving this problem relies on having a trusted third party to verify transactions. In a decentralised, blockchain-based system, the verification process is handled by the consensus, which reduces the risk of a single bad actor influencing transactions. Some blockchains also employ ‘smart contracts’, which further increase security.
Credit card companies adapt
As the technology behind cryptocurrencies matures, the virtual coins are poised to present greater challenge to credit card companies. However, the biggest companies in the sector are already looking for ways to build presence in the crypto space.
In October Mastercard applied for a patent for a proposed new method of simultaneous crypto and fiat storage. The method involved “managing fractional reserves of blockchain currency”.
“The use of traditional payment networks and payment systems technologies in combination with blockchain currencies may provide consumers and merchants the benefits of the decentralized blockchain while still maintaining security of account information and provide a strong defense against fraud and theft,” Mastercard says in the patent filing.
Meanwhile, the largest US digital currency exchange, Coinbase, last week teamed up with Mastercard rival Visa to launch a debit card that allows users to “spend crypto as effortlessly as the money in their bank”. The Coinbase Card, which supports Bitcoin, Ethereum and Litecoin, can be used by Coinbase users to spent their BTC, LTC and ETH holdings in physical locations around the world. The card converts the cryptocurrency to fiat when the card is used. At the moment, the card is available only in the UK, with Coinbase planning to have launches in other European countries in the coming months.