Blockchain has long ceased to be the domain of tech geeks and enigmatic crypto traders that can recite Satoshi Nakamoto’s white paper by heart, enchanting the public imagination with its promise to disrupt industries from peer-to-peer payments to identity verification. It is hard to think of an industry more in need of disruption than that of cross-border payments. While sending money to a local recipient is a matter of searching for their Venmo nickname and coming up with a clever message to accompany the payment, an international payment can feel like a devil’s obstacle course.
While accounting for around $716 billion in P2P payments in 2019, according to the World Bank, cross-border transfers remain one of the most inconvenient consumer transactions, plagued with head-scratching processing times, notoriously exorbitant fees, and a troubling lack of transparency.
The Current State of Affairs
The World Bank estimates the average percentage transaction fee for cross-border remittances to be around 6.51% as of Q4 of 2020. The number is even higher for transactions initiated through banks, averaging a whopping 11%. An average international payment takes 2-3 days to clear, which stands in stark contrast to domestic remittances, which typically take a few seconds to show up in one’s bank account. This is especially troubling as the primary initiators of cross-border remittances are migrant workers sending money to their families at home, many of whom rely on these cash transfers for a large portion of their livelihoods.
According to the World Bank, remittance inflows accounted for as high as 40% of the GDP for some countries, totaling 716 billion in 2019. Lowering the cost of cross-border remittances has been adopted as a priority by the G20 governments over the past decade, with the international consortium making a commitment to lower the average transaction fee to 5%. Blockchain-based payment systems appear to be a promising way to achieve this goal.
Why Are Things the Way They Are?
Many of the issues with traditional cross-border payments stem from the high number of intermediaries in the form of correspondent banks that are involved in processing a transaction. Each additional intermediary drives up the processing fee, increases the number of failure points, and adds to the risk of fraud somewhere along the payment pathway. SWIFT, the international payments messaging network that connects the transacting institutions in international payments, is notoriously slow and subject to security breaches.
In 2017, the Central Bank of Bangladesh lost $81 million after hackers obtained the bank’s user credentials for the system and routed cash to accounts in the Philippines and Sri Lanka. Additionally, compliance with the patchwork of regulations that each bank is subject to makes it even more costly to complete the transaction. Blockchain allows banks to bypass these traditional payment rails by offering a secure way to record transactions in a distributed ledger without directly involving any intermediaries. Blockchain also decreases the risk of fraud and creates a higher chance of compliance with consumer data privacy regulations, as the transaction information is stored across a distributed ledger network that is very difficult to modify without the permission of all network members.
Players Entering the Market
A number of companies are entering the blockchain-powered cross-border payments market ranging from fledgling fintechs to legacy industry incumbents. Ripple Labs Inc. is a notable example of a fintech company emerging in the space, with their XRP currency and RippleNet payments network. Ripple claims to empower cross-border settlement and currency exchange in real-time by allowing banks and other money-transfer institutions to join their distributed ledger network and hold funds in the XRP tokens. According to Ripple’s CTO, David Schwartz, an average transaction takes no longer than 5-7 seconds to complete. The decentralized nature of the network offers a seamless alternative to the traditional caches of high fees incurred as a result of funds moving between correspondent accounts, the sluggish pace of the SWIFT system and lack of transparency that come with traditional cross-border payment routes.
In 2019, PNC bank was the first U.S. bank to join the Ripple network, offering its cross-border payments service to their corporate clients, according to Cointelegraph. Other high profile members of the Ripple network are Santander, MasterCard, and American Express. Last year, Ripple launched the beta version of Payburner, an integrated payments system and digital wallet, allowing users around the globe to make P2P and P2B payments in XRP in a matter of seconds. Payburner can be installed as a browser extension in Google Chrome and Brave, making it a readily available feature within the user existing digital eco-system.
IBM has also joined in the frenzy with its pilot distributed ledger international payments system called the IBM World Wire, allowing members to transfer funds and exchange currencies in the Stellar cryptocurrency. At the time of its launch, IBM claimed that the network supports payments across 70 countries, in 50 currencies and 45 banking endpoints. Stellar allows users to access its open source network and utilize their API to adopt their technology to specific use cases. Despite serving corporate clients, IBM’s offering is hopefully going to decrease the cost of cross-border remittances for end users.
