A Deep Dive Into Payments
Why every tech company will be a FinTech company, and how blockchain networks and stablecoins will aid the development of a global digital payments system.
At CoinShares, one area we’ve been very focused on recently is payments, the different ways that digital assets including cryptocurrencies and stablecoins could play a role in the development of a global, digital payment system, and what platforms and infrastructure will be needed to support this type of activity. We thought it would be interesting to share some of our perspectives, in the below excerpt from an investor newsletter.
May 22 marked the 10th anniversary of Bitcoin Pizza Day, a celebration of the first recorded exchange of bitcoin for goods, when Laszlo paid 10,000 bitcoins for 2 large pizzas.
Historically, payments businesses in this industry have focused on enabling users, like our friend Laszlo above, to spend their bitcoin and to help merchants accept bitcoin and resolve the associated cash management challenges by converting crypto payments into fiat. As investors, we recall the days of the payment service provider (“PSP”) BitNet, which was launched by former Visa executives in 2013, raised $14M, and got acqui-hired in 2015 after a rapid expansion spree and a subsequent lag in adoption as bitcoin prices fell from $1,200 to $200 in the span of six months.
Turns out not many people wanted to spend bitcoin.
Similarly, BitPay, another PSP, also launched around 2013, but their expansion was more measured and they’ve continued to grow, albeit slowly. In 2016, Coinbase also partnered with Shift and Metropolitan Bank to offer a Visa debit card that allowed users to spend bitcoin directly from their Coinbase wallet using the card.
Today, the industry is in a very different place. Not only has the digital payments landscape matured dramatically over the last ten years, but the infrastructure around payments, from hardware to software to regulation, has enabled a whole generation of new payments platforms to emerge and to flourish.
The Private and Public Market for Payments Companies
In recent years, payments firms have been a significant growth area within the FinTech ecosystem, as evidenced by the astronomical growth of payments platforms across various use cases. For example, Shopify Inc’s (“Shopify”) recent doubling of its share price is an indication that online payments and commerce continue to be a massive engine for growth.
According to a recent FT Partners Report, M&A transactions in the Payments space have been red hot over the past few years, and include:
- Global Payments Inc’s $4.5B acquisition of Heartland Payment Systems, a hardware and software PoS manufacturer
- Visa’s $5.3B acquisition of Plaid, a financial services infrastructure API provider
- PayPal’s $4.0B acquisition of Honey, a browser extension that finds discounts for shoppers
These private market transactions have made it clear just how profitable various segments of the payments space are for existing financial institutions, and the opportunity that exists for new financial institutions to be built around various payments verticals.
On the public market side, multiples are soaring to all-time highs despite the broader market malaise. As per the chart below, payments companies are trading at an average of 25x forward earnings and 5–10x forward sales, which highlights the growth potential that investors see in these businesses in a digital-first world where purchasing and the services around it are increasingly moving online.
Payments Companies P/E Multiples, 2020 Estimates
Source: FT Partners Research, Payments Report May 2020. Note: Estimates of 2020 forward earnings is used to calculate P/E multiples.
Shopify is a great example of a business that was built around embedding eCommerce into social media. Shopify is now expanding into card services, email and customer support integrations, money management tools, and much more.
Interestingly, Shopify has also been exploring crypto payments, but we don’t think their approach really moves the needle. In our view, enabling consumers to spend bitcoin is not a growth business.
While using cryptocurrencies for payments could offer a reduction in transaction fees and faster payments, we don’t believe most consumers view bitcoin as a checking account, but rather more like a savings account. Providing crypto die-hards with a way to spend their balances is not going to move the needle for Shopify, however much it might validate the idea that digital assets are going mainstream.
Shopify, Inc ($SHOP) PerformanceSource: Yahoo! Finance, through May 31, 2020
If we look at how the public market is valuing Shopify, it’s wild to imagine that a business with $1.5B in revenues could have a market cap of $100B. Clearly investors see continued growth potential in eCommerce, and not surprisingly, Shopify has joined the group of partners working on Facebook’s Libra project. Shopify is a platform that derives much of its user base from Facebook and Instagram, but has created billions of dollars of value for its shareholders.
Facebook’s Libra project, in many ways, is likely an attempt to reconcile this disconnect. We believe that every platform that “owns” their customer will be looking for ways to derive value from supporting payments services and broader financial services to these customers. In a way, it’s a continuation of our core investment thesis that finance is eating the world. In fact, in Facebook’s Q1 2020 earnings call, CEO Mark Zuckerberg confirmed that Libra really drives revenue for the Facebook business in two key ways — first, by boosting ad buying by enabling direct ad sales on the platform, and second, by boosting on-platform transactions across all Facebook properties, particularly with regard to transferring money between users and enabling people to pay for goods across borders using a stablecoin.
Expanding the Payments Universe — Every Tech Company is a FinTech Company
While historically the payments sector has been conceptualized as companies engaged directly in transaction activity, we believe that with the advent of digital payments technology, and especially digital currencies, every company will eventually become a FinTech company. In our opinion, all companies will begin to derive a significant portion of their revenues from providing financial services, and particularly, payments and transaction services, to their users.
