HashKey Group Chief Analyst Jeffrey Ding

Recently, the highly anticipated SmartCon conference is taking place in Hong Kong, where Dr. Xiao Feng, Chairman and CEO of HashKey Group, will also deliver a keynote speech on the global payment network of compliant stablecoins. As a leading figure in the Web3 space, his focus on payments is undoubtedly exciting, signifying not only the vast space of the Web3 payment industry but also possibly hinting at an imminent explosion of Web3 payments.

Broad prospects, but numerous challenges; this is the true portrayal of PayFi at present.

Compliance and high-difficulty risk management are necessary conditions, determining whether the project can have a long-term future. From a long-term perspective, we need to see the positive development of current regulatory compliance, the compliance path gradually accelerating. For a PayFi project, in addition to innovative play styles and strengthening risk management, selecting partners with compliance licenses, whether stablecoins or exchanges, is of utmost importance. Once a synergy is formed, it undoubtedly opens up a broad landscape with great potential.

PayFi is a new concept but addresses an old problem.

1. The turnover efficiency of funds is the core of the time value of money.

PayFi (Payment Finance) is a unique concept in the Web3 field, first proposed by Lily Liu, the chair of the Solana Foundation, defined as a new financial market built around the time value of money.

In the above definitions, the concept of the time value of money is relatively abstract. In simple terms, the time value of money means that money has different values at different time periods. Understanding this from an economic perspective means that, without considering inflation factors, the increase in the value of money comes from the value appreciation brought by the transfer of the right to use money/funds. More colloquially, it means using today’s $1 for investment, finance, lending, etc., and at some point in the future, you earn more money. The money you earn is directly determined by the turnover efficiency, cost, and returns of this $1.

The next question then arises: does this time value of money not exist in Web2, or are there unmet needs? The answer is clearly negative. So why is there a need for Web3 to facilitate payment transformation? The conclusion can only be that the time value of money in Web2 has been greatly weakened, due to both rising costs and decreasing revenues, as well as a low level of convenience in accessing services.

Having understood the above scenario, we can roughly provide a more detailed depiction of PayFi. PayFi is an innovative financial market built around capital turnover efficiency, costs, and returns based on payment settlement scenarios through blockchain technology. It is worth noting that there are many scenarios that can enhance the time value of money, but PayFi focuses more on payment and settlement rather than financial transactions. Its primary enhancement of time value lies in shorter fund settlement times and faster turnover efficiency.

2. The demand for RWA is not necessarily rigid, but PayFi is more pressing.

If there is a widely recognized and enduring mainstream narrative in the Web3 industry, it is undoubtedly the key proposition of mass adoption. The RWA track was born under this narrative as a key direction, while PayFi, from a broader perspective, belongs to the RWA track because, at its core, both involve the interaction between the blockchain world and the real physical world, albeit in different ways.

The core definition of RWA is to put real-world assets on-chain, tokenizing/nfting tangible real assets to enable transactions on-chain, focusing on the trading of real assets on-chain, providing higher liquidity for real assets. PayFi, on the other hand, focuses on the speed of transactions between real assets and the unmet financial needs realized through blockchain.

The difference lies in the fact that the demand for RWA is not necessarily rigid; to some extent, it provides more sources of income/funds for the blockchain world. The demand for PayFi is completely rigid, as it provides more sources of income/funds for the real world. It should be noted that from the perspective of enhancing revenue, both RWA and PayFi are not one-way; the following table is more based on their essential functions.

Chart: Similarities and Differences Between RWA and PayFi

Comparing and juxtaposing RWA and PayFi, the core thinking is: under the grand narrative of mass adoption, why do we need a new narrative of PayFi instead of a simple extension of the RWA concept, and why has it aroused such high attention.

The comparison between the two above may provide some explanation: one is the migration of the real world to the blockchain world, and the other is the integration of the blockchain world into the real world. Both are similar in function, but from the perspective of demand, the latter undoubtedly has a more pressing urgency in the real world. However, the high attention to PayFi is not only due to the urgency of the real world but also the bottlenecks inherent in the blockchain world.

Furthermore, from the perspective of the operation of the blockchain world itself, whether it is second-level payment settlements or using smart contracts and on-chain DeFi liquidity pools to support the real world, the greatest time value lies in improving the turnover efficiency of money.

3. The developmental bottleneck of blockchain calls for a new narrative with real scenarios, and PayFi has extremely high potential.

