Why Visa and MasterCard will continue to reign supreme in an increasingly digital world
Below, I discuss what Visa actually does as well as the main controversy and further outline the playbook for disruption. Disclosure: this is not investment advice, just thoughts. I will be disappointed if their is not a typo. As always, I’m a taker of different views.
The last 12 months of being in and out of national lockdown really has felt like Groundhog Day. I wake up at the same time every morning; proceed to roast my morning coffee at the exact same time (admittingly, I do change up the flavour of the beans); head over to my home office and attempt to login into my Bloomberg by gently swiping my finger on the scanner of the keyboard. I am then usually presented with “not valid”. Swipe again. I’m in. Miraculously, it doesn’t take me three attempts on good mornings. I then quizzically eyeball my screen and start mumbling under my breath.. “Visa and MasterCard are mispriced. Visa and MasterCard are mispriced” I repeat this throughout the day.
This daily sequence of events has triggered me to again question my long held positive view about Visa and MasterCard (collectively “the Networks”). When you find yourself confused in the marketplace for common stocks, it is imperative to try understand what the market knows that you don’t. For the Networks, this means understanding and refreshing the core controversies and fleshing out the playbook for what disruption looks like. In doing so though, it is crucially important to separate signal vs noise. The longer the Networks underperform, the nearer their perceived demise becomes.. at least to a certain cohort of investors. Nothing drives narrative more than a little out/underperformance. There has been some discussion about disruption<>Networks (here) and I have a tweeted on a number of occasions (here, here, here) seeking answers and clues to how I am wrong. From some of the back and forth, I have become increasingly convinced investors have either forgotten or remain unaware of who and what the Networks are and how they came to be arguably the most competitively advantaged businesses globally.
What is Visa?
Before identifying and exhausting the bear thesis and concurrent playbook for disruption, I want to first attempt to explain what Visa (I will mainly reference Visa’s business in this section for simplicity reasons. I share similar sentiments for MasterCard) actually is. Visa is probably the most recognisable logo globally but is often wrongly characterised in the press as a credit card company and/or financial institution. Visa is not a bank. Visa does not issue credit/debit cards (despite the logo on your card). Visa does not take on any balance sheet risk. Rather, Visa is a digital infrastructure and technology business. Visa’s propriety VisaNet network serves as both the heart and gatekeeper of global commerce where $0.15c/$0.43c out of every $1 spent in the offline/online world flows through their rails. You can think of Visa as a toll road on the exchange of money between consumers and merchants.
History
It is important to understand where Visa has come from to try underwrite where they are going. The credit and debit card industry that we know today was born out of an awkward dinner date experience back in 1950. Frank McNamara launched the first multipurpose charge card in 1951 and by 1959, Diners Club had 1m members around the world. Not to be outdone, Bank of America launched their own credit card and pioneered the revolving credit model. The now famous, “Fresno Drop” in September 1958, would go on to fundamentally change and benefit billions of consumers, yet to be created payment providers, banks and merchants around the world. 60k Fresno residents got a weird looking plastic card in the mail with a “BankAmericard” logo written on the front of it. This card had $500 credited on it and were told to go buy whatever they wanted and pay it back at a certain date. What kind of sorcery is this some must of thought!
As more and more people utilised their cards however, two major problems and complexities became apparent. Physically authorising and facilitating transactions — before the PC age — between different merchants and customers who all had different bank accounts became a painfully laborious, and eventually, an impossible task. The early years of BankAmericard were a total disaster plagued by significant losses and distrust. The below is taken from @MineSafety’s excellent piece on Visa which remains one of the better notes I have read to better understand the utility of Visa.
The whole process was excruciatingly inefficient. Heaven forbid, imagine waiting 10 or 20.. or even 30 minutes to buy something vs. today where it is so efficient you don’t even notice it. It just happens with a tap of your phone or card.. or face.
