Banking on crypto: Five questions answered on the future of payments

The payments landscape has undergone some major restructuring in recent years. Traditional financial institutions facing recent payments disruptions must now brace for imminent impacts from cryptocurrencies. They need to decide whether to go head-to-head or hand-in-hand with these emerging, crypto-enabled technology players.

While traditional financial institutions weigh their options and determine if crypto-enabled technologies are friend or foe, new advancements in fintech are already impacting the future of payments – including through mobile wallets and contactless options.

To help get ahead of a few queries, consider the following five questions and answers for FI professionals to consider regarding cryptocurrencies in banking.  

• Do Cryptocurrency and Decentralized Finance (DeFi) pose a threat to traditional finance?

A rapidly growing lending market is occurring without traditional third-party intermediaries like banks and credit unions, and cryptocurrency (a digital asset used as a medium of exchange) is becoming popular with retail and institutional investors, sovereign wealth funds, and even countries. 

Today’s situation can be compared to a race nearly three-fourths complete, yet some participants aren’t even aware that the starter went off. For example, with less than five clicks on a mobile phone, consumers can now transfer money out of a bank and into a crypto wallet, convert those dollars to a stablecoin (a type of crypto), and then lend that out to an over-collateralized lending pool at a 3-4% annual yield. All within a contract that can be canceled at any time. Compare that to the effort required to secure a traditional certificate of deposit that would return — at best — 0.50% APR and having that money locked up for the duration of the term. 

DeFi is directly competing with traditional banking solutions. People actively engage in borrowing, lending, trading, and even insurance activities, all within a peer-to-peer setting. 

Traditional lenders must recognize that they are competing with an industry with no CEOs, offices, marketing, regulations, borders, or limits. It is an industry-supported by a community of tens of thousands of active developers using open-source software solutions – all focused on taking away the “traditional” business. This community has created a $2.3 trillion market in less than 12 years, and DeFi has grown from $700MM to as high as $100B in less than a year. 

• Are there opportunities for leveraging cryptocurrency to drive revenue? 

There absolutely are opportunities for leveraging cryptocurrency to drive revenue. Several concrete examples are provided below that show where the early chances are occurring. Several processors and mobile banking providers are working on cryptocurrency solutions to allow FIs to get into that space.  

• • Custodial services are one way that banks and credit unions can easily transition into the arena. This is holding account holders’ cryptographic keys in the equivalent of a digital safe deposit box. 
  • Cryptocurrency wallets or integration into existing mobile wallets will allow buying, selling, and using of cryptocurrencies. There’s an opportunity to capture trading revenue of up to 250 basis points on that traded crypto. Account-holders are already transferring money away from traditional accounts onto centralized crypto trading platforms, so banks and credit unions should work to take back some of that business. 
  • Cryptocurrency-based debit and credit cards and/or cryptocurrency reward programs are being introduced, as are crypto-based loyalty programs. Some recently launched cards had waiting lists of more than 100,000 customers.
  • Offering interest payments made in Bitcoin on traditional financial instruments could yield considerably more value to clients if cryptocurrency assets continue to appreciate. 
  • Lending against crypto assets can offer a low-risk, high-return opportunity, as these loans are over collateralized against the crypto asset and can be set to liquidate those assets should prices fall too close to the underlying loan value.
  • Cryptography can be used to convert sensitive data into a secure format to store on the blockchain – via “hashing,” the process of transforming any given key or a string of characters into another value.
  • Blockchain/cryptocurrency technology can be used to speed up settlement periods and provide P2P solutions.

• Are contactless payments here to stay?

Contactless payments are here to stay. In most other countries, contactless payments are the norm. Overall usage of contactless payments in the United States has risen 150% since March 2019. Nearly 83% of consumers said they had used contactless cards in the last 12 months, many of whom used contactless cards for the first time during the COVID crisis.

A mid-year survey published in 2020 by the National Retail Federation and Forrester found that 67% of merchants now accept some form of contactless payment, including mobile payments and contactless cards. They are fast, clean, secure, and readily accepted. There’s little downside except for cost. The plastics do cost more, and there’s generally some integration work processors will need to do. Once consumers are accustomed to contactless cards, those cards that are not contactless run the risk of losing any preference with the member.

• Will mobile wallets continue to gain traction, and what might they become?

For the US, in-store mobile payment app usage will hit a milestone in 2021, reaching over 100 million users. This comes after 29% year-over-year (YoY) growth in 2020. According to a study by Jupiter Research, it’s projected that more than half of the world’s population will use mobile wallets by 2025. 

While many are familiar with the “Pays” (Apple, Google, and Samsung), several others are popular in the US, including PayPal, Venmo, and Cash App. Internationally, names like M-Pesa, Vodafone, Alipay, MTN, and WeChat are established providers.  

In 2019, mobile wallets overtook credit cards to become the most widely used payment type globally and the shift to online, driven mainly by the pandemic, has accelerated adoption. Outside of the future predominant payment mechanism, many mobile wallets have added cryptocurrency trading and usage to their functionality. Providers including PayPal, Cash App, and even Apple have started hiring crypto experts, with some market analysts thinking they will enable cryptocurrency as a payment solution.

• Given there are already P2P Fintech solutions like Venmo, does it make sense for a financial institution to implement an in-house P2P solution?  

Traditional banking is vulnerable to disruption from peer-to-peer (P2P) transactions, which have grown rapidly, especially during the pandemic. BCG reports that Square, Zelle, Venmo, and PayPal app downloads rose by more than 50% in April and May 2020, compared with 2019 data. According to Zelle, about eight in ten online US consumers have tried P2P technology. However, nearly half of consumers were not aware their FI offered P2P payments, suggesting that most people use a third-party app for their P2P solutions.

According to BCG, as P2P gains acceptance, by the end of 2021, it is expected that 50% of consumers will actively use it. While Zelle is the most well-known white label P2P solution for FIs, other solution providers like Payrailz and Payveris are emerging as potential solution providers. Given that most people are utilizing a service like PayPal, Venmo, or Square, implementing Zelle or a similar service may or may not make sense. 

Traditional FIs are going to look very different in ten years. Evolving to become more digital and staying up to date with emerging payments technology is now necessary for banks and credit unions to effectively compete and remain relevant. New technology allows the elimination of intermediaries – taxi companies, real estate companies, property management, and even financial institutions. Anywhere sellers and buyers (or lenders and borrowers) are being connected, those industries are now at risk and need to ensure their technology advancements meet the expectations of a changing marketplace.