Sending international payments can be a massive pain. Particularly, if you are in a country that has only a few good options to receive money from abroad.
It seems obvious to us crypto folks. Send someone Bitcoin
: problem solved?
Yet, much of the non-crypto world doesn't realize or agree with the upsides of using crypto for cross-border transactions. In all fairness, crypto does have some downsides, too.
This article compares different cross-border payment options and explains how they work:
But first, let's look at what international payments are and how they work.
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Cross-border payments are transactions where both parties reside in different countries and use different currencies (surprise, surprise).
They are more complex than domestic payments for several reasons:
- They involve different national legal and regulatory frameworks.
- Banks have to swap currencies.
- Transactions may have to be executed across time zones and operating hours.
- Several intermediaries and financial market infrastructures are involved.
There are two types of cross-border payments: retail and wholesale payments.
Retail is the type you may have used before:
- Paying a business abroad.
- Sending money to someone in another country.
- Buying something from another country.
Wholesale payments include high-value transactions between commercial banks. These can also be batched retail transactions. Furthermore, there are transactions with and without foreign exchange conversion. For instance, payments in the EU can be across borders, but the currency remains the same (euros).
Why are cross-border payments so interesting?
Because Oliver Wyman reports
that "Global corporates move nearly $23.5 trillion across countries annually, equivalent to about 25% of global GDP
." They also incur "transaction costs of more than $120 billion per annum
." That's a lot of money that can be saved. Those costs
are incurred across different domains:
- Operational costs
- Compliance with AML regulations
- Foreign exchange swaps
- Liquidity requirements
Ideally, we'd want international payments to comply with regulations, be fast, efficient, instantaneous and support many different currency pairs. Yup, that's quite the wishlist.
With that said, let's see how different international payment options compare.
Correspondent banking is the traditional way of wiring money using banks. It is also a handful to explain.
In the most basic terms, correspondent banking involves three banks. One each for the exporter and importer of the goods in different countries and two correspondent banks used as intermediaries.
Why do we need those?
Because they take on the operational tasks and risks of sending the money across borders and swapping it for the right currency.
Here's a visual explanation:
Say you import fridges from the EU to the US. Your bank (sender bank) debits your account but does not have access to a EUR account to pay the exporter. It has to contact a correspondent bank that can make the payment to the European exporter. The correspondent bank swaps USD to EUR at the central bank and sends it to the exporter's bank account (recipient bank). The exporter ships your fridges to the US. You pay for the imported goods and a fee for the services of the correspondent bank.
Since banks process many cross-border transactions, they use so-called nostro and vostro accounts to keep track of the money. Nostro stands for “ours” and vostro for “yours.” Money in nostro accounts is money belonging to bank A but held in an account by bank B. Money in a vostro account is money belonging to bank B but held in an account by bank A.
International wire transfers use the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, a global payment network that facilitates the transfer of funds between banks and other financial institutions. SWIFT works by sending payment instructions between two banks, which are then processed by the receiving bank. In contrast to correspondent banking, the two banks do not need to have a direct relationship. This makes it easier and faster for banks to send and receive payments internationally.
Pros and Cons of Correspondent Banks for International Payments
Correspondent banking is good because, well, we know it works. It's cumbersome and relatively expensive (up to $50 per transaction), but it's tried and tested. Also, in developed countries, most people have a bank account, so the reach is good.
There are also a ton of downsides to it:
- Many intermediaries slow the process down.
- Payment systems and settlements are not always instantaneous.
- Payment message formats and AML checks need to be automated to not slow the process down further.
- Operating hours and time zones are other sources of friction.
Thus, while being the most widespread option, correspondent banks create friction for bigger players (delays) and smaller ones (transaction fees). And that is before considering that correspondent banking in developing countries is more complex and more expensive due to higher risks and AML regulations.
Fintech companies like Revolut, Transferwise and WeChat (China’s super app with payments function) have been disrupting the international payments niche for a while. They stand out with lower fees but offer much faster settlement times. Where banks take days, fintechs can send money across borders in hours or even minutes.
Fintechs leverage having fewer intermediate layers. They either have banking licenses and direct access to central bank money or control the subsidiary banks needed to make the payments. Either way, a fintech company works with one balance sheet across different currencies.
On the customer side, fintechs follow a simple process. Either the account has to be credited first via a wire transfer, or the fintech can transfer funds directly from the payer's account (with their consent). Recipients simply have to accept the incoming transfer as long as they have their bank account linked to the fintech as well.
Pros and Cons of Fintechs
Reliable recent data is hard to come by, but the presence of fintechs is more palpable by the day. This isn't surprising, given how much more convenient a Revolut or Wise transfer is compared to a money wire. Especially high-volume FX pairs like USD/EUR and other highly liquid currencies are easy to manage. The focus on payments and the systematic use of new technology has allowed these companies to take market share from established banks.
