Cross-border payments are probably the most referred to and known use case of blockchain and crypto/tokens in banking and financial industry. Whether using permissioned or public blockchain or another version, a number of banks and financial institutions from different parts of the world are already exploring/trialing blockchain and tokens for cross-border transactions.
There is really no defined way of solving the solution for now. On the one hand, we have banks that are working as a consortium to together develop blockchain-based cross-border settlement solutions and tokens and are collaborating with blockchain and other tech giant companies, and on the other hand, we have some banks trying blockchain-based cross-border settlement solutions via their own tokens for in-house application. We also have several blockchain platforms that are offering off-shore cross-border settlement solutions to an individual/group of financial institutions and banks. We shall be looking at the most outstanding ones for this article.
However, when it comes to cryptocurrencies, altcoins, tokens, and coins, confusion is not to be made between the use of blockchain for decentralized transactions as a way of digitizing transactions and other forms of digitizing transactions and operations that do not employ blockchain.
Let's look at the major platforms that are being developed to help banks and financial institutions or their clients and customers carry out cross-border settlements on blockchain.
Utility Settlement Coin (USC)
As said, a number of banks and regulators in various regions/jurisdictions are trialing blockchain and cryptocurrency for cross-border settlement through groups and consortium. For instance, a consortium of European banks is finalizing on a Utility Settlement Coin (USC) designed to make the overall transfer and settlement processes easier for global banks.
Barclays, Bank of Tokyo-Mitsubishi UFJ, Deutsche, The State Street Corporation, the Canadian Imperial Bank of Commerce, CIBC, Credit Suisse, HSBC, MUFG and State Street, building alongside founding financial institutions UBS, HSBC, BNY Mellon, Deutsche Bank, Banco Santander, Credit Suisse, NEX and blockchain startup Clearmatics announced the initiative in 2017.
USC would work like a collateralized token that simplifies buying and selling of assets through a complicated network of middlemen down to a a single, fiat-based transaction conducted on a blockchain. It would help a holder by-pass the traditional network of clearinghouses.
A bank can use blockchain and crypto or some other digital asset on blockchain to reduce complexities involved in the payment industry, especially international payment industry. For instance, when a client instructs a bank to make a transaction, the bank has to find a corresponding bank that can take the client's funds and complete the payment locally at the receiving bank. The corresponding bank has to have a nostro or vostro account with the receiving bank or another corresponding bank that has access to the receiving bank. The corresponding bank has to have enough pre-funded liquidity to complete the payment.
Besides, a receiving bank does not have a way to verify that the incoming transfer from the last corresponding bank corresponds to the original client sending the money, a reason SWIFT message is needed from the sender in order that the receiving bank can understand the purpose of the incoming funds, do due diligence or anti-money laundering checks on payment, and inform the receiver of the funds. The coordination between all the bank parties is slow and error-prone because they do not share a single version of the truth and in many cases rely on manual interventions by back-office teams. Currency conversions at both ends are needed and all parties must manage liquidity levels nostro/vostro accounts and this involves settling against central bank accounts as well.
Smart contracts on blockchain will tokenize funds and payments, apply standard or common rules for transaction which ensures transparency and audibility, records transactions on same shared ledger to provide the same version of truth to all parties in a transaction, provides for instant settlement and conversion at an end, and via cryptography reduces fraud and cyber risk.
The inter-ledger protocol based blockchain settlement systems are a great improvement to today's message-driven payments processes. Apart from the public blockchains, permissioned blockchains promise real-time transactions and also eliminate delays in settlement, need for movement of large amounts of money through central banks, the requirement to have pre-funded nostro accounts, and other settlement risks. A challenge these systems must overcome is that of liquidity.
Tokens can be used to exchange liquidity between liquidity providers and market makers globally in real time on blockchain settlement schemes. No doubt because many blockchains promising instant or near-instant cross-border settlement may, for instance, provide a platform that implements token-based secondary markets for liquidity exchange so liquid providers can spend tokens to trade with one another with much less friction and improved transparency and reduce the levels of liquidity deployed in nostro accounts in different places due to much higher capital velocity. Participants are also able to borrow liquidity from providers for use when it is more urgently needed.
The key issue is to make the tokens as universal as possible and capable of supporting all liquidity needed today in the currency markets, according to Julio Faura, the head of blockchain R&D at Santander, a bank that is partnering with many others for the development of the Utility Settlement Coin (USC). Writing on CoinDesk, he said that liquidity amounts to more than $7 trillion per day according to the Bank for International Settlements.
Thus the most pressing issue is improving liquidity management for commercial banks and market makers, but which is made worse by volatility, for instance. Use of cryptocurrencies and crypto-assets to play that role also faces huge hurdles in relation to difficulties hedging market risks due to their high volatility and the fact that the total liquid in circulation is tiny compared to what is needed in the market. The USD is a universal and hyper-liquid asset available today and works well with this kind of market.
The alternative is to have tokenized, digital central bank money and project Utility Settlement Coin project does that through intermediate vehicles that hold the backing funds on a real-time gross settlement (RTGS) account. Project UBIN in Singapore or project Khokha in South Africa has demonstrated directly implementation of RTGS accounts on smart contracts.
