Blockchain Applications in Cross-Border Money Transfer
Remittances and other cross-border financial payments are a large and technically challenging aspect of global finance. Because of the need for permissions and rules for use in cross-border payments, private blockchains are receiving increased attention in this space.
In conventional cross-border payments, the transaction is handled jointly by the Society for Worldwide Interbank Financial Telecommunication (SWIFT), and the banks involved. SWIFT specifies the exchange format and provides the network, and the banks do the debiting and crediting. This means that SWIFT and each bank can charge transaction fees, with SWIFT’s fees increasing according to traffic volume. While the correspondent banking infrastructure was ‘de-risked’ following the 2009 financial crisis, leading to fewer banks and correspondent accounts, this also created further delays in transactions.
The current system is flawed because it relies on these entities to overwrite and overturn transactions. The need to pass through several checkpoints before reaching their destination means that transactions take time to be resolved, and in some cases, the transfer protocol allows messages to be modified, such as for pooled accounts. There are also other message standards involved, like Fedwire and the Single Euro Payment Area (SEPA), which present added layers of complexity for each transaction.
SWIFT only offers secure transmission along with its network; the work of settling the accounts is left to the relevant banking institutions. Because these transactions are usually handled in batches, verifying a transaction can take days. The SWIFT system also does not sync the messaging done on its network with the actual payments, which can lead to security issues or denied transactions.
For blockchain technology to be effective in this area, it needs to address these factors — making transactions more private, more transparent, and more streamlined. Banks and regulators are still wary of blockchain currencies like bitcoin, and in some cases, it still might be easier to use conventional money transfer.
It is easy to see how blockchain technology can reduce the need for the current correspondent relationship between different payment systems, allowing for the direct bank to bank payments in lieu of Fedwire or SEPA. The distributed ledger can maintain independent records, removing the risk of interference by an intermediary in the transaction.
How might blockchain tech be improved to better meet the needs of cross-border payments? One potential avenue is to speed up transactions while maintaining the security of the blockchain. Bitcoin is difficult to use as a traditional banking system since each transaction needs to be verified by each node in the network. There are ideas for how to get around this, like dividing blocks further into epochs and designating a leader of each epoch to verify transactions. Banks are also experimenting with blockchain tech independently, on private blockchains. This localization allows for innovation without the need for banks to coordinate with other entities. In this way, the current cross-border blockchain space resembles the beginnings of the SWIFT system.
One question that comes with a distributed network of banking transactions is who would be eligible to make these transactions. Because of the level of trust established between banks, the current consensus is that banks act as network members, though most cryptocurrencies are made for anyone to use. A global network ledger would presumably have an admissions system and criteria, and another system to settle accounts.
Ripple is one example of a blockchain payment system that has some institutional attention. In this system, currencies are received and converted to the destination currency all within the Ripple network. While this seems like a superior alternative it is still up to the banks to integrate this technology, and it is yet unclear how or if that will happen.
The first blockchain cross-border payment was executed on the Ripple network by Standard Chartered and was completed in 10 seconds.
Ripple differs from the SWIFT system in that Ripple handles both the transaction communication and the balance settlement happen simultaneously. It uses messenger tools to connect payer and payee’s banks before the transaction, and the Inter Ledger Protocol (ILP) automatically settles the ledger once the transaction is approved. This ILP can also connect different blockchains to each other.
In the SWIFT system, where banks work out between themselves how the transaction will be connected, the Ripple system handles all aspects of the transaction. It can therefore offer competitive prices for each transaction as it determines the fastest path.
If the transaction is between currencies, Ripple will convert the payment to its own currency, XRP, and send that directly to the receiving bank. That bank will then convert the XRP to the local currency once the ILP confirms the transaction.
In order to prevent double-spending, the Ripple network requires each account to have a minimum balance and deducts a small amount from each transaction. This is also a way to address fraud, as these small transaction fees add up to large sums if many accounts attempt many small transfers as a means of overloading the network. Ripple also claimed to have much lower transaction fees than SWIFT.
While the Ripple network was originally developed by Ripple Labs, Inc., the actual payment network is operated by the banks that make up the network, and they can choose to develop it any way they see fit.
Other Tech in This Space
The blockchain network Quorum was developed by JP Morgan to process cross-border transactions and uses Ethereum as the means of exchange. This was developed as part of the Interbank Information Network, an initiative with 75 members.
Hyperledger fabric technology, developed by the Linux Foundation, is a blockchain technology being used in several payment systems. IBM uses Hyperledger for its Blockchain World Wire, and the CLS consortium of banks are using it for their own SWIFT competitor.
Stellar is another blockchain project, based off the Ripple source code, which differs from Ripple in that transactions can be made by the end-users rather than banks.
Bitcoin is also being used as a transfer medium. Align Commerce has a system that simply takes a payer transaction, and sells an equivalent amount of bitcoin to the payee in their currency of choice.
Corda is another example of distributed ledger technology designed to facilitate transactions and is maintained by a consortium of companies with R3, a distributed database company, as the leader.
Even for end-user systems like Stellar, the development and operation of these initiatives are done privately rather than fully public and decentralized like bitcoin. These systems also have the advantage over bitcoin of being able to maintain fast transactions. Private blockchains can also maintain user’s privacy at the node level, which would be vital for transactions between differing legal entities.
Though the many different blockchain initiatives have demonstrated success with transactions, there is still no standardization and regulation in this area. There is still work to be done in developing regulations specifying what users can be held liable for when making transactions.