Growing Pains of Online Payments

The total transaction volume of the global digital payments market is projected to reach $17.72 trillion in 2024, and grow at a compound annual growth rate (CAGR) of 15.71% from 2024 to 2029. This growth is attributed to rising consumer transactions, mobile payments, and cross-border money transfers. (Statista)

While value transfer is rapidly digitizing, the underlying representation of value online remains a complicated mess. The world of online payments and digital banking is littered with fragmented account states, and more importantly, bloated bureaucracy leading to a reality of long transaction delays and high costs.

Let's break down the steps of a simple online purchase:

1. Customer enters their payment information. (Card number, name on card, billing address, expiry date, security number on back of card, etc…)

2. Payment gateway transmits data to payment processor.

3. Payment processor receives information and verifies if payment is valid.

4. Payment processor sends authorization request to issuing bank.

5. Issuing bank approves or declines transaction.

6. Payment approval notification sent to e-commerce platform from payment gateway.

7. Settlement of funds between purchaser bank and seller’s. This process often takes a few business days.

Furthermore, merchants often receive a periodic lump sum of all payments made to their store (weekly or monthly). This is done to save on transaction fees, because transferring the money from every purchase to the bank account of the merchant would be too costly. The inefficiencies of our existing banking systems are just as prevalent in the investment world, leading to not only increased costs, but limiting accessibility to in-demand investments due to logistical limitations.

With the ever-growing demand of digital transactions, legacy financial rails are struggling to keep up. The transition to an online economy has created a pressing demand for value to be effectively represented in digital form; enter tokenization. Tokenization ushers in a new era of asset ownership, one where value will not only be transmitted online, but exist online as well. What this means is that value will begin to start being represented on the same networks that it is being transferred on. Throughout most of human history, value was represented in physical form (ex. gold coins) and was physically exchanged between parties. Since the invention of computers, and more importantly the internet, we’ve been transmitting value across virtual networks, but what we are transferring is not natively virtual. The reason being that there has not been a reliable and secure way for networks to store and settle value across different parties without relying on intermediaries, until blockchains were introduced.

The same transaction outlined earlier would be much more simplified with stablecoins. Stablecoins are tokens designed to maintain a stable value relative to a specific asset, such as a currency like the US dollar. The method of how stablecoins keep their value pegged to a dollar can vary, but some of the most popular ones are directly backed by US dollars in a bank account. An e-commerce payment as the one above using stablecoins would look like the following:

1. A user who has stablecoins in their wallet connects to the merchant’s website (using a browser extension on desktop or app on mobile).

2. At checkout, a transaction is prompted in the user’s wallet to send the money to the merchant, and the user signs.

3. The signed transaction gets sent to the blockchain for confirmation and gets picked up by a validator.

4. Less than one second and less than one cent in transaction fees later, the money is settled in the merchant’s wallet.

That’s it.

If digitizing our currency leads to such efficiencies, imagine the possibilities with the tokenization of all of our financial markets, and beyond.

Early Days of Adoption

Actors in different industries will need to adopt the technologies themselves, as they are best equipped to tackle their own needs. A clothing store invests resources into launching their own online website to sell to their audience. They spend money marketing to their audience, and are best equipped to determine which products they must sell to meet demand for clothing. There are service providers such as Shopify and Amazon to provide a platform for these retailers to onboard themselves easier to e-commerce, but the decision to offer online sales and management of the online store ultimately falls on the store. As we have seen since the emergence of e-commerce, many of the early adopters have capitalized on this new opportunity and found much success, and late adopters scurried to catch up and paid the price.

I believe that the same will be true for tokenization. As with any new technology, there are some actors who are too early to market, and their experience paves the way for the successful first movers. Some of these too-early-adopters are able to adapt fast enough (or sufficiently capitalized) to survive the tumultuous discovery period to adopt the agreed upon standard that reaches product market fit.

Current Situation

Despite the long road to widespread use, several companies already have a horse in the tokenization race.

In the payments space, industry giant Stripe acquired stablecoin platform Bridge to advance the enablement of stablecoin payments. This acquisition is Stripe’s bid to lead stablecoin-enabled purchases through easy integration and seamless on/off-ramping from blockchain rails to banking. Their intention seems to be to blur the line between on and off-chain transactions, while providing the benefits of crypto network payments.

