I. The State of the Market
Hedera and the digitization of the financial industry
2021 was a decisive year for Hedera with the creation of the token service and initial implementations in the payments space. 2022 is accelerating the pace of adoption of Hedera in fintech and payments, following the greater trend of digitization of payments and assets. According to a recent study by VISA, 59% of SME plan to shift exclusively to digital payment over the next 2 years or are already cashless, while 41% of consumers plan to do the same. The fintech startups have already revolutionized the financial services industry in many ways, yet key areas of friction remain, mainly due to heavy reliance on legacy infrastructure and payment rails.
Major challenges remain - many are uniquely addressable by Hedera
We created the Fintech and Payments Fund to drive growth for key application areas where we believe Hedera can make a difference and address both friction points and nascent use cases. Our main areas of focus are CBDCs, stablecoins & remittance services, payment & micropayment services, as well as asset tokenization. We also plan to strengthen our integration into the financial services infrastructure, to a great extent through our Ecosystem Fund.
CBDCs: A typical example of a nascent use case made possible by DLT, central bank digital currencies are being tested across all continents, with some early adoption in the Caribbean and Africa.
Asset Tokenization: This is another fast emerging sector with far ranging implications in the financial world. DLT has created a fertile ground to digitize, tokenize, and fractionalize both financial instruments and real world assets. This creates unprecedented access to liquidity, opening new economies and opportunities for retail and professional investors alike. To quote Dr Leemon Baird’s recent contribution on Nasdaq: “Within this decentralized, next generation internet, almost every asset in the world will eventually be tokenized and represented on distributed ledgers, allowing these assets to be fractionalized, shared, and transferred across the globe instantly and without intermediary involvement. The world will be tokenized.”
Stablecoins/Remittance: Originally limited to trading and defi applications, stablecoins are beginning to see more real world adoption in the payments and remittance space. For instance USDC’s integration with traditional payment rails means stablecoins can now be spent with merchants rather than just traded on exchanges. Shinhan Bank and Standard Bank’s recent POC on Hedera also demonstrates the applicability of stablecoins to international remittances, bypassing a notoriously slow and costly process.
Payments/Micropayments: Means of payment have been around almost as long as mankind. While we have come a long way from the inconvenience of carrying and trading shells or precious metals, modern means of payments remain cumbersome in many ways. Foreign exchange and high transaction fees resulting from legacy infrastructure are notable pain points that DLT, and Hedera in particular, can solve.
Infrastructure: Innovation doesn’t happen in a vacuum. Addressing the above challenges and opportunities will require deep integration into both legacy financial systems and emerging crypto economy to allow for both data and value to flow freely between the web2 world and the web3world.
II. Why Hedera? Our edge in payments and fintech
The HBAR Foundation is dedicating a significant amount of its endowment to supporting the fintech vertical through its Fintech Fund. So why Hedera? Why fintech? As a short answer, we believe that Hedera is uniquely positioned to disrupt this space. So let’s dig into the reasons behind that belief.
Network Performance. Finance related use cases, in particular those related to payments processing, are high-throughput applications requiring high network speed, finality, security, and reliability.
Those happen to be key attributes of the Hedera Hashgraph technology. Hedera can process 10k TPS on a single shard, meaning internet bandwidth will likely be the main limiting factor post sharding. In comparison. The Visa network processes 1,700 TPS on average. With finality in 3-5 seconds, a retail customer can make an international remittance in seconds, or a retail shopper can validate a coupon while paying for an item in store. Even when using smart contracts, Hedera’s EVM is several orders of magnitude faster than the Ethereum mainnet.
Network security and reliability are also paramount as the financial sector is (rightfully so) risk-averse and used to battle-tested solutions. Hedera’s Asynchronous Byzantine Fault tolerance is arguably the highest level of security in a distributed network. Geographically distributed nodes operate on 6 continents, and the network is actively progressing on the path to a permissionless network. A mainnet that has never crashed arguably seems like a low bar, but is not a given in an emerging field such as Distributed Ledger Technology (DLT).
Industry and regulator friendliness. Finance is a highly regulated vertical and Hedera offers both native and smart contracts-level compliance features that are virtually unmatched in the DLT industry.
Developers using the Hedera Token Service to mint digital assets can - with the proper admin controls - enable KYC’ed accounts, freeze accounts, and wipe account balances. It’s a major departure from a more traditional crypto stance leaving users in the cold when they get scammed, hacked, or make a transaction error. Hedera also baked in flexibility at the smart contracts level, with controlled mutability allowing products to evolve and keep up with changing regulations.
Beyond the regulatory aspect, the Hedera NFT token framework is advanced enough to cover “real world finance” needs, with features such as fractionality, custom fees to support royalty payments, and metadata support.
Fees! Fees! Fees! Finally, let me get to Hedera’s not so secret weapon: low, predictable fees, that are suitable for high volume transactions, micropayments, and minting digital assets. High fees are a major pain point for most public networks to the point where they often become a deal breaker. For example, transferring $500 which may cost you $150 in transaction/gas fees doesn’t make sense. With micropayment services like Dropp, new business models can emerge for content and data consumption beyond typical subscription paywall models. Users can now purchase bite sized contents and data for sub-dollar amounts.
Public networks are increasingly attractive to the sector. The financial sector has traditionally preferred to experiment on private networks but many are realizing that to go beyond a POC, a public network is often preferable. Public networks bring a necessary level of transparency; they allow multiple players - including other financial institutions, regulators, and auditors - to have access to a single source of truth, as well as let retail businesses and users participate.
III. Our path to success: An API-based, modular approach
API-based payments solutions supporting hbar and HTS stablecoins are needed to serve the Hedera ecosystem and beyond, and we plan to support several initiatives in the space. Projects such as HPay will help fill a need for both crypto native and traditional businesses and drive utility for Hbar and hUSDC. In the CBDC space, our partners Emtech and Zimbali Networks also focus on an API-first approach. In the remittance space, our upcoming integration with Six Clovers will provide an important financial tool for businesses in need of cross border payment capabilities. We will actively seek and support integration with major fintech and payments players, including stablecoin issuers and payment service providers.
As far as developer resources go, the Hedera Github already provides a number of building blocks and frameworks including a stablecoin demo, DID SDK, and an open source wallet. Further to this modular strategy, the Fintech and Payments Fund will aim to support more open source building blocks that can be leveraged to develop products requiring payments capabilities. But the need goes beyond technological tools when it comes to asset tokenization. The nascent digital assets industry needs regulatory clarity and established standards for security tokens. We will start with supporting a number of security token platforms so that issuers have access to the tech and legal infrastructure they need without having to reinvent the wheel, but beyond that we also plan to help define token standards and ideally open source, compliant, turn-key solutions for the STO space.
To summarize, we see Hedera as uniquely positioned to become a leading DLT player in the fintech and payments landscape. The base technology is strong but much remains to be done in terms of enabling growth in this sector. The Fintech and Payments Fund plans to fund major fintech integrations, as well as support finance and payment applications for key use cases prioritizing a modular, API-first approach, with a special attention paid to open source projects. We also acknowledge the complexities of asset tokenization and plan to dedicate a significant part of our resources to engage with issuers, technology providers, and regulators, and help shape this emerging asset class.