Faura said he believed that as these initiatives mature and flourish, they will become key enablers of the decentralized, tokenized economy the world is so intrigued about.
We heard JPMorgan already, which is a major bank because it provides banking services for 80 percent of Fortune 500 companies, with the JPM Coin. The coin works like a stablecoin pegged on the dollar and is probably a sort of digital coin issued on a permissioned blockchain rather than a cryptocurrency on a public blockchain but it will facilitate near-instant transfers of dollars using the coin, which can be converted bank after transfers. Therefore, it is basically for settlement and Jamie Dimon has said that it could one day be used for retail payments by the retail customers of the bank.
Mizuho and other 60 banking partners (not a blockchain-based solution)
One of the largest Japan financial services bank Mizuho, this month, launched J-Coin Pay iOS and Android which allows users to not only instantly transfer money from and to their bank account, send and receive money instantly, and paying at stores both large retailers and small regional shops. However, it does not employ blockchain. The initiative is a collaboration between Mizuho, other around 60 participating banks and financial institutions, and the Japanese government in line with the latter's goal of achieving a cashless society.
The government wants to double the ratio of consumers using cashless payments to 40% by 2025. The service will later be expanded to include other financial institutions in order to support transfers and payments by, to and fro non-Japanese visiting the country.
Project UBIN is a collaborative project between Singapore's Central Bank Digital Money and banking industry to test the use of Distributed Ledger Technology (DLT) for clearing and settlement of payments and securities. The Monetary Authority of Singapore or MAS says that DLT has demonstrated the ability to carry out transactions in a more transparent, resilient manner and at a lower cost than legacy banking channels. MAS and a consortium of financial institutions are partnering with R3 DLT company in the proof-of-concept project to use blockchain-based settlements.
The consortium includes 11 financial institutions and five technology partners: Bank of America Merrill Lynch, Citi, Credit Suisse, DBS Bank Ltd, HSBC Limited, J.P. Morgan, Mitsubishi UFJ Financial Group, OCBC Bank, Singapore Exchange, Standard Chartered Bank, and United Overseas Bank. Accenture was appointed to manage and develop the prototypes and R3, IBM, and ConsenSys appointed to provide support on the respective DLT platforms of Corda, Hyperledger Fabric and Quorum while Microsoft was engaged to support the deployment of the prototypes on Azure Blockchain.
Phase 1 ended on March 9, 2017, while MAS and The Association of Banks in Singapore announced in October 2017 having developed software prototypes of three different models for decentralized inter-bank payment and settlements with liquidity savings mechanisms. Banks and financial institutions were invited to tap on open source-codes to facilitate their experiments, researc, hand innovation.
MAS and Singapore Exchange (SGX) announced last year August that they were collaborating to develop a Delivery versus Payment (DvP) capabilities for settlement of tokenized assets across different blockchain platforms.
Using the protocol, banks and financial institutions as well as corporate investors can carry out simultaneous exchange and final settlement of tokenized digital currencies and securities assets, improving operational efficiency and reducing settlement risks. Three companies, Anquan, Deloitte and Nasdaq were appointed as technology partners for this project. They will leverage on the open-source software developed and made publicly available in Project Ubin Phase 2. In November last year, MAS used the protocol or technology to successfully carry out settlement of tokenized assets on two separate blockchains.
DvP was concluded on November last year and showed that blockchain technology-based solutions can offer settlement finality, inter-ledger interoperability and investor protection. MAS and SGX have produced a report providing a comprehensive view of automating DvP settlement processes with smart contracts as well as considerations for ensuring resilient operations. The report also defines a market framework that governs post-trade settlement processes such as arbitration.
The Bank of Canada (BoC), Bank of England (BoE) and the MAS jointly have identified in a report, alternative models that could be used in future to enhance cross-border payment speed, cost and transparency for users. It discusses how those payment models could be implemented from a technical and non-technical perspective. MAS and BoC are collaborating in a Jasper-Ubin project that looks at linking up Project Ubin by MAS and Project Jasper by BoC for cross-border payments.
Project Khokha is South African Reserve Bank's answer test/trial/proof-of-concept based on Quorum blockchain for issues relating to settling high volume cross-border payments and uses blockchain to facilitate cross-border transactions and has been tested to work. The project recently received the ‘Best Distributed Ledger Initiative’ award from the Central Banking Publications.
The project is itself a brainchild of a consortium of banks that was developed in 14 weeks and June last year test results showed that it is possible to settle, in 75 minutes and with complete confidentiality, the daily volume of transactions handled by existing real-time gross settlement system. In other words, the average R350bn daily transaction volume of payments done between South African banks can be settled using blockchain without any major setbacks.
The trial was done to better understand how South African Multiple Option Settlement (SAMOS) system can integrate with a DLT system. SAMOS is the current interbank settlement system for South African banks that allow banks to settle obligations in real time. The trial was carried out in three months and the reserve bank might involve other central banks on future cross-border tests according to the Reserve Bank's governor Lesetja Kganyago.
