Sending money digitally across countries can be challenging. Beneath the surface of global payments systems lies a shaky framework that has held banking operations for decades. Making money wires across borders is usually expensive and error-prone due to the intricate operations involving intermediaries. Banks complicate things further with different regulations and exchange rates. Cultural differences add another layer of difficulty.
To add complexity, wire transfers must go through a tangled web of compliance standards, coupled with the logistical hurdles of time zones and business hours. Sometimes, it can take up to five business days or even longer for an international wire transfer to be completed.
In this article, we'll look at challenges in the global banking system, SWIFT's efforts to adapt to the current needs in cross-border payments, and the higher efficiency of blockchain technology and cryptocurrency. We will also analyze the pros and cons of central bank digital currencies (CBDCs) for everyday use.
When in need of cross-border payments, traditional banking currently faces challenges in efficiency, lagging behind newer and more advanced systems.
Nowadays, the industry is mostly about software. Digital financial services firms that are essentially software firms are teaming up with banks to incorporate financial products into an easy-to-use experience, modernizing traditional banks. While this approach is innovative, it does not necessarily mean better banking. It's essentially just software innovation built on the same old and outdated infrastructure.
When considering real intrinsic value, having a slick interface does not translate to faster banking. Examples are online payment platforms like Paypal or Stripe, which claim to provide a ‘smooth’ user experience but still rely on domestic payment rails.
This means that funds are not actually processed until a user tries to cash out, which can take days. This system often distances consumers from the underlying payment infrastructure, creating a sense of improvement without addressing the core limitations. Essentially, despite the immediate changes seen on a banking app screen, the movement of funds in actual accounts remains as slow as it was decades ago.
The hurdles are also real for companies in need of completing transactions. In a recent 2023 report by Ripple, businesses highlighted the high costs and slow settlement times as major pain points when conducting cross-border transactions and consumer-to-business payments. Financial experts recognize these as pressing issues, and blockchain and cryptocurrency are stepping into the scene to circumvent bureaucracy, ensuring the money reaches its destination faster. As innovations like open banking and digital assets offer the means to transform payment networks, it becomes evident that the fundamental difficulty lies in the existing infrastructure of the banking system.
In spite of the friction between cross-border transactions, in the past and to this day, the blending of software and finance is trying to get the payments industry towards its ultimate goal: creating a ‘seamless’ global banking system. Creating this system has proven to be a complicated endeavor, to say the least, mainly due to regulatory differences between different countries or jurisdictions.
The major financial institutions in cross-border payments are currently trying to safeguard the existing infrastructure around the SWIFT system. There is an ongoing process for financial institutions like SWIFT and Fedwire to migrate its messaging platform to ISO 20022 from 2023. This means a more structured payment system that offers banks access to ‘richer data’ and enhanced messaging capabilities compared to existing standards. The migration to the ISO 20022 standard from the previous SWIFT messaging network makes banks ‘wary’ of the upfront fee they will have to pay, among other technical and strategic hurdles.
Luckily, parallel to this infrastructure, there is a better solution for cross-border payments: blockchain technology for decentralized digital ledgers for money. By using tokens on blockchains as money, cross-border transactions can be faster and cheaper without the need for arbitrary middlemen. This marks a significant change in finance.
For the unaware, blockchains are distributed ledgers that keep all transaction records, ensuring that every participant in the network possesses a copy of the ledger. Before being added to the ledger, each transaction undergoes verification by the rest of the people who have a copy of the ledger. This setup makes it extremely challenging for any individual to manipulate or modify the transaction records, making the amounts of money immutable on the blockchain.
People who adapt to this technology will encounter genuine decentralized finance, which easily bypasses conventional banks. For example, bitcoin (BTC), the native currency of the Bitcoin blockchain, is one of the many bridge assets to facilitate international financial transactions (another example is the crypto Ripple that uses XRP ledger). This means that the funds can be converted into BTC or Ripple to transfer and then back into the local currency through crypto exchanges.
The impact blockchain technology is having on the worldwide financial infrastructure cannot be overstated. The proof remains that all the other methods for conducting cross-border payments today are lousy compared to crypto.
The other alternatives for cross-border payments are traditional banking systems or online payment platforms like PayPal, Wise, or Western Union for remittances. Of all of them, only crypto payments through blockchains show a promising future due to being more decentralized and offering end-to-end transparency without middlemen.
