We are about 7 years into Bitcoin and ‘the Blockchain’ now and its time we evaluated where we are in terms of remittances, what works and what doesnt. As a founder of Bitspark we know a thing or two about Bitcoin remittances, we’ve processed transactions for individuals, businesses, charities and all manner of service providers and we have also gained some insights along the way- I thought I’d discuss some of those examples below and hope to answer the question if Bitcoin can bring value to the remittance industry. Lets quickly recap the remittance landscape in general.
There is only really one datapoint to gauge the size for this $600bn industry, thats the work done by the World Bank (new startup opportunity: be a data aggregator for this space). Remittances are a growing and critical lifeline for many people and countries around the world, as demonstrated clearly by Tajikistan where 50% of the country GDP relies on remittance income. Remittances are generally a result of migration flows around the world, often workers from developing and emerging market countries taking up jobs elsewhere and sending their newly earned cash back home. Billions of people do not have bank accounts, get paid in cash and smartphones are only just now becoming viable in developing countries globally with the emergence of low cost Chinese Android phones. Currently the vast majority of transfers happen through Money Transfer Operators (MTOs), cash money exchange shops on a street corner- a market which is very established with a few vendors with a dominant market share: Western Union, Moneygram, Ria, and others. So can Bitcoin make an impact as an intermediary for exotic currencies not often traded? Can it help deliver cash on the ground quicker and cheaper? Theres a lot of methods to approach remittances- from private blockchains, consortiums, apps, FX dealers to decentralised cryptocurrencies, lets explore some of them.
What doesn’t work for exotic currencies
Traditional FX integrations:
Only a tiny minority of currencies in the world are freely floated and exchangeable outside their country of origin. There are many online FX brokers who generally focus on the top 8 currency pairs (USD, EUR, AUD, GBP, CAD, JPY, SGD, HKD). Prices are as good as they get here, spreads tiny but these are the currencies of rich countries and not of the recipient nations of remittances globally. There are of course other currencies that are freely traded but if we are to solve the issue of remittances globally, we need close to 180 currencies to be able to be transacted easily and cost effectively but this is not currently possible. So FX providers and websites providing FX services are great for B2B payments between the above currencies and there is an immense market for that but this is not the use case we are discussing, the use case we are interested in is that of cash distribution on the ground to individuals in currencies and countries that are often not well connected to the financial system. FX providers work fine, however more is involved to deliver cash to the street corner where its needed by the recipient.
P2P netting of payments:
Transferwise and Currencyfair popularised this model, banks have been doing it for decades. Essentially transactions going from A to B and B to A can be ‘matched’, and instead of actually transferring the money via the SWIFT network you can keep currency A and B in country and the ownership of those balances will change to be withdrawn domestically via lower cost domestic withdrawal methods. A neat idea, however it works only for the most frequently traded and transacted currency pairs where there is an equal amount going each way to ‘match’.
For the big remittance recipient countries, there are always more transactions going there than is coming out, so matching an equal number of transactions to and from is mathematically impossible. At the end of the day you will need to send money to the destination and how will you do that? Likely a bank to bank transfer which for exotic currencies are always expensive. So you are not solving any problems here and will be subject to those higher exchange rates at the end of the day and will need to use traditional forms of settlement.
This model is still trying to establish itself via mobile apps but fundamentally it actually is based on an ancient system that has been in operation for thousands of years called ‘Hawala’. A pays B, B has a balance with C, C pays D. There can be many links in the chain and the links in the chain each net payments between each other or settle between each other at a later date. The people I’ve spoken to in the industry estimate the size of the hawala payments ecosystem is 2–3 times the size of the official World Bank figures as its currently an ‘underground’ payment network, but often the only option for many people. Mobile apps try to make this more efficient by digitising the connections between people. However people need to trust the places they are putting in money and receiving money. The usual workflow is deposit money with someone on the app, then the person at the other end will withdraw it from someone else at the recipient end. P2P apps generally want to try to connect you to people who can act as links in the chain nearby however some guy on the side of a street you track down via a dot on GPS doesn’t exactly illicit trust. So the logical conclusion is you onboard trusted entities who deal in cash….the Money Transfer Operators (MTOs- physical cash money transfer shops). However MTOs are not about to ditch their complicated compliance and remittance system for a mobile app as the amount of details and reporting requirements necessary is not something you can distill into a few buttons.
Even if you assume the most optimistic scenario where lets say people trust the guy by the side of the road and send P2P, how will it be scalable for that person to handle hundreds or thousands of transactions via an app which will eventually attract attention of government agencies who will force that person to become a licensed agent in which case a mobile app doesn’t provide the functionality required for licensed money transfer agents and they’ll need to ditch the app to use the incumbent providers anyway. Getting money into and out of the app is the hard part. If I give the guy on the street $100 to send to some pre-determined other person using the app in another country, the guy I give the $100 to has to have pre-funded his app with at least $100 worth of something, he needs to get the money in somehow. Also the person distributing it at the other end is credited in their app with the balance, but they just gave away cash, now they need to get their digital balance back to cash- how will they do that? Via a bank transfer most likely and likely your app company wont be able to transfer you any of the 180 currencies worldwide, even if they have a bank account which 2 billion people dont.
