As we've become more globalized, the demand from businesses and individuals for faster, easier, and cheaper cross-border payments has increased. This year, total cross-border remittances will amount to more than $22 trillion worldwide and are set to exceed $25 trillion within just two years.
With such vast sums involved, McKinsey estimates that each transaction yields an average of $20 for the bank which is a large profit margin. Now, the industry is facing pressure to become cheaper and more efficient. What's driving this demand, and what's in store for the future of cross border payments?
Consumer demands
Individual consumers are a significant growth market for cross-border payments. In the developed world and among the growing global middle classes, e-commerce is also a huge growth factor.
However, as discussed at length migrants from developing countries face some of the biggest hurdles in sending money back to family in their homeland, many of whom may be among the world's 1.7 billion unbanked. This explains why, looking at the historical timeline of money transfer firms, Western Union has maintained a market stronghold for more than 150 years now. Throughout that time, the company has remained the go-to means for anyone to send or receive cash, regardless of their banking status. The catch is that it comes with fees, which could stretch to over eight percent in some cases.
High speed vs. low cost
Even for those with a bank account, improvements in cost and speed of remittance have been small. Interbank network SWIFT rolled out its Global Payments Initiative (GPI) in 2017, aiming to create a fast and frictionless cross-border payment service.
By the end of 2018, the service had been adopted by 270 banks worldwide, making it possible to send international payments within 1-2 days, whereas previously it would have taken 4-5 days. However, many emerging economies such as Mexico and Turkey are not yet operating at SWIFT standards and miss out on its benefits.
Because the banks are failing to live up to demand, PayPal remains a popular choice, although again, it's a costly service with fees over 4% for international payments.
Competing firms such as TransferWise and Payoneer offer slightly more cost-effective alternatives to PayPal but still have only slightly pushed down fees leveled off since around 2016. One key challenge to lowering costs for these companies is that they're still dependent on the banks which still charge them high fees.
Crypto is now the front runner in cross border payments
The emergence of distributed ledger technologies and blockchain is proving to be a game-changer for global payments.
Blockchain enables people to send and receive cryptocurrencies, securely, cheaply, and near-instantly, from anywhere in the world. Although Bitcoin was the first cryptocurrency, there are now several blockchain projects starting to shake up the global payments industry.
The oldest and most prominent of these is Ripple Labs. The company has developed a product called RippleNet, a global ledger of private blockchains which are used as payment gateways. Any financial institution or payment provider can join the RippleNet, and once they do so, they can interact with other members, exchanging payments quickly and cost-effectively.
RippleNet can process payments in either fiat or cryptocurrencies, using its own cryptocurrency, called XRP, to maintain liquidity across the network. RippleLabs counts over 200 institutions as its partners, including American Express, Santander, and Standard Chartered. This explains why XRP is currently the #3 cryptocurrency in the world.
Emerging competitors
While Ripple is firmly focused on the existing financial infrastructure, other contenders have emerged with similar but subtly different targets. The Stellar network for example is an open-source, distributed payments infrastructure, but unlike the RippleNet, anyone can join the network.
Stellar boasts an impressive advisory team, which includes Patrick Collison (CEO of payment services company Stripe), Matt Mullenweg (founder of Wordpress) and Naval Ravikant (founder of AngelList.)
OmiseGO for example are also working on payment processing, however, they are focusing on improving financial inclusion in the developing world. It's an independently operated extension of Asian venture-backed payment company Omise. OmiseGO operates in a similar way to Ripple but is fully decentralized and available to individual users through its open wallet.
OmiseGO has the leverage of the existing relationships established by Omise, which include serving as a payment processor for Chinese giant Alipay. The project has also secured high-profile partnerships for payment processing with McDonald's and the Thai government.
It's true that the financial sector has made steps towards increasing the speed and lowering the cost of cross-border payments in recent years. However, demand is outstripping the pace of development. If blockchain and cryptocurrencies fulfill their initial promise, these technologies could ultimately replace the existing financial infrastructure with faster and cheaper cross-border payments, challenging the banking sector in a way it hasn't been challenged since the internet was invented.
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