How Do Crypto Payments Work?

Using cryptocurrencies for payment can seem very mundane. At check out, the customer selects crypto, scans a QR code or links a wallet, confirms the payment and waits for the confirmation. But behind these few steps lies a blockchain network that is verifying and recording a transaction on a payment path other than the traditional card or bank transfer.

The fundamental concept behind crypto payments is that digital assets are transferred from one blockchain address to another and the network verifies the transfer.

A business need not necessarily have cryptocurrency or hold it. A user can pay in Bitcoin, other crypto assets, USDT, USDC, or other accepted assets and a payment processor can convert and monitor the blockchain transactions and settle the transaction with a merchant who gets crypto, stablecoins, or traditional currency.

What Is a Crypto Payment?

Crypto payment is an exchange that involves a digital asset and the delivery of goods or services or other commitments.

The easiest way to do it is like this:

Customer wallet → Blockchain network → Merchant wallet

The blockchain is the transaction ledger, as opposed to a standard transaction card. The customer’ll authorize a transfer from a wallet, and whether or not that transfer abides by the rules of the network will be decided by the network.

More infrastructure may also be a part of the process. A company could employ a crypto payment gateway which generates the payment request, keeps track of the blockchain, changes the cryptocurrency and manages settlement.

This results in a flow as e.g.

Customer → Crypto payment processor → Blockchain → Conversion → Merchant settlement

This enables businesses to receive cryptocurrencies without having to handle the private keys or hold digital currencies on their balance sheets.

The Blockchain is the Settlement Layer

All on-chain crypto payments depend on a blockchain network.

A blockchain is a decentralized ledger that is shared among a network of computers, instead of being stored in a single central database. Once a crypto transfer is made, it gets advertised on the network.

In some blockchains, the process of verifying the transaction’s validity is handled by miners, while in others, it is handled by validators. This can encompass confirmation that it is correctly authorized and the same money is not being spent in an incorrect manner twice.

Valid transactions are added to the transaction history of the blockchain.

This enables two addresses on the blockchain to send and receive digital assets without having to update a blockchain’s ledger, which is what banks do.

But it is not the case that intermediaries don’t exist in all crypto payments. Exchanges, gateways, wallet providers, stablecoin issuers and fiat off-ramps can still be vital in the business of converting to traditional fiat, particularly for exchanges looking to serve a business purpose.

Wallets and Private Keys Make Crypto Payments Possible

Understanding crypto payments also requires understanding wallets.

A crypto wallet is not like a physical wallet where you keep banknotes, it “holds” the crypto currency. Instead, it handles the cryptographic credentials that control assets that are registered on a blockchain. A wallet address is the public address that a cryptocurrency can be sent to. Can be shared with someone else or be displayed as a QR code.

The private key is, on the other hand, used to allow transactions connected with the wallet.

Each user’s wallet when sending cryptocurrency signs the transaction cryptographically, without letting it be seen in the blockchain. The blockchain network can then verify that authorization.

That’s why it’s important to secure your private keys and recovery phrases. A person who obtains those credentials can be able to control the assets.

How Does a Crypto Payment Work Step by Step?

Suppose a customer wants to purchase a product using USDC.

1. The Customer chooses Crypto. The Customer selects Crypto.

When the customer checks out, he chooses to pay using cryptocurrencies.

Supported assets and blockchain networks are shown by the merchant or payment gateway.

2. A Payment Request is created.

The information needed for a transfer is created in the checkout system. This can consist of the quantity, cryptocurrency, network, destination address, and QR code.

A payment processor can also perform the conversion from fiat currency to crypto based on the fiat price of the product and keep the fiat price quoted for the product temporarily frozen, until it is actually converted and used.

3. Customer authorizes the transaction

Customer scans the QR code or opens the payment request from the wallet.

The customer reviews the asset, network, amount, destination and network fee, and confirms the transaction.

It is cryptographically signed by the wallet.

4. Transaction arrives at the network.

The signed agreement is added to the respective blockchain.

It is checked by validators or miners in accordance with the rules of this network.

5. The Payment Is Confirmed

After the transaction is confirmed or finalized according to the established requirements, the merchant or payment processor can consider the transaction as complete.

The transaction also gets an identifier, known as a transaction hash or TXID, which can be used to find it on a blockchain explorer.

6. The Merchant Receives Settlement

The merchant can get the cryptocurrency, other digital assets like a stablecoin or regular currency, from a payment provider.

The last step is relevant, the customer may pay for the asset the merchant ends up with, but it does not necessarily have to be the asset the customer pays for.

How fast are the crypto payments?

There is no universal crypto payment speed.

The blockchain, network conditions, transaction fee and the desired confirmation speed of the receiver, are all factors that affect the settlement.

Some blockchain networks can achieve transaction finality relatively quickly, others opt for longer confirmation periods as their intention.

Layer 2 systems can also process payments using infrastructure that is based on an underlying blockchain. This can be done through Ethereum Layer 2 networks or Bitcoin’s Lightning Network.

But it’s key to differentiate between blockchain settlement and full payment settlement.

A stablecoin can be delivered to the merchant’s payment provider in a relatively short time, but if the stablecoin must be converted and transferred to a bank account, the entire process may take longer.

What is the Advantage of Crypto Transactions?

An advantage is that it’s available. Typically public blockchain networks are not restricted to bank hours.

Crypto payments also offer alternative means of cross-border value transfer. Digital assets can be transferred to a business from customers in different countries without each trans-border blockchain transaction being dependent on correspondent banks. In addition, blockchain records allow transactions to be independently verifiable using explorers.

Another difference for merchants is that there is no chargeback for confirmed blockchain payments, which is true for card payments. While this is still possible, refunds will generally be issued as a separate transaction, not as a reversal of the original blockchain transaction.

What Are the Risks?

There are also other duties to consider with blockchain settlement.

Cryptocurrency purchases to the incorrect address or sent on an unsupported network will be very hard to recover. Normally, crypto payments are not built with the same type of reversion mechanisms found in some traditional payments.

Security is another worry with wallets. Lost assets can be caused by phishing, private key theft, malicious software or compromised accounts.

Other issues businesses must keep in mind are regulatory, accounting, tax and compliance matters in the jurisdictions in which they conduct business.

Some technical complexities may be eliminated by using a payment processor, but at the same time there is reliance on the processor involved.

Wrapping Up

Crypto payments aren’t just two wallets transferring coins—it’s a far more complex concept.

The modern transaction could involve wallets, cryptographic signatures, blockchain networks, stablecoins, payment gateways, liquidity providers, and fiat on- and off-ramps.

The process starts when a customer (or other user of the system) makes a “transfer” authorization. It is verified and recorded by the blockchain, and the method by which the merchant receives the value is determined by the payment infrastructure.

This is especially applicable to stablecoins, which not only provide a blockchain-based way to settle payments but also bridge much of the volatility that comes with traditional cryptocurrencies.

But it’s not to say that blockchain payments will supplant all card and bank transfers. Rather, they offer a payment channel one specially designed for digital assets and programmable money and transactions that require crossing borders.