Crypto Rails for the Exchange of Monetary Value

THE COWEN INSIGHT

The Lightning Network (LN) and fiat-stablecoins hold key attributes and global payment rails, including their interoperability and being digital bearer assets with instant settlement.

In this report we discuss the development of LN and fiat-stablecoins as payment methods during the crypto winter. We also provide a primer on the advantages and challenges of these crypto payment rails vs. traditional rails.

VIABILITY OF CRYPTO FOR GLOBAL PAYMENTS 

We think that the development of the Lightning Network (LN) and fiat-backed stablecoins could position crypto as an increasingly viable rail in global payments. Major friction points in the existing ~$156T cross-border payments market, high payment processing fees on merchants, and inequalities in financial inclusion are well known and the target of crypto enthusiasts.

Crypto payments have been limited to date due to low transaction throughput and elevated fees on blockchains that prioritize decentralization and security. However, traction is increasing due to scaling solutions that are developing during the crypto winter.  including lightning networkand fiat-backed stablecoins.

LN public channel capacity (a metric for usage) has grown +42% YTD. The total fiat-backed stablecoin market cap has declined only -1.5% amid the drawdown of digital assets. Key hurdles to widespread adoption include infrastructure development for fiat-to-crypto on/off ramps, lowering complexity for users & merchants, incumbent networks, and how these rails operate under regulatory frameworks.

ATTRIBUTES CONDUCIVE TO THE EXCHANGE OF MONETARY VALUE

The LN and fiat-stablecoins built on top of Bitcoin and other blockchains, respectively, hold important attributes in the exchange of monetary value.

These attributes include:

1. Their interoperability as a native currency of the internet driving network effects at the market level
2. Utilization as tech rails for fiat-to-fiat payments globally
3. Being digital bearer instruments with near instant settlement

Bitcoin utilizes LN smart contract functionality for off-chain payment channels. We expect stablecoins to benefit from layer 1 competition, layer 2 sidechains, and post-Merge Ethereum scaling upgrades (sharing + rollups) anticipated over the next 12-24 months

LIMITED MARKET AWARENESS

Our report is a comprehensive primer on the viability, advantages, and challenges of the LN and fiat-backed stablecoins vs. traditional payment systems. We think market awareness is opaque for three main reasons.

• 1) The LN does not have its own cryptocurrency token or its own blockchain. It is simply an overlay network anchored to the Bitcoin blockchain. There are no on-chain metrics to analyze, and LN payment volumes and amounts are unknown. Therefore, we think LN flies under the radar relative to other projects going on in the crypto ecosystem. Stablecoins also play a utility role, functioning as a fiat/crypto bridge and designed to retain their par value.
• 2) There are no direct pure-plays in public markets.
• 3) Much of the innovation per LN and fiat-backed stablecoins payment rails is happening in the private markets or within larger public entities.

CATALYSTS FOR & BARRIERS TO GROWTH

Lightning Network Adoption

To measure the growth of the LN, we utilize public channel capacity data that represents the total amount of BTC that is held across all announced channels of the network. Average monthly public channel capacity has seen consistent m/m increases since February 2021.

Stablecoin Adoption

To measure the growth of fiat-backed stablecoins, we utilize circulating supply, market cap, and on-chain volume. The adjusted on-chain volume of stablecoins came in at $2.3T in Q3:22, +72.6% y/y, and +15.4% q/q, marking their largest absolute trading volume quarter.

Policy Consideration

The U.S. government intends to regulate crypto payments to ensure consumers have the same rights with crypto as traditional payments. This includes being held harmless for unauthorized transactions. Crypto payment providers will need to demonstrate an ability to comply with these rules and AML/BSA controls. Crypto may also need to compete against a digital dollar, which the Federal Reserve has been working on for several years. Though not close to launching, a digital dollar could threaten stablecoin.