Using Blockchain for Cross-border Money Transfer

Blockchain technology has been attracting attention from financial institutes, and the topics about “distributed ledger blockchain” have been widely discussed by banks. Many of them have setup innovation labs to conduct proof of concepts to be able to harness the power of blockchain and distributed ledger. In this article, we’ll find out how blockchain technology can help facilitating the process of cross-border money transfer and the advantages when compare to the traditional procedure.

Disadvantages of current cross-border money transfer procedure

Remittance is a fund-transfer transaction wherein funds are moved from one account to another account within the same or any other financial institution. During the process of a cross-border payment, SWIFT (Society for Worldwide Interbank Financial Telecommunication) handles only the movement of messages along the payment chain. The correspondent banks do the actual debits and credits across accounts bassed on the message and help pass on the value to the final beneficiary.

For example, band A is sending a euro amount to a euro account in bank D in Germany and the workflow will be:

  • A payment message in $US (which is in SWIFT format) is sent to bank A in the US.
  • Bank A sends the payment request to its correspondent bank, bank B via Fedwire and accompanies a debit/credit instruction for onward transmission.
  • Bank B does the adjustments and sends a message to its correspondent bank, bank C in Brussels via the SWIFT network.
  • Bank C transmits the value via Single Euro Payments Area (SEPA) to bank D in Germany.
  • Bank D credits the supplier account in EUR.

As shown in the Figure 1 above, the banks charge fees for processing of each transaction, therefore increase the costs involved for all parties concerned. SWIFT charges for transmitting the messages and adds more to the total cost. Since the ledgers are located to the banks, the SWIFT messages ensure the debit entry of one bank’s ledger is communcated to another bank so as to pass the corresponding credit entry in its ledger. With the increase in the number of payment messages in the chain, fees on SWIFT messages are also increase.

The current process of international payments with involvement of correspondent banks has the following demerits:

  • Since no two banks can agree on a transaction based on their own ledger, SWIFT came into being to guarantee and confirm message transmission. Central banks operated as settlement agents to guarantee payments.
  • SWIFT charges the bank for processing the payment orders irrespective of whether the bank is at both the receiving and sending end of the instruction.
  • A single cross-border payment has to traverse through certain correspondent banks which are involved in activities like receiving, collating, and netting payment messages before retransmitting confirmations or denials to the respective banks. This increases the time to settle.
  • Presence of a trusted third party with powers to overwrite and overturn ledger activities needed to have a unified view.
  • A central bank typically insists tha banks maintain sufficient liquidity in their settlement accounts or nostro accounts maintained with the central banks.
  • In case of a cross-border payment for pooled account in certain banks, the originator of the message is modified and populated by an internal bank account number. This raises concern around the data protection and security in the receiving bank.
  • Since the payment moves across Fedwire to SWIFT and then through SEPA, the messages involved are varied and different.

Blockchain application in cross-border money transfer and considerations

Blockchain is a universal ledger present in a distributed network which is accessible to everyone in the network. Although each node in the network will have a complete copy of the entire database or the ledger, any modifications to the same will have to be properly verified by other nodes (parties) to validate on the modification done. Besides, it requires a consensus of nodes to agree upon the state of the ledger for it to be valid. This would mean that direct transfers can occur instantly now and without fear of manipulation even for cross-border payments, because there are no intermediaries or correspondent banks involved. The underlying concept of distributed ledger makes it possible for the banks to have a bilateral, visible, and immutable transfer of value, adjudicated by the settlement agency.

However, there are critical factors to be addressed for an industry-wide adoption of blockchain:

  • Standardization – Lack of standardization in formats. With flobalization, we have several global standards for messaging SWIFT, Electronic Data Interchange for Administration, Commerce and Transport(EDIFACT), Electronic Banking Internet Communication Standard (EBICS), ISO20022 and ISO8583.
  • Cost and time benefit with added payment transparency – Cross-border payments continue to be expensive. It is difficult to assess and deduce charges incurred through multiple correspondent banks. The identity of the involved banks are not always known between the sender and beneficiary bank and hence, the lack of transparency.
  • Data protection and privacy – There is a strict need to ensure that there is no breach of data and that the data is not modified at any point of the chain.
  • Compliance and regulatory reporting – Adhering to the compliance and regulatory reporting like the anti-money laundering (AML), know your customer (KYC), financial action task force (FATF), and others in order to ensure there is sufficient payment transparency and to keep a tab on the high-risk corridors or high-risk payments.

Collaboration – Cooperation among payment service providers to create inter-operable blockchains. Beed for an extensive global network.

Benefits of using blockchain for cross-border money transfer

As shown in Figure 2, blockchain brings in the following benefits:

  • It leads to the exclusion of any middlemen, central agencies, or correspondents from the payment processing. Transaction is amidst the parties who have entered into a bilateral agreement, thus ensuring trust is in place.
  • Reduced cost with minimal charges along the payment chain. In addition, SWIFT charges for the processing of the messages if the messages are routed through it. As of result of such charges, the correspondent banks/central agencies add to the cost of processing the payment, for activities like receiving, collating, and netting payment messages before retransmitting confirmations/denials to the respective banks.
  • Reduced turnaround time for settlement as there is no need for central agencies and movement of messages.
  • The intraday liquidity need not be ensured with the central banks. Since it is a distributed ledger and the nodes of the networks have a copy of the balances as they are maintained in the settlement accounts with the other banks, the balances are properly maintained.
  • Since the details of the transaction are encrypted and hashed, there is hardly any possibility to modify the data.
  • Subject to no messages being transmitted, the challenges around the standardization are minimized too.
  • Increased payment transparency with distributed ledger as sender and receiver are the nodes of the network/chain.

Blockchain is the future of cross-border payents. Companies that realize its potential and begin exploring ways to incorporate it will have a distinct advantage over competitors who stick with the status quo.

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