An immutable ledger sounds nice, but what about the margins, banks’ bread and butter?
On June 18, Carlos Torres, CEO of Spanish bank BBVA, declared that blockchain is “not mature” and faces major challenges. During the past month, blockchain’s effectiveness and maturity were also questioned by players as big as the Bank of Canada (BoC), the Russian Central Bank, and DNB, the Central Bank of the Netherlands.
While blockchain can indeed improve the effectiveness of cross-border payments and cut the costs by eliminating the middleman, it hasn’t yet proven itself as a tool ready for industrial-scale use. What’s more important is that some of the banks might not be happy to give up those juicy margin fees.
Ripple’s attempts to modify the system
Ripple, a California-based payment network and protocol company, was established in 2012. Essentially, it focuses on facilitating transfers between major financial corporations.
Ripple is not quite your average cryptocurrency — some argue it’s not a cryptocurrency at all. First of all, it doesn’t champion the dreams of overthrowing the government along with the banking system. Oppositely, it chose to work with mainstream financial players from the very start. As Brad Garlinghouse, CEO of Ripple, told Cointelegraph:
We were from the beginning really looking at how we work with governments, how we work with banks. And I think some in the crypto community have been very much, “How do we destroy the government. How do we circumvent banks?”
Garlinghouse believes that governments aren’t going anywhere, saying, “In my lifetime, I don’t think that’s happening,” so it’s only logical to cooperate with them and work within the existing regulatory framework. That attitude helped Ripple to land crucial partnerships with important players, including, China-based payment services provider Lian-Lian, the Saudi Arabian Monetary Authority, WesternUnion, among others.
Ripple hopes to pioneer the mainstream financial system with xRapid, its tool for easing cross-border fiat transfers between financial institutions. The platform has recently proven to save transaction costs by 40-70 percent by not having to use foreign exchange providers and has increased transaction speed to “just over two minutes.” In comparison, according to McKinsey research, typical international payments take three to five working days to complete.
In May 2018, Ripple reported positive results for its xRapid pilot. The company tested payments between the U.S. and Mexico. And there are other players who have already introduced somewhat similar features publically, having it out for its retail clients.
In April, Spanish-based international bank Santander announced the launch of its Ripple-powered, blockchain-based payment network called One Pay FX, becoming the world’s first bank to do so.
One Pay FX is a mobile application for cross-border payments backed by Ripple’s blockchain. It’s based on xCurrent technology — not the above mentioned xRapid — which doesn’t cut out the corresponding bank from the entire process, thus not quite changing the conventional system, but rather modifying it.
In other words, xCurrent uses immutable “interledger” protocol, which “is not a distributed ledger,” as confirmed by David Schwartz, Ripple chief cryptographer. In xCurrent’s case, the network peers do not have access to a shared ledger, which is the basis of major blockchain networks like Ethereum (ETH) or Hyperledger. However, xCurrent technology allegedly allows to “eventually plug” cross-border transactions into distributed ledgers.
Nevertheless, the technology still allows for cutting the costs and time normally required by traditional international funds transfers. It was introduced to Santander account holders in Spain, UK, Brazil and Poland, with the bank promising to add more countries to the list “in the coming months.” Executive chairman Ana Botín stated that “transfers to Europe can be made on the same day” and the bank aims to deliver instant transfers across several markets “by the summer.”
The system has been in the works for about three years, as Santander’s relationship with Ripple started in 2015, when the bank first invested in the California-based startup. The next year, test trials showed that Ripple’s technology concluded transfers in less than a day. The bank’s U.K. operation then made the blockchain-backed mobile payments available to staff.
Santander isn’t the only bank hoping to implement the technology for allegedly faster and cheaper payments. South Korean bank Woori Bank intends to introduce “commercialized” international remittances based on Ripple this year. Its Digital Strategy Department ran initial tests back in January and the results were positive.
