Blockchain technology has the potential to disrupt many traditional industries especially financial services such as Asset Management, Lending, Trade Finance, Remittances, etc. As per a PwC report on Global Fintech, 77% of financial institutions are expected to use or try out blockchain in their production system by 2020. Funding on blockchain-based startups is at an all-time high, exceeding over a billion in the last 5 years.
Blockchain is a type of distributed ledger technology (DLT). DLT allows the recording of transactions through a shared database among a network of computers. It is decentralized, cryptographically secure, and updateable in an immutable manner. The distributed network eliminates the need for control by a single authority.
In the case of remittance payments, blockchain technology holds the potential to remove intermediaries enabling peer-to-peer transfer, cut down cross-border transaction costs, and address shortcomings of current payment systems such as speed, access, and transparency.
Why Are Remittances Costs High?
There are several reasons for the high cost of remittances. The main ones are weak financial infrastructure in some countries, reliance on correspondent banking, lack of competition, regulatory and compliance costs, the prevalence of informal channels due to the lack of access to the banking sector by remittance senders and/or receivers, and most importantly, absence of transparency in the cross-border money transfer market.
Remittance prices are highly variable. The prices are made up of fees charged for sending a certain amount of money, the exchange rate margin between a currency pair, the involvement of intermediaries, the mode of payment and delivery (cash or transfer to a bank account), the speed of the transfer and the fees charged to the recipient of the funds.
Consumers are advised to compare remittance service providers on several parameters such as price, mode of pay-in and pay-out, etc. to narrow down on one specific provider that serves their specific money transfer needs.
How Blockchain Will Reduce The Cost Of Remittances?
The money sent by migrants to their home country, commonly known as remittances, is a major source of income for millions of households in low and middle-income countries. It is also a stable source of foreign exchange reserves for many countries, contributing higher than official development assistance (ODA) and foreign direct investment.
As per the Migration and Development Brief, remittance flows to low and middle-income countries reached $540 billion in 2020, registering only a 1.6% decline from the previous year despite the COVID-19 pandemic-induced economic crisis.
However, the existing high cost of sending remittances limits its potential benefits. The global average of sending $200 to low and middle-income countries was 6.8% of the remittance in the first quarter of 2020. The highest cost is in Sub-Saharan Africa at about 9%.
In many cases, the cost of these remittance transfers is expensive relative to the often low earnings of migrant workers, the remitted amount, and the income of recipients. Any reduction in the remittance price would result in a higher amount of money being received by the migrants' families.
High remittance cost also encourages the use of informal money transfer channels. The use of informal channels such as the hawala system prevents households from adopting the formal channels (access to bank accounts) for their savings and investments.
One of the United Nations' Sustainable Development Goals (SDGs) is to reduce the remittance cost to less than 3% and do away with remittance corridors with a cost higher than 5% by 2030.
The International Monetary Fund (IMF) and the World Bank pointed out the potential use of blockchain in remittance payments by creating a distributed network for cross-currency funds transfer that will replace the correspondent banking network, thereby reducing the transaction cost and increasing the efficiency of the transfer process.
Bitcoin, now a buzzword in the world of finance, is a decentralized digital currency that one can buy, sell and exchange peer-to-peer without the need for an intermediary entity. It is not backed or issued by any central authority. It was introduced in 2008 by a pseudonymous person, Satoshi Nakamoto, originally represented as "an electronic payment system based on cryptographic proof instead of trust."
Bitcoin, the first cryptocurrency, is the first major application of blockchain technology. Upon using bitcoin's peer-to-peer mechanism, third-party money transfer facilitators like Western Union and MoneyGram are completely removed from the process. There won't be any processing fee. Bitcoin payments will save consumers millions of dollars in commissions that are being paid to third-party remittance services providers.
While it is not easy to quantify the cost-savings of the use of blockchain for remittance payments as the technology is still in its infancy, it has been established that the high fees might be significantly reduced. On the speed of transactions, blockchain solutions have shown to be much faster in processing transactions without giving up on accuracy and security as per a 2017 report by the IMF.
Global remittance flows have increased considerably in recent years. Some crucial factors contributing to the growth in remittances include an increase in migrant population in the developed countries, adoption of digital remittances thanks to advances in mobile payments technology and mobile money, reduced dependency on costly cash transfer agents, a competitive marketplace that lowers remittance cost coupled with the United Nations' drive to lower cross-border transaction costs.