From the perspective of the blockchain world, narrative exhaustion is an undeniable fact in the current blockchain world. The phenomenon of liquidity fragmentation is becoming increasingly severe, accompanied by false prosperity of project data. After the project's TGE, most project user data nearly plummets linearly, along with a significant drop in token prices. This phenomenon reflects, on the positive side, the rapid development of the blockchain world under capital support and gradual compliance. On the negative side, it reflects that many current projects lack real demand scenarios, with most being hollow projects that have weak self-sustaining capabilities. Without capital support, they are almost 'dead on arrival'.

From the real world perspective, in an increasingly complex geopolitical environment, the increasingly bulky international payment settlement system faces not only the inertia of inefficiency but also skepticism about neutrality and equality. Russia's removal from the Swift system is undoubtedly a precedent, but it is by no means the last example. Moreover, the phenomenon of financial oligopoly and inequality is rampant, and worse still, this phenomenon is still intensifying.

It is hard to say that blockchain can perfectly solve real-world problems, especially since blockchain itself is facing developmental bottlenecks. However, it is at least one of the most likely paths at present. Whether it is Web2 giants or Web3 leaders, they undoubtedly do not want to miss the opportunity to bet on this track, such as BlackRock, JD.com, Coinbase, A16z, Sequoia, SoftBank, etc. More importantly, for the massive capital of these giants, they are less likely to be attracted by short-term limited wealth effects, but rather focus on long-term incremental space. This is also the core reason why both RWA and PayFi can attract large funds.

2. PayFi ecosystem is taking shape, from stablecoins to exchanges, compliance is the foundation of cooperation.

A broader ecosystem depends on partners with compliance qualifications.

As analyzed earlier, the PayFi track is where the blockchain world leverages vast real-world assets. In this landscape of the track, if we merely analyze individual PayFi projects, it is undoubtedly being short-sighted. It is more important to see how to form a broader synergy in such a blockchain ecosystem to create a new financial paradigm.

Chart: Overview of the PayFi Ecosystem

Source: Self-organized

As shown in the above image, the interaction between the blockchain world and real-world assets is not limited to the PayFi project itself, or in other words, PayFi is merely the gateway. However, from the project logic of PayFi itself, it connects the funding pool of the blockchain world with the financial demands of the off-chain world. This connection requires the integration of multiple forces.

The primary factor is that operations must be conducted in a relatively relaxed regulatory environment and in crypto-friendly cities. For example, the recently popular Huma Finance is located in San Francisco, where the early compliant exchange Kraken is also situated, and currently in Hong Kong.

Furthermore, the current main partners are still focused on large licensed institutions that can provide a full suite of deposit and withdrawal, liquidity provision, and decentralized infrastructure compliance services. In fact, from this perspective, this is one of the high barriers and obstacles to the scale growth of PayFi.

Taking Hong Kong as an example, there are not many entities with certain financial strength that can provide a compliant regulatory framework from infrastructure, deposits and withdrawals, liquidity, including KYC. Only a few licensed institutions, such as Hong Kong's largest licensed virtual asset exchange, HashKey Exchange.

HashKey Exchange, as Hong Kong's largest licensed virtual asset exchange, has ranked among the global TOP 10 exchanges. It is currently the best cooperation partner for PayFi projects, with transaction volumes exceeding 538 billion HKD and asset deposits exceeding 5 billion HKD. According to the latest data from Coingecko, HashKey Exchange ranks 8th globally among exchanges and is the highest-ranked licensed virtual asset exchange in Hong Kong. The benefits of cooperating with such compliant institutions lie in their breadth and depth of collaboration, as well as a lower level of synergy difficulty, which is more conducive to the rapid establishment of projects and increasing visibility. Otherwise, it would be necessary to find different partners at various stages, which in a sense increases the operational costs of the project.

1.1 The embryonic form of the track is already visible, and the future is worth looking forward to.

RWA is a major hotspot in this cycle, but the PayFi concept was only proposed in July of this year. Under the heat of the leading project Huma Finance raising $38 million in September, it has gradually gained widespread attention. In less than three months, it has become a hot and closely watched new concept and narrative in the industry, gathering top venture capital, compliant exchanges, and public chain funds like Distributed Global, HashKey Capital, Stellar Development Foundation, etc.

At this year's Token2049 in Singapore, the PayFi Summit showcased 12 projects in the PayFi track and the corresponding underlying modular Stack technology stack, aiming to further lower the development threshold for projects.

From a compliance perspective, payment businesses currently have different regulatory frameworks in different regions, such as TCSP and MSO in Hong Kong; DPT in Singapore and VARA licenses in Dubai are all regulatory frameworks that projects must consider when entering the payment track.