Bank of America eventually solved these issues by first spinning out BankAmericard into a standalone entity in 1970 called National BankAmericard Inc. or NBI. NBI was owned by a consortium of member banks (similar to its smaller competitor called Master Charge, now MasterCard) where Dee Hock would become CEO. Under Hock’s leadership, NBI removed the aforementioned friction by systemising the authorisation and interchange processes by building out the necessary digital infrastructure. This interoperability has allowed the wheels of global GDP to spin faster and faster. NBI was later renamed “Visa” as in a visa to “be everywhere you want to be.”
In more recent times, Visa restructured (merging Visa Canada, Visa International and Visa US into one standalone with Visa Europe remaining separate) and eventually went public in March 2008 at $44/share and raising $19bn in process — the largest IPO in US history at the time. Visa has generated a roughly 22% IRR since then and sports a market capitalisation of $453bn. In hindsight, the member banks cashing out at the IPO was mistake. So much so that Ken Chenault, former Amex CEO, recently noting “[to spinoff the card networks was] one of the biggest strategic blunders of the last 20 years. They gave it up on the cheap, and now the roles are totally reversed.”
Network Supremacy
VisaNet is the original network in the “network effect” phenomenon. Each day that has passed since 1958, Visa’s network continues to grow. This in turn makes it harder and harder to displace which is an important consideration when thinking about what disruption looks like (discussed later). Today, Visa connects 3.5bn card credentials (consumers) and 13k issuers (your bank) on one side and 70m+ merchants and 3k acquires (merchant’s bank who process the transaction) on the other. The scale and ubiquity of their two sided network is unparalleled around the world (ex-China) and allows them tremendous power with each participant in the four party ecosystem.
The beauty of VisaNet is that everyone benefits. Consumers benefit from the security and trust of the network and aforementioned interoperability, rewards and acceptance (we don’t fully appreciate the magic of being able to swipe our Visa issued card practically anywhere in the world). Merchants benefit from a lower acceptance cost (vs cash, h/t @BlueToothDDS) and ability for customers to transact alongside the reliance and security of the network. Another way to think about it is that merchants don’t have a choice but to accept and partner with Visa (consumers drive merchant acceptance). Payment providers benefit from an instant passport to scale which is table stakes in global payments. When Checkout.com was granted principal membership to Visa and MasterCard in 2013, Guillaume Pousaz (CEO) commented, “these are life-defining steps of the company”. He wasn’t lying. Lastly, issuing banks benefit from participating in the interchange fee (which the Networks set) stream that forms the lion share of the economics of any transaction. The interchange fee is an ad valorem “tax” to cover the operating costs to ensure the transaction flow is secure between you and the merchant. This also helps acquire and retain customers. You know those perks and rewards you get from spending? Interchange help finances that.
What is less spoken about is that Visa is a de facto multi data centre operator with private telco networks that cover more than 10m miles or enough to circle the earth 400 times. This level of compute power allows them to process $9tn+ in total payments volume (TPV) p.a. or 10% of global GDP; 140bn transactions in 160 currencies and capacity for 65k transactions per second- all the while running at zero downtime (99.999% availability) and with fraud rates of less than $0.06 per every $100 spent. A fun side note: Visa take security and secrecy quite seriously. One of their US data centres is guarded by ex-military personnel and roads that are equipped with hydraulic bollards whereby any intruding car wouldn’t be able to “navigate a hairpin turn, sending it into a drainage pond that functions as a modern-day moat.” So, Visa has a literal moat which is just metaphorically perfect.
Economics
Being a tax on commerce is not a terrible business to be in. Firstly, personal consumption expenditure (PCE) growth in the US has annualised at 6.4% since Visa was created and has only been down QoQ on a handful of occasions. There are no signs of PCE growth slowing and it serves as the anchor of their volume growth algorithm. The second secularly growing component is the shift from cash to card that adds another +4–5% to TPV growth p.a. Moreover, Visa has an embedded inflation hedge insofar as the higher the cost of your coffee, the more $ margin they receive. This may — or may not — be an important advantage in the next 12 months. Visa also has latent pricing power in their processing (flat fee per transaction) component — again, not a terrible business.
If you care about accounting and the like, Visa has one of the prettiest income and cashflow statements you will ever come across. Incremental operating margins of >80%, low single digit capital intensity which equates to FCF margins of 54% (22% higher than the S&P 500’s gross margin).
