How Digital Currencies Can Help Small Businesses

In recent years, the development of blockchain technology has brought us new types of digital assets such as stablecoins and cryptocurrencies. These innovations provide the foundation for building new payment rails that can move value across the globe not only in real time but also at a much lower cost. Unlike cryptocurrencies such as Bitcoin or Ethereum, stablecoins are significantly less volatile because they are usually pegged to a fiat currency such as the US dollar. Stablecoins have also pushed governments to accelerate their exploration of central bank digital currencies (CBDCs). While cryptocurrencies rely on decentralized networks for their operations, CBDCs would operate on public sector infrastructure and represent a direct responsibility of the central bank – essentially “digital currency”.

There is major potential here: digital assets and cryptocurrencies can support new services and create more competition in financial services. On the one hand, they promise lower cost payments for domestic and cross-border transfers. They can also facilitate real-time payments, overcoming a significant gap in the US payment system. Additionally, these new assets support programmability, which can be used for conditional payments and more complex applications such as escrow.

At the same time, these technologies – and how they threaten traditional financial intermediaries – have sparked heated debate. For example, a recent and highly anticipated paper from the Federal Reserve Board recognizes the significant benefits of digital currencies, but also raises concerns about privacy, operational risk, cybersecurity, and financial stability. Similarly, Gary Gensler, chairman of the U.S. Securities and Exchange Commission, recently nearly doubled his crypto enforcement staff to crack down on what he calls “wrongdoing in the crypto markets.” The recent collapse of UST, Terra’s Stablecoin – one of the largest stablecoins – illustrates how a failure in one of these systems can ripple through the entire crypto ecosystem. While many stablecoins derive their value from being fully backed by reserves, this was not the case for UST, which instead relied on an algorithm and a second currency, Luna, for stability. .

While recent events underscore that the risks posed by cryptocurrencies cannot be ignored, it is also clear that the status quo does not provide a satisfactory answer. The question is who bears the burden of an expensive, outdated and slow payment system. This article outlines the potential impact on small and medium enterprises, which incorporates important consequences for economic growth and stability.

Small businesses – including restaurants, plumbers and dry cleaners – play a vital role in our economy. They employ about half of all American workers, which is over 60 million jobs. They created 65% of net new jobs from 2000 to 2019, represent 97.5% of all exporting companies in the United States, and account for 32% of known exported value. Furthermore, small businesses are also a key vehicle for intergenerational mobility and social inclusion, providing upward mobility and economic opportunities, especially for underrepresented groups such as minorities and immigrants.

Small businesses are also finding new ways to reach consumers outside of their local communities through digital platforms such as Shopify and Amazon, a distribution channel that was vital to them during the pandemic to counter declining retail sales.

Nevertheless, they have been largely ignored during the debate over digital currencies. While policymakers, economists, and government officials stress the importance of ensuring the resilience and growth of small businesses, how they could benefit from a better and more competitive payments infrastructure is almost entirely overlooked.

The financial fragility of small businesses

Most small businesses operate with extremely thin cash reserves. The typical small business only holds enough cash to last less than a month. This leads to significant vulnerability to economic fluctuations, as illustrated by their collapse during the 2008 financial crisis and, more recently, the Covid-19 crisis. The latter had devastating consequences for small businesses, forcing the government to issue an emergency Paycheck Protection Program (PPP) to ensure they could stay afloat.

There are many reasons for this, including their limited access to credit and the few financial options they have compared to large companies. Small businesses are often seen as riskier for lenders because they struggle to provide the kinds of quantifiable metrics that big banks expect when assessing creditworthiness. While small businesses have relied more on community banks, bank consolidations have further limited this source of funding.

One of the most pressing issues for small businesses is late payments. Large buyers, such as Walmart and Procter & Gamble, commonly use “buy now, pay later” practices with their suppliers, with payment terms ranging from 30 to 120 days. When applying such practices, large buyers essentially borrow from small businesses, which greatly increases their working capital requirements and reduces their available cash reserves. Indeed, survey data suggests that nearly 70% of small businesses that rely on invoices report cash flow problems related to these late payments.

Difficulties in accessing credit, combined with late payments, make it difficult for small businesses to maintain healthy cash reserves, increase their exposure to economic shocks and limit their ability to make investments. Increased competition and innovation in payments could improve their long-term resilience and growth opportunities.

How slow and expensive payments are hurting small businesses

Today, most US consumer payments are made by credit card, a trend that has accelerated during the Covid-19 pandemic. Although entirely invisible to customers, merchants pay fees – to card-issuing banks, card network assessment and payment processors – which can amount to more than 3% of the transaction value and are likely to increase in the near future. Online transactions, primarily through marketplace platforms such as Amazon or Shopify, can be even more expensive. Additionally, actual receipt of funds can take several days, increasing working capital requirements for small businesses.

This clearly puts small businesses at a disadvantage, especially given their low margins, limited cash reserves and high financing costs. While larger companies, such as Costco, can negotiate significantly lower fees when accepting digital payments, smaller companies don’t have much bargaining power. At present, there are few alternatives to the major card networks, which means that small businesses operating with small margins have no choice but to try to pass on some of the fees to the customers through higher prices, which reduces their ability to compete with larger investors. rivals.

These issues are amplified when it comes to cross-border transfers, where fees and delays are incredibly high. In Q2 2021, the average cost to send a cross-border payment from the US was 5.41%, and SWIFT payments can take between one and five business days. Additionally, fees are unpredictable and businesses may incur additional costs depending on the number of correspondent banks involved in the transaction. The complexity of the payment chain also makes international payments a lucrative target for scams and fraud, further increasing its costs.

How Blockchain Technology Can Help

To change that, we need a more open and competitive payment infrastructure. To achieve this, critical public sector efforts such as FedNow and CDBCs must be combined with private sector innovation, including permissionless cryptocurrency networks. Public sector efforts inevitably evolve at a glacial pace, and there is a real risk that they will be vastly overtaken by innovation occurring elsewhere, often in “walled gardens” that lock consumers and businesses into services not interoperable.

But that doesn’t have to be the case. The public sector can take advantage of technical advances in the blockchain and cryptocurrency space to accelerate its journey to real-time, low-cost payments.

An open payment system will drive competition, reduce transaction costs and unbundle services that are currently part of all digital transactions – including those related to reversibility and chargebacks, intermediation, risk assessment transactions, etc. – helping companies pay only for what they really need. Ideally, with new forms of interoperability between digital wallets, banks, and legacy payment and card systems, small businesses could do this without compromising the customers they can accept payments from. Additionally, transferring funds directly through a blockchain would benefit domestic and cross-border payments by reducing the number of intermediaries in the picture.

If this evolution of payments is successful, small businesses would not only experience lower costs, but also faster access to funds. This would significantly improve their cash and liquidity reserves, and help them survive negative economic shocks and thrive.

By creating the conditions for a truly open and interoperable protocol for money to emerge, much like the early days of the Internet, the public sector can restore competition in payments and give small businesses the choice they so much need.

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