Jeffrey Ding, Chief Analyst of HashKey Group
Recently, the highly anticipated SmartCon conference is being held in Hong Kong. Dr. Xiao Feng, Chairman and CEO of HashKey Group, will also deliver a keynote speech on the new global payment network of compliant stablecoins on the Main Stage. As a leading figure in Web3, his attention to payment is undoubtedly exciting. This not only means a broad space for the Web3 payment industry, but also perhaps implies that Web3 payment is about to explode.
Broad prospects and many challenges, this is the true portrayal of PayFi at the moment.
Compliance and high-difficulty risk management are necessary conditions, which determine whether the project can go long-term. From a long-term perspective, we need to see the healthy development of current regulatory compliance, and the road to compliance is gradually accelerating. For a PayFi project, in addition to innovative gameplay and strengthening risk management, selecting partners with compliance licenses is the top priority. Whether it is a stablecoin or an exchange, once a joint force is formed, there is undoubtedly a broad world and great potential.
1. PayFi is a new concept, but it solves an old problem
1. The turnover efficiency of funds is the core of the time value of money
PayFi (Payment Finance), also known as payment finance, is a unique concept in the Web3 field. It was first proposed by Lily Liu, chairman of the Solana Foundation, and defined as a new financial market built around the time value of money.
In the above definition, the concept of the time value of money is relatively abstract. In short, the time value of money means that money has different values in different time periods. To understand it in an economic way, that is, without considering inflation, the increase in the value of money comes from the value-added brought by the transfer of the right to use money/funds. To put it more simply, if you use today's 1 dollar to invest, manage money, borrow, etc., at some point in the future, you will make more money, and the money you make is directly determined by the turnover efficiency, cost and income of each turnover of this 1 dollar.
The next question comes from, is there no demand for this kind of time value of money in Web2 or is there any unmet demand? The answer is obviously no. So why do we need Web3 to transform payments? The conclusion can only be that the time value of money in Web2 has been greatly weakened, which includes both cost growth and revenue reduction, and the low level of convenient access to services.
After understanding the above scenario, we can roughly give some more detailed descriptions of PayFi. PayFi is an innovative financial market based on blockchain technology, payment and settlement scenarios, and centered on capital turnover efficiency, cost and revenue. It is worth noting that there are many scenarios that can improve the time value of money, but PayFi focuses more on payment and settlement rather than financial transactions. Its main improvement in time value lies in shorter fund settlement time and faster turnover efficiency. 2. The demand for RWA may not be rigid, but PayFi is more urgent. If there is a recognized and enduring mainstream narrative in the We3 industry, it must be the key proposition of Mass Adoption. The RWA track is the key direction born under this narrative, and PayFi belongs to the RWA track from a broader perspective, because from the most core basis, they are all interactions between the blockchain world and the real physical world, but the ways of interaction are different.
The core definition of RWA is to put real-world assets on the chain, tokenize tangible real-world direct assets/NFT, and enable them to be traded on the chain. It focuses on the transaction of real assets on the chain and provides higher liquidity for real assets; PayFi focuses on the speed of transactions between real assets and the realization of unmet financial needs through blockchain.
The difference is that the demand for RWA is not necessarily rigid, and it provides more income/funds to the blockchain world to some extent; the demand for PayFi is completely rigid, and it provides more income/funds to the real world to some extent. Of course, it should be noted that from the perspective of income enhancement alone, neither RWA nor PayFi is one-way, and the following table is more based on its essential functions.
Chart: Similarities and differences between RWA and PayFi
Source: Self-organized
Comparing and juxtaposing RWA and PayFi, the core thinking is: Under the grand narrative of Mass Adoption, why is a new narrative of PayFi needed rather than a simple extension of the RWA concept, and why it has attracted such high attention.
The above comparison between the two may provide some explanations. One is the migration of the real world to the blockchain world, and the other is the integration of the blockchain world into the real world. The two are similar, but from the perspective of demand, the latter is undoubtedly more urgent in the real world. However, the high attention paid to PayFi is not only due to the urgency of the real world, but also the bottleneck of the blockchain world itself.
In addition, from the perspective of the operation of the blockchain world itself, whether it is payment settlement in seconds, or the use of smart contracts and on-chain Defi liquidity pools to support the real world, the biggest time value behind it is to improve the turnover efficiency of currency operation.
3、The bottleneck of blockchain development calls for a new narrative with real scenarios, and PayFi has a very high ceiling.