Key controversy
Cross border weakness has been the key controversy amongst investors and reason #1 not to own. Since the pre-Covid high on February 19th 20', Visa is flat or positive to the tune of 19 basis points (total return). This compares to the S&P 500’s 15% gain over the same period. One might point out that this makes logical sense. Admittedly, the global travel restrictions and subsequent border closures brought on by the pandemic has been particularly acute for the Networks. Cross-border volumes account for roughly 20% of the Network’s revenue but importantly with significantly higher yields/fees attached to said volumes (vs domestic assessments) to account for increased complexity (merchant and customer bank in different countries) and higher rates of fraud. The Networks’ reliance on cross border is now well understood by the market. Despite the obvious short term impact to the income statement, I find this delta in performance, well, kind of confusing. Why? Travel and Entertainment businesses squarely in the Covid penalty box like Live Nation (zero revenue from Q2-Q4 20’) and Expedia (revs -57% in 20’) are +17% and 32%, respectively, from their pre-Covid highs. Since the first positive vaccine readout back in early November, Live Nation is +38%, Expedia+25% and Visa is again flat (+17 basis points). Meaning, the market has clearly been happy to look through 20’ and 21’ softness with investors modelling and attempting to approximate value from a more normalised 22’ onwards basis. This makes intuitive sense. Public securities are trying to price a future long term state. So what about the Networks? I don’t think there is a lot of controversy in suggesting that consumer travel and cross border volumes will eventually start to recover sometime later this year or early next.
Structural behavioural changes emanating from this crisis will largely stick where there has been added convenience to the consumer and enterprise (for e.g.: buying groceries online). Not being able travel is not only inconvenient but antithetical to modern day life as we know it. We will all travel again. People are so desperate to travel again that they are booking flights to nowhere (what now?). Presumably to have that sweet feeling of being on an airplane sitting next to a crying infant. In September last year, Qantas noted that their seven hour flight of “sightseeing to nowhere” sold out in 10 minutes- the fastest selling flight in their history. Further, GS recently pointed out that they expect US consumers to accumulate $2.4tn (11% of GDP) in forced savings by June this year. Where will a lot of this money flow to? Probably travel. We do have some early signs that this will indeed play out. Visa noted that the US<>Mexico & Turkey corridors which reopened mid last year saw a 30–40% increase in cross border spending in the matter of weeks.
Cross border aside, the Networks core business is thriving and will exit this pandemic net beneficiaries where long term FCF estimates have increased. This crisis is displacing their largest competitor, Cash Inc., in real time (US debit volume growth of >20%) through higher e-commerce and contactless/NFC adoption. New payment flows (B2B, G2C, C2C) which are >4x core C2B volumes have transformed from buzzwords pre-Covid to partnership wins a year later and serve as the next growth leg looking out 5–10 years. These previously hard to address payment flows are increasingly being attacked as network infrastructure and layers of applications that sit atop are being built out. According to FIS, 29% (tens of USD trillions) of all B2B transactions are still cheque. This is sacrilege in a digital world.
How is Visa disrupted?
Technological advancements and ever changing consumer behaviour mean “disruption” — or threat of — is at the top of every list of risks to a business’s relevance within an industry. Capitalism is a brutal model that spits out inferiority. But what does it mean to “disrupt”? Disruption = longstanding problems yet to be solved and/or a high degree of friction and consumer and enterprise inconvenience. Technology then paves the way for the problems to be addressed. The over earning and sleepy incumbents are unable to fathom — or do anything about — what is happening around them and they slowly then suddenly become obsolete (radio DJs, linear TV distribution, travel agents etc. etc.).
So what about Visa and where they sit in the C2B flow of money ecosystem? *Everyone* has tried to take aim at Visa and failed. The reality is that debit and credit payments just work (and very well) lessening the probability of disruption. Visa’s brand, scale, trust, ubiquity and interoperability also acts as a defensibility mechanism that is *very* hard to replicate. Competitors would need to overcome one of the most significant chicken or egg causality dilemmas. In plain English, customers would not sign up to a new card credential/network if merchants don’t accept it. Merchants won’t accept it if said network is not at critical mass with consumers. I cannot overstate how powerful this is especially when Visa’s virtuous cycle has been spinning faster and faster every subsequent day for the last 60+ years.
