Bitcoin's wild Wednesday weakens its case for payments

Bitcoin's value plunged 30% Wednesday morning — and bounced back to just shy of $40,000 by the afternoon — in a stark reminder of why many people are still wary about using the cryptocurrency for payments.

As more payment companies enable crypto payments, the question is whether that business opportunity will come and go just as abruptly.

"Using crypto for payments is like a prepaid card that fluctuates in value," said Richard Crone, a payments consultant. "We're still learning how consumers behave when tapping an investment for a payment. It's new ground."

Bitcoin's value is notoriously volatile, but the difference with this new up-and-down cycle is the rush of large payment companies to support cryptocurrencies that accompanied Tesla's high-profile investment earlier this year. Crypto is more mainstream, and thus there are more people who have potential exposure, coupled with less experience in investing.

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While bitcoin is still not widely used to pay for items directly, payment companies are expanding and showcasing crypto services that reside close to retail payment accounts. In April, PayPal began allowing Venmo users to buy, sell and hold cryptocurrencies for a fee as low as $1, while Venmo is in the midst of a broader expansion into check deposits and contactless payment cards. Square's bitcoin operation now accounts for more than 70% of its revenue and is part of how Square expands its payment service for both consumers and merchants. And Coinbase recently went public, adding to the crypto exchange's ability to use its partnership with Visa to support payments.

In the short-term, there is a potential financial windfall for these companies since a choppy traders' market generates lots of action.

"[The payment companies] are banking on the volatility of bitcoin because it spurs more trading activity, which generates revenue," said Talie Baker, a senior analyst at Aite Group. "If a firm is really considering making crypto a part of its strategy, they understand the volatility and are most likely looking for ways to capitalize on the volatility, although it is of course risky."

The next step for payment companies is to create products or financial instruments that let consumers manage their investments and payment accounts to avoid sudden and unexpected liquidity shortages. There's also a corresponding learning curve that will require payment companies to educate users on the relationship between investment assets and currency for payments.

Such products, which would work similar to a crypto version of "buy" or "sell" orders on the stock market, are not widely available now, according to Crone.

"That's why a lot of these crypto wallets are also marching toward financial management as part of their service, not just payments," Crone said. "You could have something that says 'when bitcoin reaches a certain price, sell this amount and put it in my FDIC-insured account.'"

The drop in crypto's value will also test the discount level used by financial institutions that accept crypto as collateral for loans, said Tim Sloane, vice president of payments innovation at Mercator Advisory Group.

Silvergate Bank, for example, offers SEN Leverage, which uses crypto collateral that's greater than the loan amount as a way to serve crypto-focused clients while protecting the bank's own exposure. Another crypto-friendly bank, Signature Bank, in April began offering similar loans to Silvergate's SEN Leverage. During Signature's most recent earnings call (which predates Wednesday's price swings), CEO Joseph DePaolo stressed the bank's credit risk strategy when making loan decisions, saying the bank wants to be safe in this space.

Advocates for crypto payments have already taken the risks into account, Sloane said. "This recent nosedive will be a great early test and may cause some of them to adjust the approach they take."

The cryptocurrency selloff additionally draws attention to stablecoins, which are designed to minimize market movements by pegging their value to a traditional currency such as the U.S. dollar. Most crypto projects that support direct payments are stablecoins.

Circle's USDC is expanding quickly, and Diem, the Facebook-affiliated stablecoin, is expected to launch this year following a shift that has the project focusing primarily on the U.S. with a stablecoin pegged to U.S. dollars.

Visa and Mastercard have also expressed support for cryptocurrencies for payments and as technology contributors, but much of the card networks' messaging has favored stablecoins and central bank digital currencies, which are developing partly as a counter to traditional cryptocurrency's volatility. More than half of the world's nations are researching, developing or testing central bank digital currencies. These initiatives won't expand or hasten because of bitcoin's short-term decline, but the vast media coverage will draw indirect attention to digital currencies that use blockchains, yet are not subject to wild market swings like crypto.

"Stablecoins probably have the most potential to solve immediate-term transactional problems, such as international payments," said Rick Oglesby, president of AZ Payments Group. "In the long term, traditional or central bank currencies have the potential to transform currency as we know it."

While Silvergate has some potential exposure to the bitcoin selloff, the relationship between Silvergate and Diem would enable Silvergate to act similar to a correspondent bank for other banks looking to support the Diem USD coin, Crone said. FIS, Silvergate's core processor, could also benefit by extending crypto technology to its client base, he said.

In an interview with American Banker, Silvergate detailed how it will provide API connections to Diem participants, which will also be Silvergate clients.