Blockchain Payments, Tokenizaton, and Merchants
Bitcoin, which continues exploding onto the scene, not only introduced the concept of cryptocurrencies to the world, but also to the blockchain, its controlling mechanism. As cryptocurrencies have evolved from a niche product to a market containing $3 trillion, experts and developers have sought other uses for the blockchain and its innate ability to create a trusted, secure record of transactions.
As with many new technologies, efforts to apply blockchain outside its original purpose have been numerous but met with limited success: The idea of tracking real estate transactions, for instance, made all the logical sense in the world but has never actually caught on in real life.
However, the blockchain as a core part of the fundamental global payment ecosystem continues to be a focus.
As a digital ledger, the blockchain can record transactions in a secure and transparent way. It is decentralized, meaning that any single entity does not control it, and it is distributed, meaning that it is spread across a network of computers. This makes it very difficult to tamper with or hack. Each blockchain payment contains an ID as well as the ID of the preceding transaction; those IDs are encrypted (becoming what’s known as a ‘hash’), and it’s their relationship to one another that makes this a ‘chain.’
The promise is that the ledger can never be altered because:
- It is distributed, so someone wanting to alter it would have to break into every copy of the ledger currently in existence.
- The IDs are encrypted when the block is added to the chain, and any change to the block causes a re-encryption and, therefore a different value, which would break the chain to the next transaction in the ledger, thus clearly alerting users to the breach.
How are blockchain payments made today?
Suffice to say that while we can logically separate the concepts of a blockchain and cryptocurrency, payments made using the blockchain today inevitably rely upon cryptocurrency (or, on occasion, non-fungible tokens, or NFTs). That said, the process of one entity sending another entity money through the blockchain is arguably more straightforward than anything we see in the global payments system. Effectively speaking:
- The payer acquires a chunk of a cryptocurrency (either at the time of the transaction or in advance.)
- The payer registers a transfer of the cryptocurrency to the receiver.
- The receiver is now instantly registered as the owner of the payer’s cryptocurrency.
Because the cryptocurrency's ownership is recorded in the blockchain, the transfer of value from one entity to another is, to all intents and purposes, instantaneous and may be executed without paying any fees (depending on whether the users can access the blockchain directly or are required to use an online exchange as a broker.)
Blockchain Payments in a Conventional Payment System
Digital exchanges have, to some degree, solved this problem by wrapping services around the core mechanism of exchanging value via the blockchain. The slightly longer process would look something like:
- Payer’s bank receives a notice to send money to the receiver.
- Payer’s bank buys cryptocurrency for the designated amount, and decrements that amount from the payer’s account.
- Payer’s bank assigns the cryptocurrency through the blockchain to the receiver’s bank, including a message designating the receiver as the individual to receive the value.
- The receiver’s bank sells the cryptocurrency in the market at the prevailing rate, and places the proceeds in the receiver’s account (less any applicable fees.)
There are also a range of blockchain payment networks that can abstract this process (i.e., the payer bank sends money to the network, which converts it into/out of cryptocurrency and delivers the fiat proceeds to the receiver’s bank.)
The challenge here, clearly visible to experienced digital payment hands, is that the benefits of blockchain are reduced when combined with the traditional banking system.
Despite the distributed, low-to-no fee elements of transferring value through a blockchain, once banks are involved at either end of the transaction, not to mention potentially currency exchange and maybe even a crypto exchange, we return to a world of proprietary record keeping and inevitable processing fees.
Using Tokenization to Integrate Blockchain Payments
With a payment system connected to a programmable payment vault, the opportunity to include blockchain transactions becomes more achievable because the payment system can block out the need for payment service providers (PSPs) as middlemen. Logically, the system can:
- Collect the buyer’s blockchain details in a secure form that is stored in the vault, with a secure token passed back for use.
- Use that token to communicate directly with the blockchain to transmit the transaction that the buyer just approved.
- Record, and communicate back to the buyer, the transaction in which the buyer’s crypto has just been transferred to the seller’s blockchain account.
In such a transaction, no third party has touched the process, eliminating the need for anyone to pay a fee. The transaction record has been recorded for posterity on the distributed blockchain. The seller can confirm they have received funds, and they can now safely deliver the product or service to the buyer.
Challenges with blockchain integration into payments
Even when the seller can securely and inexpensively pass payments through the blockchain, there are a few things that both they and the buyers need to consider:
- Subscription payments may be tricky: no buyer should give a seller control over their crypto wallet, so they may need to approve every subsequent transaction actively.
- Returns: The buyer has no protection from a third party in the event they request a refund from the seller. With a credit card transaction, buyers can appeal to the card network to execute a chargeback if the seller rebuffs them, but no such third party exists in a blockchain transaction.
- Exchange rates: while the transaction can be executed effectively, the funds received by the seller are held in crypto, which likely must be converted back to fiat currency to be accounted for in standard accounting environments.
Given the volatility of cryptocurrencies, this may result in the seller receiving a meaningfully larger or smaller return on each sale.