Hawala has been working for centuries but it will just take time for people to adjust to applying it with new technologies. In our experience we have found many foreign workers sending money home often have long established trust with the shop they send money home with or the guy on the motorbike who collects their cash at a construction site- switching to something new is daunting and it is also why bitcoin ATM powered remittances havent taken off, nobody trusts new things. This is a battle that for P2P apps to be viable in the short term they need to integrate with legacy cash in / cash out points.
If you are a bank, a private blockchain may offer a few benefits to you in settling payments between your intermediaries or other banks in the same currency. However when other currencies are involved the lines get blurred and there is no way to avoid the global FX markets. If you have a tokenless blockchain (that is, a unit of account that does not have a floating open market price) there is no ‘value’ to transact across borders, it is merely a database entry at either you or your connected intermediaries- this is possible without a Blockchain. If you have a Blockchain with an underlying value token, you need buy-in from entities in your private blockchain system other than yourself to act as counterparties and regardless of how you structure it, it will never be as liquid as the global FX markets. There may be a case to be made for exotic currencies which are not currently traded or adequately connected to global FX markets but settling payments across currency pairs requires liquidity.
A private blockchain requires buy in from entities other than yourself, so the solution may be to setup a consortium to debit and credit balance between consortium members using a Blockchain as an asset tracking database. Indeed, asset tracking via a blockchain is a sound use case, but perhaps not related to the problem we are attempting to solve here. Banks settling payments between each other via a blockchain is not going to impact the world of developing countries’ remittances anytime soon.
What could work:
Consortiums in this space might be setup to debit and credit payments between each other are an efficient way of settling payments without moving armoured vans holding cash across borders but it requires everyone to be on the same page (or ledger). Everytime consortium members interact they are generating credits and debits with each other digitally for settlement at the end of the day, digitally. If I have $100 of payments going to one bank and they have $50 of payments coming to my bank daily, instead of making two transactions, I will simply make one to them for $50 at the end of the day netting off the remainder (100–50=50). A more efficient way to handle things.
In the above diagram, two banks are involved in a transaction where Bank A is sending Dollars to Bank B in exchange for Euros. We will assume this consortium runs without the involvement of a Central bank in this process and consortium members are transacting privately between themselves. The diagram demonstrates the process by which a dollar balance is debited from Bank A, dollars are credited to bank B, Euros are debited from Bank B and credited to Bank A.
In this simple process both banks need sufficient Dollars and Euros in their designated accounts to make this happen, so they need to apportion appropriate liquidity to be made available the consortium. It also requires both banks to have balances in those corresponding currencies, this is easy with popular globally traded currencies like USD which, as a reserve currency, all banks hold a portion of but for a payment between Nigerian Naira or Thai Baht, its not so easy. If the counterpart to the transaction doesn’t actually want the currency you are offering you have a problem, who will you trade this currency with? The likely solution is trade a currency everyone wants, something with a ‘value’ to both counterparts, like a reserve currency like USD (or maybe, Bitcoin). Exchanging a reserve currency means you would need to exchange Nigerian Naira for USD then USD to Thai Baht- this is called a ‘cross-rate’.
While there may not be a big market for Naira to Baht transactions, the point is you need your consortium to be able to adequately provide liquidity in exotic currencies for it to actually mean anything for remittance companies. If remittance companies themselves made their own consortium directly this may be solution, as holding balances in exotic currencies is what they do for a living so liquidity would be there, however those balances at the end of the day would all be held by banks so ultimately the banks would have the last say. A remittance company consortium would also need buy in from lots of different players and in this industry who often don’t want to even talk or engage with each other let alone develop some project hand in hand.
More importantly, to settle the balances accrued between consortium members to actually get the cash at the end of the day (not just a balance in someone else’s consortium account) would require either a central bank or existing central bank authorised system to be involved to act as that settlement system (like Swift), otherwise you merely have digital accounts at other banks which in order to clear must pass through existing RTGS/Swift infrastructure at a central bank anyway. So clearly the optimal solution involves the use of Central banks at some stage in the process. Or you could bypass everything and use a token of value like Bitcoin for settlement but we’ll get to that.
What can work
Central Bank Blockchains
I described this in a previous blog post here the use of a Blockchain type system is inevitable for central banks- it offers them the control and oversight they want while also removing inefficiencies in the existing monetary system, give it a read if you haven’t already. All private banks dealing in a national currency would also be participants in the blockchain and be running the same ledger- any transactional payment metadata can be associated with the Blockchain transaction is in built into the currency itself. This provides the benefits of a consortium described above (all on the same ledger debiting and crediting balances on the ledger) and also effectively handles end of day clearing which in the above private consortium model requires the use of a thirty party (RTGS, Swift etc) and ultimately needs to happen at the Central bank level anyway.
Central banks are not innovators or anywhere close to it so it will be slow for this to catch on, eventually however it will be inevitable as it aligns with their goals: more control over monetary policy and better oversight of their licensees- blockchains do that for them, so they will do it eventually guaranteed. Various central banks have been talking about blockchain pilots and as competition between jurisdictions in this space heats up (we are already seeing this with various ‘fintech rankings’ of regulators). However this is all well and good but its not going to help our need for improving the remittance processes on the ground today.