From the perspective of the blockchain world, narrative exhaustion is an indisputable fact in the current blockchain world. The phenomenon of liquidity segmentation is almost getting worse and worse, accompanied by the false prosperity of project data. After the project TGE, the user data of most projects has almost plummeted, and the price of the currency has also dropped sharply. This phenomenon shows the rapid development of the blockchain world under the blessing of capital and gradual compliance from a positive perspective. From a negative perspective, it reflects that there is no real demand scenario behind many current projects. Most of them are nesting doll projects with extremely weak self-sustaining ability. If there is no capital blessing, it is almost "dead in the light".
From the real world, in the increasingly complex geopolitical environment, the increasingly complex and bloated international payment and settlement system is not only facing the inefficiency, but also facing the question of neutrality and equality. Russia's exclusion from the Swift system is undoubtedly a precedent, but it is by no means the last one. In addition, financial oligarchs and inequality are everywhere, and what's worse is that this phenomenon is still intensifying.
It is difficult to say that blockchain can perfectly solve the problems of the real world, and blockchain itself is also facing a development bottleneck, but it is at least one of the most likely paths at present. Whether it is the giants of Web2 or the top streams of Web3, they are undoubtedly unwilling to miss the bet on this track, such as BlackRock, JD.com, Coinbase, A16z, Sequoia, Softbank, etc. More importantly, for the huge capital of the giants, they are more attracted by the short-term limited wealth effect, but pay more attention to the long-term incremental space. This is also the core reason why RWA or PayFi can attract large funds.
2. PayFiecosystem has taken shape. From stablecoins to exchanges, compliance is the basis for cooperation
A broader ecosystem relies on partners with compliance qualifications
As analyzed in the previous article, the PayFi track is the blockchain world to leverage huge amounts of real-world assets. In this track landscape, if we simply analyze the individual projects of PayFi itself, it will undoubtedly be a blind spot. What we need to see more is how to form a broader synergy to create a new financial paradigm in such a blockchain ecosystem.
Chart: Panorama of PayFi Ecosystem
Source: Self-organized
As shown in the above figure, the interaction between assets linking the blockchain world and the real world is not limited to the PayFi project itself, or PayFi is just an entrance and exit. However, from the perspective of PayFi's own project logic, it links the capital pool of the blockchain world and the financial needs of the off-chain world. This link relationship requires the integration of multiple forces.
The first factor is that it must operate in a relatively relaxed regulatory environment and crypto-friendly cities. For example, the recently popular Huma Finance is located in San Francisco, and the early compliant exchange Kraken is also located in the city, as is the current Hong Kong.
Secondly, the current main partners are still focused on large licensed institutions that need to provide a full set of deposit and withdrawal, liquidity provision, and decentralized infrastructure compliance service solutions. In fact, from this point of view, this is also one of the obstacles to the current high threshold and scale growth of PayFi.
Take Hong Kong as an example. There are not many physical companies with certain financial strength that can provide a compliant regulatory framework from infrastructure, deposit and withdrawal, liquidity, including KYC. There are only a few regulatory licensed institutions, such as HashKey Exchange, the largest licensed virtual asset exchange in Hong Kong.
As the largest licensed virtual asset exchange in Hong Kong, HashKey Exchange has ranked among the top 10 exchanges in the world and is the best partner for the PayFi project. Its current trading volume has exceeded HK$538 billion, and its asset accumulation has exceeded HK$5 billion. According to the latest data from Coingecko, HashKey Exchange ranks among the top 8 exchanges in the world and is also the highest-ranked licensed virtual asset exchange in Hong Kong. The benefit of cooperating with such compliant institutions is that the breadth and depth of cooperation and the difficulty of collaboration are reduced to a higher level, which is more conducive to the rapid construction of the project and the expansion of its popularity. Otherwise, it is necessary to find different partners in different links, which in a sense increases the operating costs of the project.
1.1 The track has taken shape, and the future is worth looking forward to
RWA is a hot topic in this cycle, but the concept of PayFi was only proposed in July this year. Under the popularity of the leading project Huma Finance raising $38 million in September, it has been widely spread. In less than three months, it has become a hot and popular new concept and new narrative in the industry. Behind it are the top venture capital, compliant exchanges and public chain funds in the industry, such as Distributed Global, HashKey Capital, Stellar Development Foundation, etc.
In this year's Singapore Token2049, the PayFi Summit event also focused on displaying 12 PayFi track projects and the corresponding underlying modular Stack technology stack, intending to further lower the threshold for project development.
From a compliance perspective, the current payment business has different regulatory frameworks in different regions, such as TCSP and MSO in Hong Kong; DPT in Singapore and VARA license in Dubai, which are all regulatory frameworks that projects must consider when entering the payment track.