Threat from Fintech, Closed loop networks/wallets & Big Tech
Much has been spoken about how emerging closed loop competitors will render the Networks irrelevant and result in both to become the “dumb pipes” of modern commerce. Many point to the success of WeChat and AliPay and their dominance in China and SEA where card networks, issuing banks and acquirers are simply not part of the transaction. Frightening! There are however some important differences to the developed market (DM) payments ecosystem. Firstly, Chinese financial service infrastructure is less developed. Bank card penetration was roughly 35% (vs. DM penetration of >94%) when Alipay first received their payment license. Bank card penetration has since plateaued just above 50%. With such high bank penetration in DM, it would be incredibly hard — and lengthy — to incentive consumers to switch to a closed loop digital wallet and upend the entire industry. Second, Chinese citizen’s first introduction to a digital life was not a laptop. It was a mobile phone. The convenience of the QR code enabled transaction experience resulted in adoption to skyrocket. This rapid adoption was abetted by zero competition and lax regulatory oversight (until recently, of course).
In the US and Europe, there is still roughly $7.5tn worth of cash and cheque (which surprisingly grew 4% p.a. from CY 12’-18’) in the system today and accounts for 55% of all transactions <$10. Meaning, Cash, Inc. is still by and large Visa’s largest competitor. The contactless/QR code debate is an interesting one; however, adoption in the former continues to ramp. Visa recently told the market that almost 2/3rds of all face to face transactions ex-US are now contactless. In the US, 300m NFC enabled cards have been issued and almost all of the largest merchants are now equipped to accept contactless. The US playing catch up to the ROW is one of the more interesting stories in payments today.
What have we learnt over the past 24 months regarding the perceived threat from fintech’s to the Networks?
Past foes are now friends. It turns out they didn’t really have a choice. Paytm, Line Pay, Gojek, Rappi, Toss et al were all previously closed to Visa and touted their disruptive potential. They then quickly found out that in order to scale internationally they couldn’t do it alone and needed to join the Visa club. Even Tencent/WeChat partnered with Visa last year to further their cross border capabilities which was the first time Tencent co-branded with an international payments network.
Closed loop networks having to open up to Visa is very instructive in understanding their dominant power within the ecosystem (Polen’s “moat attack” framework), and by extension, value proposition i.e.: you can try fight Visa and lose or give up and partner and reap the rewards of being in the club. Visa continues to stress how they don’t pick winners and losers. Rather, they enable emerging players to access their rails to scale through partnerships (they mentioned “partner” 64x in their most recent annual report). This step change of competitors opening up is naturally great news for Visa and further entrenches their rails in the global movement of money. Closed loop networks issuing Visa cards opens up their acceptance network to add 1bn+ new Visa cards (vs 3.4bn today) and 70m+ more merchants (vs 70m today). US Big Tech tried payments but in similar fashion quickly realised they had to partner with Visa.
What about the in vogue Buy Now Pay Later (BNPL) schemes and perceived threat? AfterPay, Affirm and Klarna are processing billions worth of volume. BNPL players are still basis points of what the Networks process (Visa quote total volume in trillions & not billions). It is true that Visa doesn’t participate in the initial BNPL transaction and thus is perceived to be a share taker. But how do customers repay their balances over multiple fee generating transactions? You can’t repay it in cash. The balance is therefore repaid with a customer’s credit or debit card issued by…. Visa. Meaning, Visa does in fact participate in BNPL growth and economics. Visa has also partnered with BNPL standalone players and will likely continue to do so in the coming years.
