By Jan Lorenc, Managing Director for Europe at Banxa
When El Salvador authorities decided to grant Bitcoin legal tender status, one of the driving factors behind the decision was how easy it is to do foreign remittances, which account for a major share of the nation’s GDP, with crypto. Now, Tonga, a small Polynesian kingdom, may mimic the move in 2022, for exactly the same reason, hinting at what could become the selling point that drives crypto adoption home in the years to come: cross-border transfers of value.
In today’s interconnected economy, money likes to travel. Global cross-border transfers are expected to reach $156 trillion in 2022, a volume exceeding the U.S. GDP by about seven times. Remittances account for less than one percent of the total transfers, standing at $0.8 trillion, but that is still a market of a gargantuan scale where crypto could make an impact. Furthermore, by getting its foot in the door with remittances, it could set the stage for an offensive on B2B and C2B cross-border transfers.
In principle, blockchain-based assets have a clear-cut competitive edge when it comes to cross-border transfers. Traditional remittance services move the funds via a network of correspondent banks, thus accumulating fees along the way. With crypto, though, a transfer only takes one step. You send a single transaction removing coins from one wallet and adding them to the other to the blockchain, paying a small fee for the miners validating it. It’s quite obvious which option is faster and cheaper.
In real life, though, crypto transfers are more complicated. After being paid with fiat, the migrant worker first has to buy crypto with it. Once the transaction is processed, the recipient often needs to convert the crypto back into fiat to be able to make transactions. The latter is known as the last-mile challenge, the challenge of getting the money into the person’s hands after moving it across the border.
Assuming the recipient could be willing to keep the money off the books, it’s not unimaginable that they may not convert crypto into fiat at all. Instead, if their circumstances allow that, they could seek to conduct p2p transactions in crypto. This scenario, though, is not ideal for anyone involved. For crypto, it means being effectively banished into the unofficial, shadow economy, something most companies and projects in the field have no appetite for. For users, this means bearing all the risks associated with transacting in such an economy, with no regulations or consumer protections.
To avoid all this trouble, the recipient needs a legal off-ramp for crypto, and finding one takes some effort. So does setting one up, as a matter of fact, due to the regulatory and legal provisions for the remittances industry.
The cost-benefit equation
A crypto project handling cross-border payments will quickly find itself in the same regulatory crosshairs as the services that route the money through traditional banks. The problem here mostly comes down to six letters: KYC and AML. Anti money-laundering rules around the world is what has effectively turned cross-border money transfers into the domain of larger financial bodies in the first place. For non-crypto transfer services, this means having to plug into a larger bank network to handle the transfer. By doing so, they put multiple intermediaries working behind the scenes between the sender and the recipient, amping up the remittance fees.
KYC compliance is a costly endeavor in itself. According to a 2016 Thomson Reuters report, average annual spending on KYC stands at $60 million. In 2020, KYC spending was projected to make up to $1.2 billion globally, and the year saw a spike in compliance costs, which may not necessarily level off in 2022.
A crypto cross-border transfer service would have to shoulder such costs like others do, and rightly so, because otherwise, it may find itself inadvertently assisting various groups with shady agendas. This is set to expose its clients to higher transfer costs, though, because the service will have to raise its own fee—not to be confused with the miner fees, which still remain intact too, but depend on other factors—to offset these expenses.
That said, compliance and the associated costs does not eliminate the mechanism that puts crypto ahead for remittances: When sending value over blockchain, the number of middlemen is lower. The transfer still does not have to follow the regular rails, taking place on the decentralized ledger, with the last-mile service and the required liquidity delivered by a local partner or by the service itself, depending on its business model.
The model utilized by Wise could be a good reference point here. The company has bank accounts in a multitude of states, and when a client hands it money in state A, the money that the recipient gets in state B is issued from Wise’s account in that state. This model, seemingly inspired by the hawala system, could probably come in handy for crypto remittances services too.
Additionally, crypto companies tend to be more international than banks, which are closely tied with their respective home jurisdictions. Building up their infrastructure around a database distributed around the world comes with its benefits, and it’s not unheard of for crypto projects to be organizationally decentralized as well, making it easier for them to be geographically-versatile.
Crypto has a genuine competitive edge when it comes to handling cross-border transfers, operating faster and cheaper than its traditional competitors. While the industry needs to step up its KYC/AML efforts, and the appropriate regulations are required from national authorities, the value proposition is clear, and remittances could, in the long run, become the function that would eventually propel crypto into a market worth trillions.
About the Author:
Jan Lorenc, Managing Director for Europe at Banxa, a leading payment service provider (PSP) bridging traditional finance and regulation with digital assets. Before joining Banxa, Jan led the European operations of Wirex fintech company as its Managing Director and Head of EEA Markets. Throughout his long career in finance and compliance, he has also worked for TransferMate Global Payments, JP Morgan, Allied Irish Bank, and Anglo Irish Bank.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.