The world is paying millions more in transactions costs!
How banks are slower and actually make the people poorer. A strategic business insight on the future of global payments.
Bitcoin was created with the idea of a global decentralized ecosystem in which intermediaries have no role to play. People and businesses around the world will have the freedom to make transactions without any third party interference. Transactions that will be faster, cheaper and efficient.
In 2019, transaction costs with Bitcoin for macro payments were drastically cheaper than any other facilitator for making transactions around the world. With banks having high transaction costs for global payments, its centralized risks and the looming fear of currency wars make it more important than ever to adopt cryptocurrencies as the future of payments.
The market for global payments grew at a CAGR of 6% in 2018. This growth comes due to the whole world becoming increasingly more liberal promoting free trade, pushing the revenue generated by global payments to $1.9Tn in 2018.
In all this, banks have become exploitative by remaining the most expensive facilitator to make global payments. Through banks, the average cost of sending money to another country is 10.49%. However, the global average stands at only 6.84%, which is still significantly higher than the average transaction cost of Bitcoin, which is around $0.23 per transaction (for the transaction to be approved at a depth of three blocks) on an average at the time of writing.
Centralization of global payment mechanisms is a major hurdle to make global transactions. By 2015, only 54 countries were able to establish cross-border payment links, while 23 new countries were supposed to join this group by 2017 or later. These links are established by ensuring bi-lateral structures. Cryptocurrencies can easily solve this problem as all you need to make payment with these cryptocurrencies is a wallet address on the blockchain.
Did you know?
Quite recently, $1bn worth of Bitcoins were transferred on the bitcoin blockchain, it drew a lot of attention not merely because of its high volume but the fact that the sender overpaid the transfer fee by around 20 times which was still drastically lower than rates that banks would charge. In 10 minutes $1bn of BTC could have been transferred by paying only $35 as transaction cost but the sender paid around $700 whereas, commercial banks would have charged thousands of dollars.
Futures and Securities Settlement:
To hedge against the foreign exchange rates, businesses use futures contracts. They agree on a price prior to the actual trade. With future contracts, businesses can make huge savings. Bitcoin on average has lower bid-ask spreads and has significantly better exchange rates than foreign currencies.
The chart above compares the average bid-ask spreads of foreign exchanges on major asset classes with some major cryptocurrency exchanges. The difference is clear.
Forex rates also lead to hidden costs which most banks do not show but in fact, this leads to a major cost that people have to pay for the transaction.
But the price of Bitcoin is highly volatile. This a major problem of Bitcoin, and has been the reason why it has not been globally adopted. Stablecoins are a way to overcome this problem. Their value is pegged to the US dollar.
Time-value of money is something that also needs to be factored in that makes the current global payment ecosystem very costly. The average time that it takes to settle a cross-border transaction is around 7-days. Through blockchain, it only takes around half an hour to settle the transaction. Last month, daily risk-free rate of return of around 0.027% was observed in the US dollar index. This could lead you to lose about 0.19% of the total amount transferred. Which may not be a big issue for small scale transaction but for big transactions this is a huge unaccounted loss. On the other hand, stablecoins only take 10 minutes. In which there may be negligible price movements. Hence they add greater value to the global payments ecosystem.
Solutions:
Bitcoin’s volatility and its price have made it a store of value used for trading, other than that there are some platforms that are trying to minimize the credit risk on Bitcoin transfers. Like ABRA wallet - What Abra wallet does is that on Bitcoin transfers, it immediately takes long and short positions on the asset they have (Bitcoin/Litecoin for now) by which they minimize the risk of losing money if the price moves against them. If they are losing on their long positions, their short positions make profits. Although this strategy has its flaws, for example, it is currently not suitable for big transactions, as to maintain liquidity on its platform, Abra borrows the funds deposited with them from a broker. For transaction worth of billions of dollars, this may not be a suitable strategy.
Remittances:
Global remittance to developing economies in 2017 was around $450 bn. Of which high and middle-income economies comprise more than 95% of the total transaction volume while low and middle-income economies have 60% of the total share at the receiving end. A lot of these transactions are facilitated by commercial banks at rates as high as 10%. Stablecoins have become a popular way of remittance transactions. It removes the volatility aspect of Bitcoin or Ethereum and can be transferred at a lower transaction cost. You will only have to pay gas used for the transaction which is in cents for small transactions. USDT has the largest market cap of all the stablecoins of $4,124,546,901 at the time of writing. Its fee structure is:
It is far lower than rates charged by commercial banks, and the global average rates.
A solution to politics around currency exchange:
One other major problem with the current global payment ecosystem is that the USD (United States Dollar) dominates the market for global transactions. Of the total value settled per day, the dollar was involved in 88% of the total settlements on at least one side of the transaction.
This dominance leads to currency wars because in response countries try to gain competitive advantage by driving down exchange rates or setting them too low. The United States under the Donald Trump administration has recently unraveled the silent threat of a possible currency war among nations. Trump has accused China and Russia of setting low rates to gain on exports to boost the economy at home. Such market manipulation will be very costly to execute in a cryptocurrency ecosystem, where the price of assets is determined by free markets because it is decentralized and to lower its price, anyone will have to dump lots of assets, which is very costly. It will also be visible to the whole world because of the blockchain database.
Cryptocurrencies show a lot of potential in the future of global payments and more so in cross border transactions. A global financial ecosystem built upon decentralized ecosystems will save a lot of time and money of people. Banks use redundant technology at this point in time and they have started to notice it. Morgan Stanely has partnered with banks for its private blockchain payments initiative.