In the investment world, Blackrock had one of the first successful launches of a tokenized fund with their BUIDL fund announced Q1 2024 (currently over $520 million in AUM). Other competitors have since launched money market funds as well, like Franklin Templeton’s BENJI. These tokenized funds have already found great adoption in the wider ecosystem of decentralized finance (DeFi). These tokenized funds are being used to back stablecoins and being used as collateral for on-chain loans. You do not need to look further than Ondo Finance to see the successful adoption of these tokenized funds.

Governments have been experimenting with blockchain tech as well, many looking to convert their dollar to being natively digital. These projects go by the name Central Bank Digital Currencies (CBDC). A great website to track the status of CBDCs worldwide can be found here. Governments have not stopped at CBDCs however, one other major field of adoption has been digital IDs. Estonia has been a leader in the adoption of new technology throughout the years, and they maintain that status when it comes to blockchain. They’ve recently started issuing digital e-Residencies to entrepreneurs around the world to remotely launch companies out of Estonia. The success of this program highlights the need for governments to embrace the digitization of different aspects of society.

Tokenizing Financial Markets

To understand the current state of financial markets digitization, consider the parallel between securities trading and restaurant menus online. Today's digital securities trading is analogous to restaurants simply scanning and uploading their menus to their websites, while the information is available digitally, the interaction remains limited. Some restaurants, particularly pizzerias, offered delivery services before the internet, just as traditional financial institutions have long facilitated the buying, selling, and transferring of securities. However, the true transformation came when delivery service apps not only enhanced the existing experience, but dramatically expanded access, enabling new business models like ghost kitchens that operate solely through delivery platforms.

Currently, we can execute securities transactions online, but we have barely scratched the surface of what's possible with tokenization's programmability. Many struggle to envision the end state of programmable securities because no direct equivalent exists today, leading them to question the necessity of moving beyond the current paradigm of online trading. This perspective, however, overlooks the transformative potential of programmable assets.

The programmability of tokenized assets introduces a new dimension to financial markets, enabling the development of various applications as we've witnessed in DeFi. This transformation extends beyond merely improving existing securities trading, it opens the door to the financialization of assets and liabilities that were previously difficult or impossible to capture efficiently. Just as delivery apps revolutionized the restaurant industry, tokenization can facilitate the emergence of specialized applications catering to niche markets, driving innovation in financial products at an unprecedented pace.

Perhaps most significantly, the ability to seamlessly enter and exit positions through stablecoins, and subsequently deploy those stablecoins for other purposes, will accelerate the velocity of money to levels previously unimaginable. This increased fluidity and programmability will create new opportunities for financial innovation. The ease of interaction and reduced friction in transactions will likely lead to the emergence of novel financial products and services that we cannot yet envision, just as few could have predicted the rise of ghost kitchens before the advent of delivery apps.

Future Possibilities

Building on the transformative potential we've seen in financial markets, tokenization's applications extend far beyond traditional assets. The technology is already revolutionizing the collectibles market, where physical items can be represented digitally while maintaining their uniqueness and provenance. Platforms like Courtyard demonstrate how tokenization can reshape collectible markets by enabling collectors to buy and sell collectibles without needing to ship the item at every transaction.

The future of sports fan engagement is evolving beyond traditional selling tickets and merchandise into more meaningful team participation. FC Barcelona's fan tokens demonstrate how digital engagement can transform the relationship between teams and supporters, giving token holders the ability to vote on various club decisions like dressing room designs and goal celebration music. This example shows how tokenization can transform passive fans into active participants in their favorite club's journey, creating new ways for supporters to feel connected to and involved with their team. This model could extend to various creative industries, enabling direct patron-to-creator relationships and novel forms of collaborative ownership.

Beyond finance and collectibles, tokenization could streamline supply chain management by creating immutable records of goods, revolutionize real estate by enabling fractional ownership of properties, and transform education through verifiable digital credentials. The technology could even facilitate more efficient resource allocation in public services, from managing carbon credits to coordinating shared infrastructure.

As with the early days of the internet, we are likely only seeing a fraction of tokenization's potential applications – the true innovation will come from entrepreneurs and communities finding novel ways to represent and transfer value in our increasingly digital world.

If you’re curious in exploring the growing world of tokenization and stablecoin payments, check out the following links:

Daimo is building an easy to use wallet and payments platform for stablecoin payments.

ERC-3643 - A rapidly growing standard for compliant tokenization of regulated assets.