Plaid and that volcano
The DOJ’s successful suit and compliant against Visa regarding the Plaid acquisition is an interesting read and presents evidence (illustrated via an island volcano graphic among other anecdotes) that the acquisition was on grounds to protect their dominance in debit and not for financial reasons. The compliant goes on to suggest that Plaid through its network of 11k FIs and 200m consumers would mount a serious threat to Visa’s monopoly in US debit with a pay-by-bank service using Automated Clearing House (ACH) rails. ACH is an alternative network to VisaNet and is less expensive. Two important points to note 1. Plaid had yet to develop their competing debit service and 2. ACH is less expensive for a laundry list of good reasons. From the DOJ complaint. “A basic ACH transfer is not reasonably interchangeable for most online debit transactions. ACH transfers are inconvenient for consumers because they require a burdensome onboarding process in which the consumer must enter her bank account and routing information for each merchant, and then take steps to verify her account, which requires additional input and can take several hours or even days. ACH transfers are inconvenient for merchants because it takes two to three days to determine whether a payment is successful, and such transfers are more subject to fraud.
In short, it would not mount a challenge using ACH. Post the termination agreement, Visa will keep their stake in Plaid from the prior Series C round ($2.65bn valuation) and could still partner with them (and others) in the future. Plaid is rumoured to raise new money at a $15bn mark (almost 6X on Visa’s stake in < 3 years) which helps soften the termination disappointment. Important to flag that various countries are embarking on modernising their antiquated infrastructure to create more efficient rails and to better compete with the Networks. This will take time (government moves slowly) and have chosen to partner with the Networks (more on this below) in some instances in the past. This remains a long term/headline risk but not a tangible risk through a 3–5 year lens.
Defensibility against Disruptors
Visa has a front row seat to any innovation in the payments industry. Visa’s Fintech FastTrack Program is their trojan horse to shield against any disintermediation. The way this program works is that Visa will host various competitions whereby several hundred (literally) fintech’s submit ideas for a grand prize to partner with Visa. Through this process a few get selected and then receive an investment and/or are partnered with (Visa invested in Square in 2011 at a pre $ valuation of $213m before increasing their stake to 9.99% in 2016). As a result, Visa get a window into what would be competitors are working on and can react accordingly. Emerging fintech’s with a good/interesting idea benefit because they can solve the problem of scale and scope — a good idea in payments is just that without scale. By Visa opening up VisaNet through 600 API endpoints, Visa recently noted they received 1bn API calls per month! This has allowed them to have a win rate of 70% in global fintech deals.
Nationalism
There has been growing concerns over the years about local governments and policy makers launching alternative domestic schemes to challenge the dominance of the Networks. The European Payments Initiative (EPI) is the latest attempt by the ECB and EC to build a European payments champion backed by 16 large European banks (DB, ING, BNP etc.). Europe has long tried to defeat the Networks but without much success. Again, hard to “fix” something that works well underpinned by strong invectives across the ecosystem. There are already numerous local payment networks in Europe. The predominant issue however is interoperability (a German can’t swipe his or her card in Holland with a domestic scheme) which is a nonstarter to scale. Monnet, which was backed by 24 European banks, collapsed without getting started due the member banks’ reluctance to spend an enormous amount of capital (billions) into a project which would have been negative ROIC. The overriding interpretation here being it was a political project and not an economic project. The EC did indeed cap interchange fees in Europe which actually ended up benefiting the Networks. How? Interchange is a revenue stream for the issuing banks and not the Networks. Capping interchange made accepting card payments cheaper resulting in more merchants opening up to the Networks i.e.: regulation helped drive acceptance (more volume on their rails) in the region. Last year, the ECB increased the contactless limits (due to Covid) across the region which resulted in helping displace more cash in the region (are the regulators friends?). There are various other cases of nationalist intent in both EM and DM which is something to closely monitor as it is worrisome long term but again, it doesn’t seem like a tangible risk looking through a 3–5 year lens.
Bitcoin & Cryptocurrencies
Gosh.. where do I begin? I was reluctant to offer a view on Bitcoin and crypto so as to not insult anyone reading this. Let me begin by just saying I have never owned any crypto assets nor intend to anytime soon (I am clearly opposed to making $). It is however one of the more polarising debates I have ever seen. You are either a maximalist and think it is worth something — say $1m — or a minimalist and think it is worth nothing. Say, precisely $0. What I find fascinating is that there are people who I have deep respect for on both sides of the Bitcoin debate. There doesn’t seem to be a middle ground which means higher vol and lower Sharpe ratios.