The promising blockchain performance and delivery time are seen by the surge in stablecoins use, a success case in the crypto ecosystem. Stablecoins like USDT are the fastest to transact, with an average transaction speed of 2 minutes. As for PayPal, a standard transfer is usually completed within 3-5 working days.
Blockchain payments offer a swifter and more convenient alternative to traditional cross-border transactions. Blockchain also enables portability and access to digital money through a cell phone from anywhere with internet access.
Another big and rare attribute of blockchain is its security and auditability. Although not every blockchain experiences the same level of security (some have suffered exploits and even power outages), most blockchain-based payment systems use encryption to protect user data and private keys, a significant step up in security from traditional banking. It also adds an extra layer of security compared to less secure, more centralized platforms like Paypal, Cash app, or Venmo (the last two do not support international transfers).
A decentralized, shared ledger or blockchain structure seems the logical way forward regarding global trade. However, there are significant adoption barriers, especially when historically competitive or non-cooperative parties must still align.
According to this Forbes article, the main obstacles to the widespread adoption of blockchain are scalability, energy consumption, interoperability, security concerns, and regulatory uncertainty. However, it remains to be seen whether these negative perceptions of blockchain will shift when considering its efficiency and overall performance in cross-border payments.
While not inherently complex, blockchain and cryptocurrency payment platforms may initially seem less intuitive than expected in terms of usability. Take into account the following considerations when doing crypto transactions:
The efficiency and security of blockchain technology is undeniable. Still, there are ongoing disputes in the matter. There is a struggle between advocates for financial privacy and proponents of government oversight over personal data. Blockchain companies find themselves at the center of this plight because they enable cryptocurrencies that hide people's personal funds from government oversight. This creates a wary feeling in governments and central banks, who are uneasy about this newfound financial autonomy from regular people.
This wary sentiment that stems from a lack of control has led to the creation of CBDCs. Another reason for their creation is the current low demand for paper money, having reached its lowest level in more than 20 years. Also, CBDCs will likely use blockchain-based rails, even though some of their monetary policies will vary depending on the preferences of central banks. It will be like a cryptocurrency like Bitcoin, only fully controlled by governments.
As for the outlook of CBDCs as a digital financial instrument, reports suggest that CBDC payments could see a significant surge in value, reaching $213 billion by 2030, according to Juniper Research.
To date, only 3 countries have fully launched a CBDC, but 134 countries are looking into it. China leads the global rollout with its digital yuan, aiming to transition towards a cashless society. Other countries, including micronations like Palau, embrace CBDCs to modernize their financial systems.
This shows that governments issuing digital currency instead of physical currency is not a distant reality. It would just be replacing the physical money printers of the central banks with digital ones, which does not seem like a real solution to excessive monetary emissions.
Whether CBDCs will prove useful in the long term or fade away, it remains certain that governments and central banks have historically often lagged in implementing financial innovation. Most of the successful monetary instruments have typically originated in the private sector.
Objectively, CBDCs give central banks tighter control over monetary policy. They also allow for a more seamless management of currency when enabling citizens to make cashless, contactless payments. This was evidenced during the Covid-19 pandemic.
Still, CBDCs pose dangerous trade-offs. In contrast to decentralized cryptocurrencies, they are subject to significant regulation and centralized issuance, providing governments complete control over the funds in the digital ledgers.
Negative situations could arise concerning government censorship stemming from differing viewpoints, political activism, or other motives, such as experiencing loss of access to funds or the inability to transact. This underscores the importance of censorship-resistant cryptocurrencies like Bitcoin for the decades ahead.
Also, Sam Callahan, a financial expert at Swan, explains in this video why CBDCs are not a solution for cross-border payments. Fundamentally, they do not solve efficiency or costs in transactions due to being a heavily centralized system. An excessively centralized system becomes susceptible to manipulation or tampering by interested parties such as governments or malicious actors due to all the assets being in one place, easy to reach. As this article from The Economist clearly states, "the economy does not need a digital replacement for cash."
The bottom line is that for conducting international payments, we suggest using blockchain technology that outperforms the traditional financial rails in efficiency and cost-effectiveness. The potential of CBDCs to deliver on its promises of global financial inclusion and future-proof technology remains uncertain. For peace of mind, consider diversifying holdings into assets like bonds and Bitcoin to safeguard against the long-term devaluation of fiat currency.