The global remittance market size is projected to reach $930.44 billion by 2026, with a 3.9% compound annual growth rate (CAGR) from 2019 to 2026. Although personal remittance is mainly talked about, business remittance is estimated to be the fastest-growing segment of the remittance market with a CAGR of 33.81% through 2025. International expansion of businesses, especially in developing countries with untapped opportunities has resulted in an upsurge in cross-border business payments.
With the sheer size of the remittance market and the fact that most countries of the world are involved in remittances in one way or the other, the money transfer industry is an attractive space for fintech startups. Many new fintech companies are attracting customers with lower fees, better exchange rates, faster speed.
Several blockchain startups have entered the market offering bitcoin transactions that advocate lower fees, instant payment settlements, etc. Using bitcoin for remittance seems to be catching on due to its potential to disrupt the remittance industry.
Some of the prominent blockchain startups are given below:
Founded in 2013, BitPesa is a Nairobi based digital foreign exchange and cryptocurrency liquidity provider in Africa that leverages blockchain technology to reduce the cost and increase the efficiency of payments across markets. You can send and receive bitcoins and fiat currencies through bank accounts and digital wallets.
It is the first blockchain company to be licensed by the United Kingdom's Financial Conduct Authority (FCA).
Currently, its services are available in Nigeria, Kenya, Uganda, Tanzania, and the Democratic Republic of the Congo (DRC), integrating with banks and mobile money.
Released in 2012, Ripple is a digital payment and remittance network based on blockchain technology, having its cryptocurrency called XRP. It was created by Ripple Labs Inc, a United States-based technology company.
It supports all tokens: fiat currency, cryptocurrency, commodities, and other units of value like mobile minutes, and frequent flier miles.
Ripple claims to allow instant, secure, and nearly free global financial transactions of any size. It is one of the top 6 most valuable blockchain-based tokens by market capitalization.
It does business with other top remittance services providers such as MoneyGram, Azimo, and Ria Money Transfer.
Launched in 2013, Bitwage is a crypto-focused international payment company that provides payroll, invoicing, and benefits for digital assets.
With Bitwage, employers can send out payroll to employees or freelancers through the payment platform using a variety of methods from local currencies to crypto. This way, employers and employees can bypass the cumbersome international payment process and save time and money.
Will Western Union & MoneyGram Be Disrupted By Cryptocurrencies?
The attractive features of blockchain make it an ideal candidate to address the shortcomings of existing payment systems concerning cost, speed, and transparency. However, cryptocurrencies cannot be considered a reliable source of payment at the moment. The prices are highly volatile and face issues of scalability, regulatory and governance, and risks associated with money laundering/ terror financing and consumer protection.
For crypto-based remittances to work, access to digital infrastructures such as mobile and internet connectivity and technological literacy is critical. However, more than half of the world's population still does not have internet access. Furthermore, lack of financial inclusion makes it difficult to receive remittances through formal channels such as access to bank accounts. Nearly 1.7 billion adults remain unbanked globally as per the World Bank.
In such a scenario, cash remittances, which is often the most expensive option, remain a widely used payment method in the world for migrants. Due to the demand for cash-based services, industry giants such as Western Union and MoneyGram, which are known for having the largest network of agents all across the globe delivers cash to people where mobile money and other formal financial institutions failed to reach.
An important point to note is that the adoption rate and legality of cryptocurrencies are not uniform in each country. It may work in some countries such as Venezuela whose local currency Bolivar was more volatile than bitcoin. The legalization of the use of cryptocurrencies made it easier for citizens to use it as a mode of exchange in the country.
In El Salvador, bitcoin was declared as a legal lender as a major step to reduce the remittance cost. 70% of the country's population receives remittances from overseas but has to pay commissions to remittance facilitators like Western Union. It is speculated that remittances providers could lose $400 million a year in commissions due to El Salvador's bitcoin adoption.
However, it would be wrong to assume that these large remittance corporations like Western Union and MoneyGram are sitting idle. They have been experimenting and investing with the technology. They recognized the benefits of it and to remain competitive, they would jump on the bandwagon of bitcoin-blockchain rails once it becomes a viable alternative.
The adoption of blockchain technology in the remittance industry is sure to bring multiple benefits, from cost reductions and increased transaction speed to the inclusion of the unbanked and informal segment of the market. However, the technology is still young and experts have emphasized the need for further experimentation in partnership with regulators and policymakers. Currently, there is not enough demand and trust mostly due to its complexity and its connection to financial crime.
Policymakers can help create a favorable ecosystem for technology to be deployed by setting up pilots, projects, and innovation bubs and coming up with regulatory standards that can be applied at a global scale. Blockchain technology can be implemented successfully in the remittance industry once there is a structural change in the way governments and society think of blockchain and cryptocurrencies.
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