The payments industry is undergoing a tremendous amount of change with billions of capital being injected into the start up and late stage scene every year. Allocating capital to public payment businesses means you have to have a flexible and open mind. I do subscribe to the view that anytime there is so much hype and concurrent financial asset bubble, that usually means there is something there and built upon some semblance of truth. Roy Amara, past president of the Institute for the Future, and his eponymous law stated that “we tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.” Amara’s Law is very relevant to payments and seems inevitable that the movement of money will continue to be digitalised. How economies and governments will go about crossing this bridge is clearly important for investors to grasp. History does suggest however, that the first iteration of hype doesn’t necessarily always get widely adopted. Archie Query Form, Yahoo! Search, LookSmart, Excite preceded BackRub/Google Search in 98’. A similar dynamic played out in mobile phones. Investors and institutions clearly think Bitcoin will be the Google Search of crypto and digital currencies but only time will tell.
What is Bitcoin?
Questioning what problems will be solved (and drive change in payments) in the next 5–10 years is a good place to start. Questioning what won’t change in 5–10 years is a better place to start. Before tackling this question, I need to first answer this seemingly simple question: what on earth is Bitcoin? A new asset class, new digital currency, anti-establishment vehicle, religion..? Let’s start with the notion that Bitcoin is a new form of currency and payment solution. Satoshi Nakamoto’s whitepaper in 2008 did indeed state that Bitcoin will be “a purely peer-to-peer version of electronic cash [and] would allow online payments to be sent directly from one party to another without going through a financial institution.” This sounds like Satoshi is talking about a new form of money.
But what are the functions of money? Money is 1) a store of value (SoV) to transfer purchasing power to the future 2) a medium of exchange (MoV) to buy stuff and 3) a unit of account (UoA) to measure what stuff is worth. Bitcoin’s success (higher price), scarcity value (21m max supply) and volatility (realised vol of 120%+) all make it an unlikely mechanism for transacting or at least adopted to a point that will challenge the current payment competitive structures. Bitcoin cannot fulfil the MoV or UoA properties of money. Spending Bitcoin does not make logical sense. Why would someone want to spend something that has built in deflationary (system was designed to reward early adopters) properties vs. spending inflationary fiat currencies. Bitcoin maximalists are also generally part of the #neversell camp, or more to the point, #neveruse. I.e.: a security with an investor base of HODL’ers ≠ payment utility.
Let’s bring this to life with some examples. A certain individual with an apparent affinity for SPACs purchased a Lake Tahoe property for $1.6m in 2014. The interesting point is that he paid for the house in Bitcoin and for a total amount of 2,739 Bitcoins. Using today’s price of roughly $46k, he paid $126m for the property. Not an insignificant difference. Another fun example is Bitcoin Pizza Day. On May 22nd 2010, an individual by the name of Lazlo Hanyecz became hungry and longed for two pizzas. Instead of wasting his real money, he thought it would be a smart idea to offer 10k Bitcoins for two delivered Papa John’s pizzas. No one took the bait. This was until a Brit took him up on his offer and paid $25 for two Pizzas and in turn received 10k Bitcoins. Lazlo was no longer hungry and still had an extra $25 to his name. Great deal he must of thought to himself while getting stuck into the second pizza. Fast forward to today and 10k Bitcoins is now worth… more than $25. These are extreme examples but the main point remains: Gresham’s Law is real.
There are various other important limiting factors that make Bitcoin an unlikely mechanism for low value high frequency transactions at scale. Transacting in Bitcoin is grossly inefficient and expensive (currently USD $22.32 average transaction fee). The limit for Bitcoin is 1mb meaning the capacity to process is currently 7–10 transactions per second (vs Visa’s 65k per second capacity). Transactions can also take between several minutes and days to get confirmed . The Lightening Network is undoubtedly super interesting and looks to address this scalability issue but has its own set of challenges and teething issues.