However, a number of things require to be checked before implementing the project or before it goes production-ready. These issues include "evaluation of supporting frameworks and other systems that integrate with the wholesale system, as well as the legal, regulatory and compliance factors."
Of course, the project may be a starting point for hosting financial platforms onto blockchain in the country given its benefits, and may act as a reference point for many African banking institutions and regulators alike. But for South Africa, one among many use cases could be facilitating cross-border transfers between the neighboring counties of South Africa and Namibia where transactions are technically forex and both countries use Rands and the system could offer more benefits than multi-currency forex exchanges.
Ripple is one of the blockchain-based platforms that completes inter-bank cross-border payment transfers in seconds and with immense opportunity to grow given the overall potential in the sector. xCurrent is the SWIFT alternative for banks and payment providers who want to move money and payments between themselves.
While each nation's real-time gross settlement (RTGS) system settles its own currency leaving a host of issues such as delays when it comes to settling other currencies, Ripple's xCurrent (which uses RippleNet protocol) is a real-time gross settlement (RTGS) system that settles multiple currencies on distributed ledger and using real-time messaging. Ripple has so far signed partnerships with more than 200 institutions globally so far, although not all are using its commercial applications. That's compared to more than 11,000 SWIFT customers.
With Ripple, customers install xCurrent and can send messages to each other in real time on the platform to confirm payment details before initiating a transaction, and send confirmation once it settles. The payer can gather information such as all fees details by each bank in the chain and the FX rate before sending a transaction.
The payer bank is able to inform the customer the total costs of the transaction when sending the transaction. That's favorable compared to the fees uncertainty associated with traditional bank-initiated cross-border payments. The software them holds funds at the banks involved and simultaneously updates all the banks' ledgers to do the payment.
SWIFT also has a service known as SWIFT gpi which facilitates same-day cross-border payments, end-to-end tracking, and greater cost transparency. The platform was SWIFT's response to growing threat of blockchain-based cross-border settlement involving Ripple and banking and financial institutions.
GPI standard employs the traditional SWIFT messaging network but participating banks are able to sign up to a new service level agreement to complete same-say processing and upfront fee transparency. Banks can also use a cloud-based tracker to monitor the status of the payment as it moves along the correspondent banking chain to reach the recipient account.
And just to signify the importance of immediate or instant payments on cross-border scale, SWIFT reported last year February -- a year after launching the service -- that 150 banks around the service had signed up to use the service and that the payment service was delivering transaction volumes representing 10 percent of its international payment volume and more than $100 billion in value each day. It said that 50% of payments were credited in less than 30 minutes and nearly all within 24 hours. Corporates can use the service to pay for international goods and services in minutes or seconds and to track payments.
However, in this week's interview by CNBC’s Crypto Trader, Swift Asia Pacific Managing Director Lisa O’Connor said that SWIFT would be open to working with DLT platforms that look at issues from the perspective of the market infrastructure because that is what SWIFT's stakeholders look at.
However, O'Connor said the bank doesn't "have to do things like multilateral netting ourselves (themselves) in the market, to clear transactions." Some of the reasons that make it trend carefully on the issue is that the problem of international payment delays occur for one major reason: legal and regulatory conditions make it impossible for banks lacking mutual know-how with customers to use the shared ledger. According to O'Connor, SWIFT is open to blockchain but is not planning to use it directly to settle transactions done between banks.
But the other possible reasons could be due to the young nature of the tech itself and its readiness for market at the current state because a lot of work needs to be done.
IBM and Stellar
IBM has been working on couple of (permissioned) blockchain solutions in collaboration with financial and non-financial institutions alike and in the cross-border settlement realms, there is IBM World Wire which IBM Blockchain development solutions head Jesse Lund termed as a solution that targets to "provide fungibility of digital assets across financial institutions."
Lund and Jed McCaleb, the co-founder of Stellar which is a platform partnering with IBM for IBM World Wire, will be making a presentation at the on-going Money20/20 conference in Singapore while IBM is set to make an exclusive product announcement during the same event. Prior to the conference announcement, Jesse Lund told Cheddar yesterday that banks are “very interested” in utilizing stablecoins and that IBM was going to make an announcement about the product at the event. That means the platform could sort of facilitate cross-border transactions via a stablecoin on blockchain. They could also announce partnerships with banks who will be using the same product for cross-boarder transactions.
"We are really feeling excited that we are on a roll to build something new and revolutionary that's really going to change the landscape of cross-border payments," Jesse Lund, head of blockchain solutions and digital currencies at IBM Blockchain told Cheddar.
As early as 2017, IBM and Stellar had started the partnership to develop a platform that would finally let merchants and consumers be able to send money to another country in near real-time thus accelerating payments that typically take days. During the earlier announcement, the company said that the banking network they were working with includes "12 currency corridors" that encompass Australia and New Zealand, as well as smaller countries like Fiji and Tonga. Reportedly, they were targeting the platform to process up to 60% of all cross-border payments in South Pacific's retail foreign exchange corridors.