Visa's New Opportunity In Blockchain

| About: Visa Inc. (V)

Summary

Visa is testing a new blockchain project for interbank lending.

Blockchain is a threat to Visa's business, but company's entrenched ecosystem can work to its advantage as it adopts new technologies.

Visa's attempting to build early-mover advantages in the blockchain, and investors should expect Visa to continue to pursue opportunities in this area.

In the latest step to increase the company's exposure to blockchain technology, Visa (NYSE:V) announced that it would allow select European banks to test its new blockchain-based interbank payments system. Visa partnered with BTL Group, a digital-payments start-up firm, to apply its blockchain technology that could make interbank transactions more efficient and potentially challenge the SWIFT system used by banks today for settling and clearing transactions between parties.

Visa views new mobile-based payment systems as a disruptive threat to its underlying business:

The global payments industry is intensely competitive and, as a result, our payment programs compete against all forms of payment. These include … electronic, e-commerce, virtual currencies and mobile payments, as well as traditional card networks. Our position in the payments value chain is key to our business. Some of our competitors operate payment systems with direct connections to both merchants and consumers without any intermediaries. These competitors seek to derive their competitive advantages from this business model.
- 2015 Annual Report

Visa's entrenched competitive advantages are so strong that we believe blockchain is perhaps the only thing that could compromise the firm's competitive position. Visa derives its strong market position from massive scale and network effects. The company accounts for almost half of all credit card transactions and nearly three fourths of debit card transactions, and this makes Visa an essential intermediary: the greater the number of consumers that use Visa's payment systems, the more valuable Visa becomes to merchants, and as more merchants accept Visa's cards, it attracts more consumers.

Blockchain, which is essentially a "shared digital database that allows transactions to be recorded and verified electronically over a network of computers without a central leger" could compromise Visa's advantage. It allows parties to connect directly from online networks, and could potentially make middlemen obsolete. But when it comes to adopting new technologies, Visa's strong market position works to the company's advantage, and we think that new payment methods will more likely integrate with Visa rather than replace it. If Visa can incorporate blockchain technologies into its payment infrastructure at a relatively early stage, it can mitigate the threat of disruption through these network effects. It appears this is what Visa is attempting to do as it applies the blockchain to interbank lending.

We believe this project has potential in the long-run. The blockchain could lower costs for banks, reduce settlement times, and minimize the credit risk involved in interbank transactions. We think banks would be willing to adopt it, given how challenging the current environment is for them. Stringent regulations and low interest rates are weighing on the net interest margins companies can generate from their core banking operations, forcing banks to come up with new ways to trim costs and become more efficient. We think these challenges will persist, which will support demand for such a service going forward. The project would also reduce regulatory risk for Visa. The company's practice of price-gouging merchants has caught the eye of regulators, and there are fears that regulators will implement stricter pricing policies in the future, which would dent margins for Visa.

Conclusion

Visa is fully aware of the disruptive threat that the blockchain brings, and is doing what's necessary to mitigate this threat by integrating it with various operations, including micropayments, machine-to-machine transfers, business-to-business payments, and now interbank lending. We think there could be a strong demand for block-chain technology from banks, as low interest rates will continue to be a headwind and banks are running out of ways to cut costs. Visa's massive scale and entrenched position will play to the firm's advantage as it adopts new technologies, so long as Visa integrates them early before swell to a scale large enough to put Visa's businesses in jeopardy. We expect Visa to continue to pursue opportunities in the blockchain as the firm seeks to build early-mover advantages.

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