Notably, that trial was part of a Japanese-based scheme involving Ripple and SBI Group, with 37 other institutions participating in the test. Of these, along with at least 23 more involved in trying out blockchain remittances, the vast majority are Japanese banks, so Asia appears to be particularly ripe for blockchain solutions to traditional money wirings. Indeed, in Singapore, the idea of blockchain-powered cross-border payments is even propelled by the local central bank. In March, Monetary Authority of Singapore (MAS) managing director Ravi Menon reaffirmed that the country's blockchain plans — dubbed ‘Project Ubin’ — will “solve the challenge” of increasing efficiency in the arena:
“One of the potentially strongest use cases of crypto tokens is to facilitate cross-border payments in traditional currencies”
Other startups trying to disrupt the banking system
On May 21, Argentinian Banco Masventas (BMV) announced a partnership with Bitex, a local fintech startup founded in 2014 with a focus on “developing the Bitcoin market in Latin America.” Now, BMV clients can use Bitcoin for international payments as an alternative to conventional ways.
As a result, the bank states, the customers get to transfer money from account to account in less time than traditional bank transfers: BMV states that the new service will reduce transfer times by up to 24 hours.
José Humberto Dakak, a principal shareholder of Masventas, said that the move intends to strengthen the bank’s digital and smartphone-based services and reduce banking service costs. In addition to expediting transfers, Bitex claims that it can provide more secure transactions.
Moreover, there’s Wyre, a San Francisco fintech startup whose self-titled cross-border payments platform alleged in 2016 to make international payments faster and more cost effective by putting them on a blockchain. In addition, Red Belly Blockchain — a project run by researchers at the University of Sydney — has been developing new blockchain technology for secure and rapid transfers of virtual currencies that have allegedly outrun Visa and Bitcoin network with “more than 440,000 transactions per second on 100 machines." However, these startups don’t deal the existing banking system, per se, essentially trying to substitute it instead.
Finally, there are big league players experimenting with blockchain as well: In February 2018, J.P. Morgan (JPM), whose CEO has infamously called Bitcoin a fraud, launched the blockchain-powered Interbank Information Network (IIN) in collaboration with the Royal Bank of Canada along with Australia and New Zealand Banking Group Limited. The platform, which is based on the bank's private Quorom blockchain, allows JPMorgan to exchange information with other banks and “minimize friction in the global payments process,” speed up the process and improve security, according to the bank.
Moreover, IBM has announced a blockchain banking solution that aims to cut the settlement time and costs of international payments; and MasterCard (MA) has introduced its own blockchain technology for partner banks and merchants.
SWIFT, the dominant player, is skeptical about blockchain
Blockchain-based systems appear to challenge the longstanding players in the industry directly. Santander’s Ana Botin told the Financial Times that her company is confident in taking on big fintech companies like TransferWise, hoping to expand its One Pay FX to small companies — as it is now only available for individuals — and even putting out a separate app for open market payments. “I think Santander offers more and better [sic] as of today than many of these other companies,” she said.
Cue in SWIFT, a longstanding and extremely significant player in the banking industry. SWIFT is a 45-year-old Belgium-based interbank messaging service that handles about 50 percent of the world’s high-value international payments and a co-operative owned by about 11,000 member banks.
What is SWIFT’s view on the new technology in the game that’s been reportedly showing prominent results? Well, it doesn’t really share the enthusiasm, giving mixed signals regarding blockchain.
In early March 2018, SWIFT said it had finished a “Proof-of-Concept” test of blockchain to coordinate cross-border payments between the accounts of 34 banks. The result: blockchain is not ready for mainstream use as “further progress is needed before it will be ready to support production-grade applications in large-scale, mission-critical global infrastructures,” although the tests went “extremely well.”
As SWIFT explained to the Financial Times, a substantial amount of banks would have to drastically modernize their systems before they could turn to a blockchain-based system for their cross-border payments.
Reportedly, the testing involved the creation of 528 sub-ledgers for 28 participating banks to avoid confidential information being revealed to rivals. Thus, as Damien Vanderveken, head of research and development at SWIFT, told Financial Times, all of their members — the thousands of banks — would require 100,000 sub-ledgers to be established, which is technically burdensome because of maintenance issues, among other reasons.
Nevertheless, SWIFT also reports positive results for blockchain, as Distributed Ledger Technology (DLT) helped reconciliation of Nostro accounts for lenders (a Nostro account is basically a bank’s account in a foreign currency in another bank).