Overall, the current scale and heat of the track cannot yet be called mainstream; however, in the context of the industry’s narrative fatigue, the high attention given by the industry indirectly proves the recognition of this direction. At least under the current influence, the embryonic form of the track has already taken shape, and the future remains promising.

1.2 The three major challenges of PayFi: Compliance is the foundation of development, risk control is the guarantee of development, and lowering barriers is the leverage for development.

Looking ahead, the most pressing issue for the development of PayFi is regulatory compliance. Next is how to manage the entire scenario from on-chain to off-chain through process management, which involves the main challenges as follows.

Challenge 1: Compliance management of the entire chain. From a risk perspective, if on-chain compliance risks spread to off-chain, it would pose a fatal blow to the project. Therefore, using compliant stablecoins is just the first step; looking further ahead, the current stablecoins are all pegged to the US dollar, which may face foreign exchange control risks between countries during large-scale promotion, as Korea also plans to introduce related regulations recently. Moreover, compliance in the deposit and withdrawal stages and liquidity provision stages plays a decisive role in the success or failure of the project, which is also why it is mentioned earlier that cooperation with compliant exchanges like HashKey Exchange is necessary.

Challenge 2: The difficulty of managing technological and security risks and credit risks increases. If the business model purely occurs on-chain, technological risks are relatively concentrated. However, the business model of PayFi determines that its technological risks exist not only from on-chain hacking but also from off-chain fulfillment risks. Additionally, whether based on receivables or trade, it requires a large amount of cross-validation of online and offline data, and without on-site offline research, this actually raises higher requirements for credit risk management capabilities.

Challenge 3: The entry barrier for users remains high. From the current PayFi projects, due to regulatory compliance factors, user KYC and investment thresholds are currently not very suitable for widespread retail participation, being more appropriate for institutional/high-net-worth individuals. However, from a business logic perspective, institutional business is easier to develop, and the model is relatively simple. Nonetheless, if large-scale promotion is to occur later, user thresholds remain one of the barriers.

IV. Recommendations and Prospects: Based on compliance, multi-party cooperation, innovative play, and great potential.

From the development of PayFi, it is currently still in the stage of one-way financing solutions, which means finding financing for real physical scenarios in the blockchain world. If it progresses further, it can develop into an integrated payment and financing business, or it can be said to be a comprehensive form of PayFi + DeFi + RWA. On one hand, it expands funding sources while increasing the yield sources of on-chain DeFi or exchange financial products; on the other hand, it also seeks breakthrough solutions for the massive financial turnover needs of offline assets.

Chart: Innovative Scenarios of PayFi Business

Source: Self-organized

As shown above, the current PayFi funding pool does not come directly from DeFi and exchanges, but rather from the self-built funding pools of the projects themselves. However, concerning the underlying assets, under compliant funding, the source of funds is not particularly relevant, especially given the current market's liquidity fragmentation. Cooperation with DeFi protocols and compliant exchanges can be considered to fully integrate the liquidity of the blockchain world. On one hand, this can design products with more diverse risk attributes and durations, while also achieving the integration of payment and financing. In other words, utilizing the high timeliness of blockchain payment settlements combined with on-chain earnings, seamless integration of payment and financing can be realized. Essentially, users can obtain credit advances from the PayFi platform as collateral for earnings obtained through LP, which can be used directly for offline consumption.

In addition, for centralized compliant exchanges and DeFi protocols, it provides an effective grip on user fund retention. A possible scenario is: for example, User A deposits and withdraws funds through HashKey Exchange. After investing in BTC and gaining returns, they can invest compliant stablecoins such as BTC or USDC into the exchange's financial products. The underlying assets of these financial products are financing projects from PayFi, aiming to earn stable returns, which can also be directly used for offline payments through PayFi.

In summary, from the perspective of PayFi's own development, combined with the many play styles of the blockchain world, the time value of money can be fully utilized for innovation through the efficiency of blockchain. The shortened time not only improves turnover efficiency but also facilitates the formation of a product shape that integrates payment, financing, and settlement.

According to incomplete statistics, the entire payment field, including credit cards, trade financing, cross-border payments, etc., has a market exceeding $40 trillion. Currently, PayFi is only expanding into the long-tail market that traditional finance has overlooked.

Given the increasingly compliant blockchain world, the scale of PayFi is roughly estimated to exceed one trillion. In the foreseeable future, if the barriers to deposits and withdrawals are broken down, online-offline integration deepens, and compliance accelerates, perhaps the expressway from the Web2 world to the Web3 world will be truly opened, and PayFi may be the key turning point for Web3 to achieve true mass adoption.