Still, fintechs aren't perfect. Less liquid currencies aren't supported. An even bigger problem is liquidity
. Wholesale payments or bigger sums entail regulatory challenges, but these companies do not always have the appropriate licenses to solve them. Still, fintechs are growing fast for a reason.
The boogeyman of the crypto industry. Almost all countries have released one or are planning to do so in the near future.
Read this article for a complete overview of CBDCs.
The technical side of CBDCs is not too difficult. Depending on the design of the CBDC
, the retail customer holds either an account with a commercial bank and access to central bank money or an account at the central bank itself. Almost all CBDCs follow the former approach to retain the business and goodwill of the commercial banking sector (among other reasons).
The goal of cross-border CBDC payments is to make them as fast and frictionless as possible. A payment in digital dollars to digital euros should, in theory, be near instantaneous if the two systems are connected.
Pros and Cons of CBDCs for International Payments
Though disliked by most in crypto, CBDCs are not only bad
For one, they would be efficient and convenient. Further, they would allow states to onboard all their citizens to the financial sector. And yes, they would preserve monetary sovereignty (to a degree).
But, of course, they could come with privacy concerns
and can be weaponized for political goals
, both foreign and domestic.
Moreover, CBDCs could undermine the competitiveness and credibility of the banking system
. In the worst case, they could distort credit creation and lead to citizens and businesses only accepting CBDC money because it's the safest. This would concentrate enormous power in the hands of the central bank, with possibly unpredictable consequences.
is a "peer-to-peer electronic cash system." There is good reason to believe that the entire point of Bitcoin
was to become a frictionless medium of exchange
that disrupts existing solutions. Other coins like Ethereum
also fall into this category. But Bitcoin is probably the most widespread non-stablecoin used for cross-border payments
Of course, the mechanism is well-known. All the two parties need are two Bitcoin addresses, which are free to create. Settlement is comparably fast. Transaction fees are comparably low most of the time. Once you have bitcoin, sending it is easy. But there are downsides, too.
Pros and Cons of Bitcoin for International Payments
Some problems are well-known attack vectors: BTC is too volatile
, and it can be used for illicit payments
But even those get exaggerated a fair bit. For one, Bitcoin's volatility is currently at an all-time low:
Second, most bitcoins are acquired through centralized exchanges
(CEXs), which nowadays all require KYC
checks for meaningful sums. Although 'anonymous' bitcoin does exist on peer-to-peer
exchanges, the use of crypto for illicit purposes is minuscule. Chainalysis found
that only 0.24% of all crypto transactions in 2022 were made for illicit purposes.
But that hints at the real problem
of using BTC at scale for international payments: it is a fairly siloed ecosystem with few entry and exit points
. Without centralized exchanges
, it's difficult to get BTC. It's certainly not feasible to do meaningful business in Bitcoin. Moreover, its long-term security model
is not sustainable without increased use as a medium of exchange — so custodians are needed again.
Bitcoin's advantage is that it's "outside money" that is difficult to seize. That also makes it a suboptimal candidate for cross-border payments.
Stablecoins are the elephant in the room. Unlike other crypto liquidity, stablecoin settlement volume has been growing in the bear market of 2022:
Source: The Block
Stablecoin settlement works just as Bitcoin. But stablecoins have quite a few legs up on BTC when it comes to cross-border payments.
Pros and Cons of Stablecoins for International Payments
Obviously, stablecoins eliminate the (short-term) volatility of Bitcoin payments. That is a massive plus for any kind of payment. They are also technologically efficient and provide economies of scale — the more volume a stablecoin issuer settles, the more trustworthy it becomes and the easier it can access further liquidity.
Stablecoins provide access to dollar liquidity for those who don't have it. Consider the following thought experiment:
But stablecoins also have downsides, if not for the individual user, then in the grand scheme of things:
- Their economies of scale mean the stablecoin market is an oligopoly.
- They are not (yet) as widely accepted as fiat.
- Transactions can be frozen.
- They are not capital-efficient since they need to be fully collateralized (in theory).
- They undermine the sovereignty of non-dollar currencies.
You can argue the latter two can be advantages since stablecoins increase the demand for treasury bills and bonds if backed by real-world assets
and spread the power of the dollar, especially to countries with a devaluing currency.
What is the best way to send international payments?
Truth be told, there probably is no one best way.
Even a cumbersome and inefficient solution like correspondent banking still has its place because it can cover wholesale transfers and adhere to AML
But the sector is ripe for disruption, and digital currency transfers, especially stablecoins, may likely continue to gain further market share in the future.
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