Overall, the current scale and popularity of the track cannot be called mainstream; but in the context of the lack of new narratives in the industry, the high attention given by the industry also indirectly proves the recognition of this direction. At least under the current influence, the prototype of the track has taken shape, and the future is still worth looking forward to.
1.2 PayFi's three major challenges: compliance is the foundation of development, risk control is the guarantee of development, and lowering the threshold is the lever of development
Looking to the future, for the development of PayFi, the most important thing to overcome is regulatory compliance, and the second is how to connect the entire scene from on-chain to off-chain through process management. The main challenges involved are as follows.
Challenge1:Compliance management of the entire chain. From a risk perspective, if the compliance risk on the chain spreads to the off-chain, it will be a fatal blow to the project. Therefore, the use of compliant stablecoins is only the first step; in the long run, the current stablecoins are all pegged to the US dollar. In the process of large-scale promotion, they may face the risk of foreign exchange control between countries. For example, South Korea is also planning to introduce relevant regulations recently. In addition, compliance in the deposit and withdrawal links and liquidity provision links plays a decisive role in the success or failure of the project. This is why it is necessary to cooperate with compliant exchanges such as HashKey Exchange as mentioned above.
Challenge2:The difficulty of managing technical, security and credit risks increases. If the business form occurs purely on the chain, the technical risks are relatively concentrated. PayFi's business form determines that its technical risks exist not only in hacker attacks on the chain, but also in offline performance witnessing risks. In addition, whether it is based on accounts receivable or trade, a large amount of online and offline data cross-verification is required, and there is no on-site offline research, which actually puts higher requirements on its credit risk management capabilities.
Challenge3:The user entry threshold is still high. From the current PayFi project, due to regulatory compliance factors, the user's KYC and investment threshold are not suitable for the participation of retail investors, but are more suitable for institutions/high net worth people to participate. However, from the business logic, institutional business is easier to carry out and the model is relatively simple. However, assuming that it is to be promoted on a large scale in the future, the user threshold is still one of the barriers.
Three, suggestions and prospects: based on compliance, multi-party cooperation, innovative gameplay, great potential
From the development of PayFi, it is still in the solution of a one-way financing solution, that is, looking for financing in the blockchain world for real physical scenarios. If it goes further, it can develop into a payment and financing integrated business, or it can be said to be a comprehensive form of PayFi+Defi+RWA, which will expand the source of funds and increase the source of income of DeFi or exchange wealth management products on the chain; on the other hand, it will also find a breakthrough solution for the huge financial turnover demand of offline assets.
Chart: PayFi business innovation scenario
Source: Self-organized
As shown in the figure above, the current PayFi funding pool does not come directly from DeFi and exchanges, but more from the funding pool built by the project itself. However, for the underlying assets, under compliant funds, it does not matter what the source of funds is, especially considering the current liquidity segmentation in the market, it can be considered to cooperate with Defi protocols and compliant exchanges to fully integrate the liquidity of the blockchain world. On the one hand, it can design more products with fund risk attributes and terms, and at the same time, it can also achieve payment and financing integration, or use the high timeliness of blockchain payment settlement, combined with on-chain income, to seamlessly achieve payment and financing integration. Equivalently, the income obtained by users through LP can be used as collateral to obtain credit advances from the PayFi platform immediately, which can be directly used to pay for offline consumption. In addition, for centralized compliant exchanges and Defi protocols, there are more effective means to retain user funds. A possible scenario is: for example, user A deposits and withdraws funds through HashKey Exchange. After investing in BTC income, he can use BTC or USDC and other compliant stablecoins to invest in the exchange's wealth management products. The underlying assets of the wealth management products are PayFi's financing projects to earn stable income, which can also be paid offline directly through PayFi.
In short, from the perspective of PayFi's own development, combined with the many ways to play in the blockchain world, the time value of currency can make full use of the efficiency of blockchain for innovation, and the shortened time can not only improve the turnover efficiency, but also more conveniently form a product form that integrates payment, financing, and settlement.
According to incomplete statistics, the entire payment field, including credit cards, trade financing, cross-border payments, etc., has a total market of more than 40 trillion US dollars, and currently PayFi has only expanded in the long-tail market that is ignored by traditional finance.
Combined with the increasingly compliant blockchain world, this scale is roughly estimated to exceed one trillion in PayFi alone. In the foreseeable future, if the barriers to deposits and withdrawals are broken, the integration of online and offline is deepened, and compliance is accelerated, perhaps the highway from the Web2 world to the Web3 world will be truly connected, and PayFi may also be the key turning point for We3 to truly move towards Mass Adoption.