General Adoption of Blockchain in Payments
Blockchain-powered payments have been around for quite some time, but not all consumers have been rushing to adopt them as their preferred value-transfer method. Since the inception of cryptocurrencies, the biggest obstacles to widespread adoption have been the difficulty in purchasing cryptocurrencies for lay users, as well as the lack of stability in their value. Over the past three years, the price of Bitcoin has fluctuated from a low of just over $4000 to a high of over $40,000 in the first weeks of 2021. Another obstacle is the relative novelty of blockchain technology and lack of adoption by consumers.
This is evidenced by the majority of respondents in the Mercator’s North American Payments Insights Fall 2020 Survey reporting that they are not familiar with cryptocurrencies and only 15% of respondents claiming to own crypto assets. PayPal’s recent move to offer users the option to send P2P payments in four different cryptocurrencies is a major step for widespread adoption of blockchain in cross-border payments. This was accomplished in partnership with Paxos, a provider of cryptocurrency and custom stablecoin payments integrations for corporate clients.
Regulators Are Playing Catch-Up with the Technology
The year 2020 has marked an important milestone for cryptocurrencies and blockchain as governments around the world are embracing blockchain technology by expanding the regulatory frameworks for the industry. The IRS has considered cryptocurrencies legitimate property since 2014 and has issued additional guidance regarding taxation of crypto-assets in 2019. Last year, the Chinese government went as far as creating a first central-bank digital currency with the launch of the digital yuan. The Russian government passed a far-reaching regulatory amendment to its existing cryptocurrency law that officially legalizes the trading of cryptocurrencies and requires citizens to report their crypto-assets. The fact that governments across the world are moving into the virtual currency regulatory space signals that the advancement of blockchain technologies for cross-border payments may see widespread adoption in the coming years. This may be especially true for cross-border payments in countries with governments that are under sanctions and have been threatened with expulsion from the SWIFT payment network.
Obstacles to Cross-Border Blockchain Payments
The biggest obstacles to the adoption of cross-border blockchain payments are the lack of clarity in the regulatory environment and limited interest among the incumbent players in the market. Taavet Hinrikus, CEO of TransferWise, a fintech company offering fast P2P cross-border payments at a fraction of the traditional cost, stated in 2018 that he does not see the benefits to his company adopting Ripple until more banks join the network. Hinrikus voiced his skepticism about Ripple’s ability to offer added operational efficiency to his company’s transfer system, which also bypasses the SWIFT system to speed up payments and reduce fees. Western Union, a more traditional player in the international payments space, had previously signaled its skepticism of utilizing blockchain technologies and chose to forego affiliating itself with Ripple.
Then in 2019, Western Union signed a contract with Coins.ph, a Philippines-based blockchain startup. The partnership allows P2P users of the Coins.ph app to send and receive money through Western Union, which, though not a blockchain innovation in itself, signals Western Union’s willingness to maintain a link to the industry. Another obstacle to the ascent of blockchain in the international payments space is the various regulatory ambiguities surrounding the industry. Ripple is currently the subject of a lawsuit filed by the U.S. Securities and Exchange Commission in response to their use of XRP tokens for fundraising. The SEC alleges that Ripple sold $1.3 billion in unregistered securities, using the proceeds to fundraise for the platform and bolster the personal wealth of the company leadership. Ripple leadership maintains that XRP is a currency rather than a security and, as a result, does not fall under SEC’s regulatory purview in the same way as asset classes that constitute investment vehicles.
The lawsuit has prompted some investors to turn away from Ripple, such as the cryptocurrency asset management firm, Grayscale, which divested all of its XRC assets. The result of the court proceedings, the first of which will take place on Feb. 22, will not only determine the fate of the biggest player in the industry, but also will set the tone for the regulatory landscape of the entire industry.
The Future Is Bright
The advent of blockchain solutions in the cross-border payments space is good news for both the consumers and the banks that are proactive in adopting the technology. It is likely that the era of waiting 3-4 days for settlement and 8% fees is coming to an end, and consumers will be able to enjoy faster, more reliable, and secure international money transfers. The banks that adopt the technology also will likely profit as it will allow them to tap into underserved markets and improve their bottom line by shedding some of the operational costs associated with traditional international payment rails.