A recent Bloomberg opinion piece noted that “One Bitcoin transaction would generate the CO2 equivalent to 706,765 swipes of a Visa credit card, according to Digiconomist’s closely-followed index.”. There has been some debate about the cogency of the article but I continue to challenge the need to expend such a considerable amount of energy to try replicate something that is already incredibly efficient and works very well (consumers have made the choice to use debit and credit networks).
Bitcoin can also just simply be “lost” and there is nothing one can do about it. If a virus corrupts data or a wallet, Bitcoin will forever be lost in the system. If you mistakenly throw away or misplace a hard drive with mined Bitcoin on it, there is nothing you can do about it. Mt. Gox lost $400m of customer’s money after finding a basic flaw in the code. If your entire net worth is in Bitcoin, you could be bankrupted within seconds. Various exchanges have also at times (most recently Binance) suspended withdrawals due to network congestion (liquidity?).
Further, if you buy something in Bitcoin and you would like reverse or dispute the transaction, there is nothing you can do about it. Wait… so will consumers really be willing to give up their credit card rewards for the luxury of not being able to reverse a transaction? This is why there is no free lunch in payments. The associated cost ensures trust and security (through incentives) as well as the ability to dispute (this is entirely different infrastructure that needs to be put in place to support back office). Lastly, the elephant in the room: regulation. There has been various cases of fraud (remember ICOs) and governance issues. The bigger Bitcoin becomes, the more it will need to come inside the public policy envelope. What this looks like remains to be seen but Gary Gensler being named SEC Chairman is nonetheless very interesting.
Visa, MasterCard, Adyen and various other payment companies have shared similar sentiments (not a payment mechanism) to the above. Perhaps they are biased and talking their book. Let’s look at what others have said and done who helped create and develop the industry. Coinbase’s (crypto exchange recently marked at $100bn) pivot in the early days offers some interesting clues. Their initial strategy was to facilitate payments but later moved toward being a brokerage. They discovered that Bitcoin was indeed more an asset class vs. consumer demand for transacting. Back to Satoshi Nakamoto and his famous whitepaper and subsequent blog posts. Here are a few interesting comments to help understand his vision (h/t @danheld):
- “Bitcoins have no dividend or potential future dividend, therefore not like a stock. More like a collectible or commodity.” Link. (2010)
- “It might make sense just to get some in case it catches on. If enough people think the same way, that becomes a self-fulfilling prophecy.” Link. (2009).
- “In this sense, it’s more typical of a precious metal. Instead of the supply changing to keep the value the same, the supply is predetermined and the value changes. As the number of users grows, the value per coin increases”. Link. (2009)
I continue to believe Bitcoin is a store of something. I’m just not entirely sure yet what that something is — perhaps value, speculation or both? Being a store of something means Bitcoin is therefore a new asset class or “digital gold” and not a payment mechanism.. for now (subject to change as always, a good heuristic is not bet against curious engineers). It does make sense that the market cap of Bitcoin has gone parabolic. Limited supply, growing cult following, excess liquidity, and now, new interest from institutions is a cocktail for euphoria. With that said, I don’t exactly see the problem Bitcoin is solving in the payments industry. Even if it was solving a problem, it would need to overcome Visa’s scale and ubiquity with both merchants and consumers. Further, the current incentive structure in all parts of the ecosystem make this challenge even harder to overcome.
Stablecoins
Private (FB’s Diem, JPM’s coin for interbank payments between clients) and public (Central Bank Digital Currencies or CBDCs) stablecoins backed by fiat currency look to solve the aforementioned volatility problem facilitated by new modern centralised (vs decentralised) distributed ledgers and networks. There are currently over 50 CB’s working on digital currencies with the PBOC ostensibly the furthest (interesting implications for Alipay and WeChat). Christine Lagarde of the ECB commented that she wouldn’t be surprised to see a digital Euro within the next 5 years. Using a digital Dollar or Euro to buy stuff transaction free — or a lot less — will compete with cash, networks and potentially upend the entire global payments industry. This has the potential to be undeniably disruptive long term and especially for the Network’s cross border businesses.