Cryptocurrencies- Using a token of value:
Physical money transfer shops have customers because they are trusted entities dealing with physical cash. Doing trading between currencies is easy, providing a way for people to actually extract that money as cash in their hand is the hard part.
There are a few Bitcoin →cash startups around the place, and there is space for 10x more of them, in every country, in every currency, an essential part of the ecosystem. But also these brokers need to have access to local forms of payments. Maybe people in one country predominantly get their cash and pay bills at a 711 whereas other countries people pay with prepaid RFID cards, whatever the payment method its important to have companies on the ground who understand this and can offer their services using the local mechanisms while accepting Bitcoin in exchange for these localised payments. The problem Bitcoin is solving here are:
- Less capital requirements, no need to batch payments and hedge currency risk as each transaction can be traded and settled instantly no matter the size. Currently its impossible to make a viable business of sending $200 internationally and paying a $20 wire fee, so companies do batch payments where they will transfer $10million in one payment for $20, much more efficient. However before they actually send that $10million they are committing to payout the people sending money at the other end at some establish exchange rate, they are ‘taking a position’ in that currency pair of $10million in advance.It means they need $10million sitting there to take that position while they have cash piling up on one side of the transaction and cash being paid out on the other side. With Bitcoin you don’t need to take that $10million position you can transfer each individual $200 transaction individually for close to no cost internationally. Game changer.
- Efficiencies in pricing of exotic currencies. Emerging market currencies are notoriously hard to deal with. What if I want 5000 Liberian dollars right now, how can I make that trade? Normally it requires various antiquated in-country mechanisms, bank contacts, accounts, shaking the right peoples hands and ultimately settlement through the US dollar- a very time consuming and costly process. However Bitcoin is traded 24/7 around the world at the touch of a button. If I can trade directly into and out of Liberian Dollar via a freely floating Bitcoin market then that is much more accessible, cost efficient and timely.
- Lower overheads for new companies in the space. Starting a remittance company using Bitcoin as an intermediary mechanism can be done cost effectively without needing to deal with legacy companies in the space. If you don’t need to deal with expensive banking infrastructure and FX brokers and can do it all yourself it means more new companies can enter the space and provide a competitive alternative.
Bitcoin is tradable globally, which is a great start when looking for a payment rails that can service multiple geographies, currencies and users. In the case of a remittance company, in order to accept cash from your customers and send it elsewhere you need those connections ‘elsewhere’. Often when dealing with multiple countries, payment methods and regulations, payment processors tend to only specialise in the few countries they cover which means potential cash remittance shops need to integrate with many payment processors to offer a service with full coverage in the areas you are interested in. The ‘last mile’ is an essential part of this and in our case we connect all the existing last mile providers and act as the bridge between them. Existing last mile providers are our friends we don’t seek to disrupt their business but only seek to offer them efficiencies in their business.
Cryptocurrencies- Pegged Crypto’s
One of my favourites for a while now are pegged crypto’s, particularly the decentralised kind, like Nubits. While the Nubits project has had some hiccups of late I think the idea is intriguing. Essentially these pegged crypto’s are a token of value that adjusts automatically to market conditions to maintain a peg to a chosen fiat currency or commodity. If the price rises above the peg, more tokens are created for wallet holders, if it falls below the peg, tokens are removed from circulation by offering wallet holders a market defined interest rate to stake them (remove from circulation) for x period. Peg pricing information can be taken from a network of Oracles. Very cool and before long we’ll have 180 parallel FX assets. However it only works if its decentralised, if I have to trust any company or single entity along the way for a pegged crypto it becomes uninteresting and subject to all the common problems associated with holding customer funds and will get shut down. The 180 parallel FX assets cant be understated, this will be huge, if it costs me nothing to trade into and out of a token of value for exotic currencies this will be a massive boon to the remittance industry.
Thats a lot of stuff to consider but have we got closer to answering the question if Bitcoin can provide value to the industry? I agree with Moneygram’s recent comments that while it’s useful to watch how it evolves its not something big players like themselves can wade into yet for a number of reasons. If a big conglomerate were to wade in, as discussed earlier a private blockchain without a token of value and no counterparty would not solve any of their problems, money still must be moved somehow. So the other options may be to make/join a consortium (remittance companies notoriously hate talking to each other) or to use a common token of value and if they were to do the latter they’d need to be massively involved- setup an exchange, maintain banking relationships at both ends, support it with lots of liquidity. Thats probably not something they’ll do but if they did it’d only be good news for the bitcoin industry and support the growth of many bitcoin startups.
Yes, the truth about Bitcoin remittances is that Bitcoin can and already does bring value to the remittance industry and does provide a solution for trading into and out of exotic currencies. There are many new companies in the space making it happen but for their business model to be viable they will need to focus on streamlining the on and off ramps into the system. As a token of value it is reducing barriers to entry, simplifying back office work for new companies in the space and at the end of the day providing superior pricing to end users even when taking into account the last mile, it’s going to be a very exciting 2017.