LeoGlossary: Payment

Payments can take on different forms. Some are:

Payments are usually made in some form of currency. To create a quantifiable transactions, there needs to be a standard unit of account. Often this is solved utilizing the currency denominations associated with the legal tender.

Digital Networks

Much like the monetary system, communications is a large portion of payments. When dealing with a physical banknote, the payment is obvious. Over the decades, the move away from cash meant that we saw communication systems take over. At first they were electronic only to be converted to digital.

Network participants run ledgers. This is true for banks, credit card companies, or clearing houses. Regardless of what is used, ledgers are maintained to ensure adequate debits and credits. Money tends to be closer to accounting than traditional currency.

Visa is one of the largest payment networks in the world. Some feel this company is more akin to a computer infrastructure company than finance. Global communications is required for point-of-sale transactions along with settlement.

Even the central banks are in the the game. There are two forms of central bank money: banknotes and central bank reserves. The first is legal tender although waning in terms of usage. As for the latter, this is essentially a bank instrument.

The commercial bank network is tied to the central bank. When a transfer is made from an account, to one in another bank, settlement is required at end of day. This is done on a net basis at the moment although FedNow will operate with real time settlement.

Inter-bank settlement for depository institutions is done using central bank reserves. This is essentially one bank paying another the money it is owed. Central bank reserves are not physical in nature nor are they legal tender. They are use as an instrument of payment for these financial institutions.

Payments are transactions that appear on the ledgers of the participating banks.

Cryptocurrency

Cryptocurrency is a virtual currency that is built on a blockchain. Like most of the the modern system, this is ledger based money. Cryptocurrency only exists in digital form.

Blockchain is a series of nodes that run the software. This is called distributed ledger technology. Each node is responsible for keeping a copy of the ledger, which is updated by the block producers. This is no different than the ledger banks or credit card companies keep. Where the difference enters is in the control of the ledger.

Since a copy of the ledger is on unrelated nodes, there is no entity in control of it. Here is where the concept of decentralization enters. Depending upon the consensus mechanism, the transactions are accumulated, processed, and secured in a block. Each block is linked to the chain via hash.

Cryptocurrency is the ledger based money that operates on top of the blockchain. This is a peer-to-peer system allowing any wallet to receive money from another. That means every blockchain is, by default, a payment system if it has a cryptocurrency tied to it.

The first blockchain that solved the double spend problem in a decentralized way was Bitcoin. This was introduced by Satoshi Nakamoto, utilizing the Proof-of-Work (PoW) consensus mechanism. It is what is referred to as mining.

One of the problems blockchains faced, especially those using PoW, is scaling. For this reason, the Lightning Network was set up as the payment system for Bitcoin. This batches transactions on a second layer before sending them down to the base layer. It is a way to facilitate more transactions utilizing that coin.

Another difference with blockchain is there are payment systems without intermediaries. This reduces counterparty risk since dependence upon individual corporations or companies is removed.