By Shreyas Mishra, senior analyst, Lateral Frontiers VC
A couple of months ago, we hosted a portfolio dinner at a restaurant in Nairobi. We thought we would pay for this with the company credit card which is a virtual card linked to our bank account. The restaurant issued an online link to pay for the dinner. It did not work. They shared another link to pay directly into their US$ account. That did not work. So we used Paypal to remit money directly to M-Pesa, we lost 5% on FX and it took over 24 hours for the cash to reflect.
This got me thinking about how businesses pay each other on the continent and why is it such a slog to do so.
This is a sector where a lot of time and capital has been invested to help improve the speed and reliability with which money is sent and received. On the back of this, we have seen innovations that have led to mammoth enterprises being built.
The big winners in payments, however, have largely come from solving for C2B or P2P channels. But businesses today in all parts of the globe still heavily rely on manual ways of sending and receiving payments to each other. In the US, an average invoice takes $17 and 10 days to process, and the entire lifecycle of a B2B transaction stands at an egregious 34 days!
But why?? The factors below can help explain that.
- Operational complexity – C2B payments are pre-set to be instantaneous where the customer must pay immediately to avail the good/service. B2B payments have a lot more nuance with varying payment terms for various suppliers and discounts embedded in the price depending on when or by whom payment is executed. Businesses also have to constantly manage liquidity needs through working capital management. As a result, for a fintech to truly service and automate functions, a plethora of integrations are required to a business’ ERP software which will vary from company to company. In some cases, a company may not even have an ERP to integrate into.
- E-commerce proliferation – Akin to what Jio did for internet usage in India, e-commerce has done for C2B payments. The rapid growth of commerce on the internet and the need for instant online payment mechanisms have accelerated the need for innovation around allowing consumers to pay for products online.
- KYB/AML processes – KYB/AML procedures for B2B are traditionally paper-based and differ across each business partnership, making it difficult to automate procedures around this function.
- User is not the decision maker – With C2B payments the user of the payment mechanism is the decision maker on the payment. On the other hand with B2B transactions there are no decision makers involved in conducting the transactions and therefore the shortcomings are more likely to be overlooked.
- Internationalisation – As businesses expand across borders, suppliers would want to pay in different ways which is an operational burden and expensive. Add to this, the cost of compliance including payment regs, taxes and others variables across jurisdictions and adds another layer of complexity. This is magnified with payments moving from a country with a more advanced domestic B2B payments network to one with a less advanced network.
The complexities above show that B2B payments require an additional back office layer to support the actual payment being made. Redpoint Ventures coined this CFO-as-a-service. The layer includes automations to help teams process payment approvals, reconcile the books and detect anomalies/fraud all in real-time. Startups globally have been building to solve for these pain points.
Like with all sectors, blockchain technology has the potential to hugely disrupt the B2B payments space and we have already seen big organisations being built in this space.
Ripple ($294 million raised) and Circle ($710 million raised) are the most well-funded start-ups tackling payments processes for businesses. Ripple allows transfer of money at a fraction of the cost with real-time settlement. Their product RippleNet is tailored for financial institutions, completing settlements in 3-5 seconds at a cost of $0.01 per transaction. Customers today include Bank of America, Santander, Standard Chartered, and Flutterwave.
Now we all know that using blockchain rails enables quicker and cheaper payments. But there is a lot more to this. Blockchain technology is programmable and allows for complex apps to be built on top of a base protocol. With the complexities around B2B payments, this makes blockchain the perfect base on which to build products on.
In the chart above we see different companies solving for payment processing and others for the CFO-as-a-service stack. However, what really excites me is that developers can build complex applications on top of L1 networks. In this case, I see a future where you can build CFO stack functions on chain with payments processing being settled using the native token i.e. we can have an all in one solution. You have companies like Paystand ($98 million total funding) and Corechain ($5.5 million total funding) that are now looking to build such solutions.
This can streamline hours of paperwork as an immutable blockchain network will provide auditable transaction histories to businesses, preventing manual entries and streamlining those oh so lovely end-of-month reconciliations that accountants love doing. Now as a finance graduate, the resulting threat to employment is slightly disconcerting, but there is no denying the efficiency it brings to businesses.
The technology can also be used to automate KYC/AML processes when you can verify vendors and whether or not they honour their payment terms with other suppliers.
Zeroing in on Africa, the issues above are further complicated by each of the 54 countries having their own currencies, payments, and settlements system. Another layer of complication is brought about by the majority of the population still using cash or mobile money. While mobile money has greatly increased financial inclusion, their services lack the interoperability, or the sophistication articulated earlier for businesses to run their payment operations on.
This is particularly palpable when examining the cross-border payments eco-system. The lack of an interoperable system is one problem, then you add to that the liquidity – or lack thereof – among African currency pairs. In the present day, when you want to exchange one African currency for another, the issuing bank must first convert to US dollars before the acquiring bank then converts to its domestic currency.
Despite the bottlenecks, you still had $69 billion of intra-Africa trade in 2019. Now I believe crypto solves these issues. Given the borderless nature of digital currencies, you can build on and off ramps to enable efficient cross-border settlement. Now all we need is on- and off-ramps, and that is where you have global protocols looking to solve for this. Celo is investing $20 million to improve on- and off-ramp experiences. Stellar Development Foundation (a protocol focused on cross-border payments) has partnered with African companies such as Flutterwave and Clickpesa to facilitate business transactions on the continent.
Away from the chain, you also have the Pan-African Payments and Settlement System (PAPSS), a payment and settlement infrastructure for intra-African trade and commerce payments launched by Afreximbank as tenant of the African Continental Free Trade Agreement (AfCFTA).
Lateral Frontiers portfolio company, Appzone have built their Appzone Switch product, an interbank payments processor built atop of blockchain technology. The product allows for instant settlement of funds between financial institutions.
While the benefits of using blockchain technologies to power business payments are plain for all to see and businesses are opening up to the use of these technologies, there are a few structural impediments to mass uptake.
- Regulations – A key barrier to companies leveraging blockchain technologies has been the myriad of legal stances taken by regulators with respect to cryptocurrencies. This has prevented reliable off-ramps to fiat in many counties and this is especially visible in Africa with major markets such as Nigeria and Kenya being leaders in crypto adoption but almost exclusively through P2P channels which circumvents the usage of traditional financial services (i.e. withdrawing crypto into a bank account).
- Assurance layering – Circle CEO, Jeremy Allaire, pointed out that while the base operating system (the public blockchains) and protocols such as cryptocurrencies that enable financial contracts and settlement have been built, the assurance layer has not. In transactions today, this role is played by financial intermediaries. For blockchain payment systems to gain more mass uptake, crypto/blockchain native assurance innovations for KYC/KYB, and identity protocols need to be built so users know which endpoint they are interacting with in a transaction.
- Stablecoin concerns – Asset-backed stablecoins have been the predominant asset used to enable transactions and while the use cases as a medium of exchange are evident, there are various concerns about their use. Asset collateral-backed stablecoins are in danger of mass redemptions should doubt arise about the asset themselves. These concerns may give rise to CBDCs being the primary medium of exchange on blockchain networks, but most countries are a ways away from formally launching their own digital currencies for mass usage.
The opportunity to build a fully automated platform that can scale across multiple markets and payments systems is a huge one but has many layers within it and therefore I feel that this will not be a winner take all market, at least the v1 version of it will not.