What this means, more practically for us as investors, is that the infrastructure required to enable this transformation will need to be built, and will fundamentally transform the payments ecosystem as we know it.
For years, financial innovation has largely been at the “experience” layer where companies have simply slapped a new, incrementally better user interface onto the same broken, paperwork-intensive, manual-process-driven banking system. In tech-speak, innovation has been on the front-end.
Now, finally, we’re beginning to see more and more firms embracing the idea that for payments and financial services to live up to their true potential in the 21st century, we have to start from the ground up by ripping out legacy systems and building internet-native protocols, networks, and applications around a new set of more flexible, dynamic, open-source technologies. We have to build a new back-end.
According to McKinsey, 85% of payments revenues have historically accrued to the players at the endpoints of the value chain (the figure is 91% for US consumer credit cards), so it makes sense that this front-end is where innovation flourished initially. But as new opportunities emerge further down the stack and as margins on end-points come under attack from free compression, we expect this calculus to change.
Breaking Down Banking as a Service
One of the interesting innovations of cryptocurrencies is the ability for companies — especially startups — to integrate payments quickly and cheaply, without spending a tremendous amount of capital on IT maintenance, licenses, compliance, and hardware. For consumers, that will translate to more choice, better products, and possibly, lower prices. The predominant business model of the internet–monetizing attention through ad sales–will inevitably evolve. For the first time, cryptocurrencies and blockchain-based payment systems provide the ability for payments to occur instantly, with settlement finality, and at a very low cost.
More importantly, the ability to send value to public addresses removes the need to exchange private and personally identifiable information, and the ability to operate outside the bounds of regulatory restrictions.
Most banks are indeed looking at blockchain initiatives. As with previous cycles of innovation however, we believe that the real innovation will occur outside the incumbents. Banks don’t have the global reach or infrastructure to lead the payments charge (hardware manufacturers are the biggest distribution channel via native install) but hardware manufacturers and social media companies do. We believe the next wave of payments innovation will be driven via device, as we see with Apple Pay, AliPay, and SamsungPay.
Transaction Value of Next-Gen Payments
Source: CoinShares Crypto Trends. Note: this includes EMV chip, QR code, and NFC/contactless payment systems. Data after 2018 are projections.
As we reported in our November 2019 Crypto Trends Report, the evolution to device-driven payments is already playing out across the globe, with mobile / eWallet payments expected to surpass cash payments globally by the middle of this year. Asia-Pacific has a head-start, with this crossover already happening in 2018. Many other emerging & frontier markets are also particularly attractive.
Take Turkey, for example, where 66% of transactions in 2019 were done with cash and only 8% were done from digital or mobile wallets. (It doesn’t help that PayPal was banned in Turkey, and there is no local replacement). Even Asia-Pacific, where mobile has much higher penetration (36% last year), cash was still 30% of all POS payments. (For more on bitcoin in Turkey, see our video with BTCTurk’s CEO)
This trend is also picking up in the developed world, where users are increasingly less likely to use cash or cards and are relying more on digital wallets and device-driven services. ARK Invest, an asset manager focused on disruptive innovation, expects 220 million digital wallets in the US by 2024. With this number in mind, ARK concludes that “if every user were to be valued according to the lifetime value of traditional bank customers, the digital wallet opportunity could be worth more than $800 billion (27x today’s $29.5B valuation).” We have provided a link to this research at the end of this article.
Financial institutions are slowly getting used to the idea of payments that are instant, invisible, and free. It is, however, worth noting that in addition to the threat of loss of the revenue stream itself, there is a secondary risk. According to McKinsey, 90% of banks’ useful customer data is generated by payments. This is where we really see the opportunity in retail begin to shine, and given cryptocurrency is still largely a retail-driven phenomenon, we believe blockchain-based payment tokens (note we didn’t say cryptocurrencies) have a natural place in the retail payments landscape.
Projected Payments Revenues — Retail v Wholesale
The last place we’ll comment here is on the rise of “Super-Apps” or “Super-Platforms” that use their platform to deliver a variety of products and services, but all share an underlying payment network and suite of financial products and services.
In the last two years, the FAANGs (together Facebook, Amazon, Apple, Netflix and Google) have all experimented with different ways of delivering new financial services to consumers. These five companies, as of May 1 2020, comprise 25% of the US stock market in terms of market cap, and have enormous user reach. Facebook counts over one-third of the world’s population as users. Fully 82% of US households have an Amazon Prime membership, and Amazon has 40% market share of the cloud computing industry. Netflix has nearly 200 million subscribers, making it one of the world’s largest media companies. If these numbers seem astronomical, it’s because they are.
While all of these companies have historically been tech companies, each one is slowly becoming a financial services company, and this trend will only accelerate as firms look for new ways to grow revenue from both existing and new users.
We hope some of these insights on developments in the payments space are informative, and we look forward to investing in innovative companies in this domain which are capitalizing on some of the trends we highlighted here.
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