Blockchain Semantics Insights
Business Case | Deep Tech | Announcements | Blockchain Glossary |
Cross Border Payments Using BlockchainMarch 3, 2018, 1:18 p.m. GMT
Cross-border payments are one area of the banking sector that has yet to benefit from recent progress in digitalization. Most international transactions are still processed using a 600-year-old correspondent banking system. This system of manual entry of transactions is not a scalable solution for the flourishing digital payments space. While this may seem like an issue for institutions, a huge segment of the population can benefit from the technological advancements in this sector. Remember we do not need banks, but do need banking.
The global payments industry is undergoing a fundamental change, thanks to Blockchain.
Since entering the world in 2009, Bitcoin has enabled low-cost and transparent peer-to-peer transactions. Today it lives on - amid its highs and lows - as does the blockchain, which is gaining the attention of various industries who are realising the benefits it can provide. Arguably, it’s the global banking system that could benefit from blockchain whether that’s through settlements or cross-border payments.
According to a McKinsey & Company 2016 report, in 2020, the global payments industry will generate an estimated $2.2 trillion in revenue, over $400 billion more than 2015’s $1.8 trillion figure. Looking ahead, digital innovation is expected to continue being a primary disruptive element in the payments arena. However, in order inr banks to remain competitive in this changing landscape, they will need to drop their back-office costs for international payments by 90-95%, the report states.
Problems with the existing system
There are two key issues with the prevailing system of cross-border payments:
- The cost of transfers
- The duration
On an average, most transactions take two to three days to process. The lack of traceability does not help. On the cost front, post offices and money-transfer operators charge over 6% of the amount remitted and commercial banks charge around 12%.
New and improved technologies, such as prepaid cards and mobile operators, resulting in lower fees for sending money home. However, these technologies are not yet widely available or used for many remittance corridors.
The current system has multiple problems, it is deeply integrated and thus difficult to disrupt. As of 2015, SWIFT, the most widely used payment interface linked more than 11,000 financial institutions in more than 200 countries and territories, who were exchanging an average of over 15 million messages per day. It has become as popular as VISA and MasterCard in the international payments space. It does not mean, however, that it is as efficient.
The presence of a large number of middlemen makes SWIFT slow. The majority of its clients have huge transactional volumes, making manual entry of instructions impractical. The need for automation of SWIFT message creation, procession and transmission is urgent.
This is where the Distributed Ledger System of blockchain holds promise. A distributed ledger means that no single authority, like a clearinghouse, needs to verify or execute transactions. Instead, the participants themselves have computers that serve as ‘nodes’ within the network, which add time-stamped blocks of transactions to form an immutable database.
A number of industry players are already exploring the possibility of using a distributed ledger to cut down on cross-border costs and help speed up transactions. With consumers requiring faster payments and improved customer service around international transfers, blockchain has the potential to change the global payments market and end the expensive system we are currently forced to use.
DEVELOPMENTS IN THE BLOCKCHAIN FIELD
Ripple and Stellar are the major actors leveraging the blockchain in India’s banking sector and the major ones addressing the cross-border payments but with different approaches. Ripple has used the consortium of banks that use its technology to form a ‘global payments steering group’ to take advantage of the network effects. It includes some of the biggest banks around the world, including Bank of America, and Standard Chartered, Mitsubishi, Barclays, Santander. Axis Bank and Yes Bank are the only Indian banks that are a part of it.
Stellar, on the other hand, is an open-source platform that can be adopted by any organization. Recently, IBM decided to partner with Stellar to develop a solution addressing the issue. In this battle of cross-border payments, the incumbent SWIFT is still the Goliath. It is not easy to topple a recognized organization such as SWIFT, which has a significant advantage with its 11,000 partners.
Recently, however, even SWIFT has decided to test the blockchain technology. As part of its global payments innovation (GPI) initiative to modernize the cross-border payments system, it has tested some proof-of-concepts to supplement its current framework. While these are the established blockchain networks, Indian banks have taken the route of forming its own consortium ‘bankchain’ on a separate blockchain platform. Announced in February 2017 by SBI, the network has grown to 24 members, including international banks, with the aim of exploring, building and implementing blockchain solutions in the banking sector. It currently has 10 active projects underway, such as shared KYC, syndication of loans, virtual currencies and 12 cross-border payments. While it is an exciting initiative with bright prospects, it will be interesting to see if they embrace or fight the international counterparts who benefit from a broader global network and have already started gaining traction in India.
DIFFICULTIES IN IMPLEMENTATION
As with any new technology, there are some difficulties in adopting the blockchain. Even with all its benefits, the technology brings with it the notorious reputation of cryptocurrencies.
Since its inception, Bitcoin (the biggest cryptocurrency) has been associated with illegal activities such as drug trafficking and extortion, due to its ownership anonymity. Although, recently, exchanges have been forced to implement KYC (Know Your Customer) and AML (Anti-Money Laundering) norms, the anonymity aspect remains.
Other cryptocurrencies, too, have faced their fair share of controversy. Unlike Bitcoin, whose creator is still unidentified, XRP (Created by Ripple) is backed by an enterprise that makes it easier to be held accountable for its actions. In May 2015, the Financial Crimes Enforcement Network charged Ripple with a US$700,000 fine due to its non-compliance with KYC and AML laws.
Going forward, while it may be easier for Ripple to monitor its transactions due to its B2B nature, authorities will still be skeptical of other cryptocurrencies that make it difficult to track their holders.
Blockchain’s benefits to India
India, the biggest receiver in the cross-border remittance market, can benefit immensely by adopting the blockchain technology. A major problem in the current system of payments is that there is an inverse relationship between the size of transfer and the fees charged. Since blockchain does not discriminate between the transaction sizes, the low cost of transactions will allow a whole new demographic to participate in the cross-border payments space. Much of the population still relies on an informal or alternative remittance system (better known as ‘hawala’) that allows both domestic and international transfer of funds due to its cheap and fast nature. The informal and illegal aspect of that system makes it difficult to estimate its exact size, but there are reports approximating it to be around US$100–200 billion.
Formalizing even a fraction of this amount will be of great benefit to banks and citizens alike. It will also be the ultimate test of this technology. According to Ripple, the leading blockchain network in the banking sector, the global payments costs can go down by up to 60% through the implementation of its blockchain network.