A penny saved is a penny earned.
Cryptocurrencies provide two major advantages compared to other digital payments: they have lower fees and they settle faster, made possible by cutting out the middleman. But there’s a trade-off—it shifts the risk management from the merchant to the customer. Merchants no longer have to worry about charge back fraud, but instead customers lose the ability to do charge backs.
Fees in cryptocurrencies are relatively straightforward: each transaction has a fixed fee, independent of the transaction value. The one who sends the transaction pays the fee.
For the most part, cryptocurrencies have very low fees—enough to call them negligible. But there’s an elephant in the room: Bitcoin has large and unpredictable fees.
In fact, Bitcoin fees of $2-3 is still low compared the fees during the bull run in December 2017, which reached an average of $50(!!) per transaction. This is because transaction throughput in Bitcoin is maxed out, and to get your transaction accepted you need to pay more than others.
You may think the fees are so high because Bitcoin is much more popular than other cryptocurrencies, but that’s not the whole story. In fact, it would be easy to lower the fees—Bitcoin Cash can for example handle at least 20 times the transaction count of Bitcoin, while keeping the same low fees. See the discussion of the scalability challenge for more details.
Bitcoin just doesn’t work well as a currency with these high and unreliable fees, but it’s not representative of cryptocurrencies in general.
Who pays the fees?
Visa has been misusing its position and charging retailers excessive fees for a long time. They conceal from customers what Visa and its banks charge retailers to accept Visa credit cards.
Wait a minute, isn’t paying with credit cards, debit cards, PayPal etc already free? I’ve never paid a fee except for a yearly fee for having a card. Many credit cards even give you a bonus for every purchase, so what’s the deal?
That’s because you as a customer don’t see the high fees—but the merchant does. Fees of 1-4% per transaction can be very demanding, especially for low-margin businesses. To make up for the fees (and to compensate for charge back fraud) merchants instead raise their prices. So you as a customer actually pay for the fees, they’re just indirect and hidden from view.
It’s difficult to compare the fees of different digital payments in a complete and fair manner. This is my attempt, but please be aware it’s a generalization.1
There are different types of cards; debit and credit cards, and different providers like VISA, Mastercard or American Express. I’ll treat them as one category for simplicity, even though they have slightly different fees. Wire transfer fees also vary a lot and international transfers outside of SEPA can be very expensive depending on your bank and country.
Mobile payments have become popular recently.2 As a representative, I’ll choose Swish, which is used everywhere here in Sweden. It’s connected to your bank and have free person-to-person transactions, but unsurprisingly there are fees for businesses.
|PayPal||2.9–4.4% + $0.30|
I’ve also left out any monthly and yearly fee, common for regular payment systems. For example, merchants might rent credit card terminals and Swish—with comparatively low transaction fees—also has a $10–50 yearly fee (the fee varies depending on your bank).3
As we can see, cryptocurrencies are decidedly cheaper than the other options. Even Swish, which is much cheaper than PayPal or cards, is 100 times more expensive than Bitcoin Cash. There are also no yearly fees of any kind just to receive payments in it (but there might be fees if you want to convert it to fiat).
As the purpose of money is to increase economic efficiency, a 1–4% tax on nearly all digital payments is really counter-productive.4 Therefore a move towards cheap payment solutions like Swish or cryptocurrencies would be beneficial economically.
Shifting focus a little, let’s take a look at payment speed. We can identify different stages of a digital payment:5
You’ll get a notification a few seconds after your payment.6 For a credit card this ensures the customer has a valid card and has entered the right PIN-code, but no money has been transferred yet. The money changes (virtual) hands during the settlement, which might be several days later. Finally, a transaction might still be reversed much later. When this is no longer possible, I call the transaction irreversible.
Charge back fraud
For us customers, it’s a feature that transactions can be reversed. If someone steals your credit card or a merchant is fraudulent, you can reverse the transactions by calling your issuer. But this can also be abused, which is called charge back fraud (or friendly fraud).
It goes something like this:
- Place an order
- Receive item
- Claim your card was stolen
- Get your money back
This can be a big problem for some merchants, especially those serving digital goods, who often have to swallow it as a loss. To make matters worse merchants also have to pay non-negotiable and non-refundable charge back fees even when disputing.
Credit card transactions can take days to settle, and they can be reversed several months after via charge backs. Mobile payments—via Apple Pay and similar—are often tied to credit cards and share their properties while others—like Swish—instead connect to your bank account directly.
Wire transfers aren’t usually used for payments, but it’s still a useful comparison to make. They are typically much slower than other payment systems but they’re generally harder to reverse as they don’t offer the same charge back protection as credit cards do.7
A unique property of cryptocurrencies is they become irreversible very quickly. In Bitcoin it usually takes 10–60 min.
|Cryptocurrencies||seconds||an hour||an hour|
The speed that cryptocurrencies settle and become irreversible significantly reduces the risk of charge back fraud and eliminates it for most use-cases.8
The risk management trade-off
It seems payment systems needs to choose between these two options:
- Provide consumer protection but merchants might suffer from charge back fraud.
- Protect merchants from charge back fraud but don’t provide protection for customers.
Traditional payment systems have chosen to protect customers (or maybe that’s the only option they can realistically choose—for social and technical reasons). Cryptocurrencies try to prevent transaction reversal and charge back fraud instead.
While it’s of course bad to not have customer protection, there might be other solutions. For example, offering optional fraud insurance or offering custodial wallets with extra protection. (A custodial wallet is managed by a third-party, similar to a bank account.)
In addition, it might make risk management more practical. While it’s basically impossible for merchants to audit all their customers, it’s plausible for customers to check out a merchant. In fact, we do it all the time: “this website looks shady!” or “my friend uses them all the time”. Merchants are known and have a reputation while customers are innumerable and anonymous.
We’ve seen three large benefits to cryptocurrency payments:
- Settles faster
- Reduces or removes the risk for charge back fraud
And one large drawback:
- No inherent fraud protection for customers
The drawback might be alleviated with optional systems in the future, giving us the best of both worlds.