What is not clear is what model (through banks or directly through CBs), infrastructure and applications will underpin CBDCs around the world. The implementation of CBDCs will be incredibly complex and multivariate with a high price for any missteps. Governments generally lack the technical wherewithal to build a payments network from scratch and often seek out private partners to assist them in the buildout process. Who has deep payments expertise? The Networks. Who is building out additional rails to facilitate all movement of money and be network agnostic? The Networks. Ongoing public payment innovations and modernised network buildouts such as real time payments (RTP) have in the past sought the help of the Networks. The infrastructure is one thing, the applications that sit atop are another. MasterCard, for example, through its acquisition of Vocalink and Nets, has already partnered with governments and consortiums such as The Clearing House (TCH). This is indicative of how the Networks operate: they end up partnering with would be public and private competition.
Visa is one of crypto’s biggest cheerleaders (huh?)
Visa is already very active in crypto, stablecoins and blockchain initiatives and has made a concerted effort to steer all potentially consequential initiatives into their orbit (it is a classic case of buying insurance protection should it actually become a thing). What progress have they made? Visa recently announced that 35 of the leading digital currency platforms and wallets (Coinbase, Blockfi, Bitpanda etc.) have chosen to partner with Visa and issue Visa credentials. This will allow users to purchase crypto with a Visa card or to cash out onto a Visa card to use at any of their 70m+ merchants. I.e.: the decentralised opens up to the centralised. Last year, they made an investment into Anchorage (crypto custody platform). Just this month, they announced Visa Crypto APIs (built on Anchorage) that will give banks and fintechs the ability to integrate and allow trading of crypto. On the B2B side, their Visa B2B Connect platform utilises blockchain architecture for high value cross border payments between corporates. This initiative is really interesting and disruptive as it will try eat away at SWIFT’s near monopoly who are clearly overearning.
On the public stablecoin front, both the Networks are actively engaging with governments and policy makers around the world to shape the dialogue in helping them understand digital currencies. The World Economic Forum (WEF) have issued a recommendation “CBDC Policy Maker Toolkit”. Who contributed to the paper you may ask? Visa. Their research lab has also written various recommendation whitepapers which call for CBDCs to run on an offline (no internet) payment system protocol underpinned by two tiered trust infrastructure (their rails). I can go on but this is regulatory capture in the wild. My sense is that the path of least resistance (money, time, security , ubiquity, expertise) for policymakers would be to run CBDCs on one of Visa’s networks. This will all but ensure Visa will participate in any future innovation in the global payments landscape.
Payments is already digital
In some closing remarks and thoughts, I would point out the obvious: every facet of the payments industry is already increasingly digital. Paying rent online; buying groceries and clothes online; jumping into an Uber; tapping to pay etc. already is clearly digital and works very well. The Nordics for example are completely cashless economies with digital payments now accounting for 99% of all transactions. C2B aside, new flows like B2B, B2C, G2C, P2P are being addressed. Visa through their acquisition of Earthport have access to 99% of the word’s bank accounts in 88 countries. This has allowed them to develop digital solutions for carded →carded payments(Visa Direct); carded →bank account and bank account (ACH) →bank account (RTP) for both consumers and enterprises. The point here is that the infrastructure is already in place to digitalise payments and displace the roughly $18tn in cash and cheque in the global system today. Are alternative digital currencies and crypto really worth all the effort and hype? Are they solutions looking for problems? These are questions that will be answered in the next 5–10+ years.
My thesis could also be horribly wrong. However, because of merchant and consumer inertia, things do take time to change displacing a scaled network in payments (allowing me time to change my mind). Paper cheques peaked in 1995 and has been in structural decline ever since but people still write billions (with a ‘B’) of them today. For now though, it is clear that the emerging threats of fintech, nationalistic efforts , Bitcoin, Blockchain and Stabelcoins has collectively prompted the Networks to wake up, adapt and improve. My bet is that they will continue to be the global taxman of the movement of money and succeed in their quest of a fourth 10x growth inflection since the 1960s.