Back in April 2017, SWIFT announced that it was going to use the Hyperledger platform as a grounds for updating its practices of cross-border market payments in collaboration with Australia and New Zealand Banking Group, BNP Paribas, BNY Mellon and others. Later, in July 2017, SWIFT’s test project added an additional 22 banks, including Commerzbank, Societe Generale and JPMorgan Chase Bank. The participating banks had their own node deployed in a SWIFT DLT sandbox, with the underlying technology being the Hyperledger Fabric v1.0.
PoC results showed that DLT could provide the functions needed for Nostro account reconciliation, including “real-time event handling, transaction status updates, full audit trails, visibility of expected and available balances, real-time simplified account entries confirmation, the identification of pending entries and potential related issues, and [...] the data required to support regulatory reporting.”
Blockchain improves the system by creating competition
As the Financial Times reports, the blockchain initiatives prompted SWIFT to readjust their fusty system. Thus, apart from proceeding with their own tests on the potential of blockchain, they updated their messaging system by launching a service called Global Payments Innovation (GPI), which is reportedly being used by 165 banks. According to the representatives of SWIFT, more than 50 percent of money transfers on GPI are reaching their destination “within 30 minutes of being initiated.” Harry Newman, head of banking at SWIFT, told the outlet:
“It is no secret that correspondent banking is a 1998 model and we are busy addressing that, bringing it to a 2018 model… But in terms of speed, what problems are you trying to fix? We have our own cloud and API solutions and are already doing payments in minutes or even seconds.”
As for blockchain, SWIFT doesn’t seem enthusiastic about it in the end, naming scalability as one of the primary issues. Newman elaborates:
“[Blockchain] is not straightforward to scale and it is not yet appropriate to do so… All the announcements [by banks about their blockchain payments projects] made to date, they are either in-house or bilateral projects between banks. As you bring scale, you get escalating complexity.”
Some banks are not ready for blockchain
It’s not just SWIFT who’s not that cheerful about the idea of moving to blockchain: some of the banks are pessimistic as well. First of all, shifting to decentralized ways of transferring money means giving up a large chunk of margains, an important source of income for banks. At the moment, U.K. customers of Santander are not required to pay any additional fees using the One Pay FX system, while the average cost for a bank to execute a cross-border payment through correspondent banking costs $25 to $35, according to a McKinsey research.
Indeed, as Citigroup’s “Bank of the Future” report suggests, fintech companies are actively disrupting the banking market with new technologies and driving out longstanding participants. For instance, the paper estimates that by 2025, major North American banks could lose 34 percent of profit from mainstream areas such as payments, investments, and personal lending.
In the same way, it could be argued that Santander is hoping to drive out fintech competitors, such as TransferWise, WesternUnion, etc., and hence grow their customer base at the cost of lower commissions. In the future, more banks might have to start dealing with competition interlinked with the new technologies, changing their traditional financial strategies.
Moreover, a significant number of central banks have voiced their concerns regarding blockchain’s capabilities. The Bank of England started testing its Real Time Gross Settlement (RTGS) service to conduct the transfer of funds between banks in “real time” and on a “gross basis” with plans to put it on a blockchain, but then changed its decision after trials, citing the technology's immaturity.
Similarly, on June 14, a Bank of Canada (BoC) official questioned the effectiveness and security of using blockchain tech for banking.
While discussing the BoC’s Project Jasper, a Proof-of-Concept payment system utilizing so-called Distributed Ledger Technology (DLT) at a conference in Seoul, James Chapman, senior research director at the bank’s funds management and banking department, mentioned that although the testing showed some promising results, BoC wasn’t that keen on the technology, citing security as an issue:
“At this time, there is no cost-saving effect compared to the existing central bank system. Hacking and other operational risks are likely to occur.”
More central banks have echoed this sentiment. Thus, first Deputy Governor of the Russian Central Bank has recently said that blockchain technology is not yet “mature” enough for industrial-scale use, while the central bank of the Netherlands, after three years of experimenting with Distributed Ledger Technology (DLT), has also concluded that the current algorithms are unable to handle the volume of transactions of financial market infrastructures in a completely secure and energy-efficient way.