Traditional Finance vs Decentralised Finance: International Transfers
Traditional finance; the financial services utilised by most people in the western world, including borrowing, lending, and trading.
Decentralised finance; the new form of finance utilising blockchain technology.
Traditional finance. Institutions governed by a central authority, a ‘trusted’ third party, or a mediator between two participants. They utilise a centralised ledger and require significant information from the participants to utilise their services. In contrast decentralised finance uses blockchain technology and open distributed ledgers, so that every participant has access to every transaction, and abolishes the need for a third party.
In this article International Transfers will explored. First, how do international transfers take place within traditional finance, second, what is the SWIFT system, and finally, how international transfers take place within decentralised finance. Throughout this article it shall be argued that decentralised finance offers a superior method for transferring funds internationally due to higher speed, lower cost, and enhanced simplicity.
What is an International Transfer?
It is the transfer of funds from a bank in one country to a bank in another country. As the world becomes more interconnected, international transfers are more essential, and are the lifeblood of global commerce. It is estimated that the global money transfer market in 2020 was worth over $700 billion and this figure will grow to $930 billion by 2026.
The current process in traditional finance requires a few steps for the participant. First, they must complete some form of identification check with the bank they wish to transfer funds from compliant with financial regulations within the territory, secondly, the currency sent, and the currency received must be decided and there will be an exchange rate- the first fee. Thirdly, the participant will pay another fee for the transfer. Finally, the money is sent and normally arrives to the recipient’s bank account within 1 to 5 working days.
SWIFT- Society for Worldwide Interbank Financial Telecommunications
The SWIFT network is the current backbone of international transfers. Behind most of these international transfers is the SWIFT network. It sends an average of 42 million messages per day and has more than 11,000 global member institutions. It must be noted here that SWIFT does not hold or transfer assets, it is merely the messaging network utilised by financial institutions.[1]
SWIFT is an integral part of global financial infrastructure; it allows banks to transmit information and instructions through a system of standardised codes. It assigns each member institution a code that identifies the country, city, branch, and bank name.[2]
For example. John wants to send money from his bank in London to a friend in Tokyo. His bank in London will send a payment transfer message through the SWIFT network to the bank in Tokyo, when the bank in Tokyo receives the message regarding the payment, it will clear and credit the money to the account in Tokyo. Through this example it is shown that, banks are the relay points and SWIFT operates as the messenger.
SWIFT must be given credit. It was conceived in 1973 and has served admirably in its role, which was to improve communications for cross-border payments. It is a marked improvement on the system which preceded it, Telex. Telex operated with a free message format system with no standardisation, so bank employees would write sentences outlining instructions to other banks, and this led to mass amounts of human errors primarily due to language barriers. Telex was no longer feasible with the uptick in cross-border payment volume. But in the modern economy the SWIFT system faces the issue of an on-demand economy where clients expect everything instantly.
SWIFT messages must pass through multiple banks before arriving at their destination, this is aimed at preventing fraud. Holidays. Bank’s only process messages once a day, perhaps twice. If the bank is closed, then the payment cannot be processed. Currency conversion. If currencies need to be converted this is a further drag. Different time zones. Someone may send a transfer in business hours in London, but it could be well be midnight in the recipient address. All these factors cause international transfers to be slow and cumbersome, and when currency exchange is included, there is often a discrepancy in the intended and the received amount.
Large companies that do international business regularly have come up with a botched fix for this dilemma. Namely pre-funding. They allocate sums of capital to be kept in foreign accounts that can be utilised when needed. The growth of cross-border payment companies has seen global pre-funding soar. But this is fraught with its own set of difficulties. Smaller businesses struggle with the capital entry barrier to pre-fund multiple accounts in multiple countries. And the opportunity cost is great, capital that could be allocated for development and growth is left dormant in foreign accounts.
Enter Decentralised Finance
Decentralised finance represents the new age of finance. It mimics the services found within traditional finance and improves upon them. It follows the natural progression of any idea, which first understands all that came before it, draws new links between these ideas, and then leaps forward. Decentralised finance has taken the utility from traditional finance and mixed it with the idea of transparency- an area sorely lacking in traditional finance.
It must be noted that in 2017 the World Bank estimated that 1.7 billion people are unbanked.[3] Yet most of these people have access to a mobile phone and internet connection. These are the only requirements to utilise decentralised finance. The barriers for entry found within traditional finance such as personal checks have been dismantled.
To send money internationally using decentralised finance only requires the sender to know the recipient’s wallet address. For example, if John wants to send money from London to a friend Tokyo, he sends the required amount from his wallet and it will arrive, dependent on the chain utilised, within 5 minutes with a fee totalling no more than a few cents.
This example has a few hidden assumptions: John already has a crypto wallet containing the necessary funds, and his friend also has a crypto wallet enabled to the chain he sends the fund on. This can be done from a custodial wallet- a wallet owned by a centralised exchange such as Binance where the participants does not truly own the funds and relies on the exchange to remain solvent but does not have to worry about the security of his funds- or a non-custodial wallet- such as metamask where the user is in full control of their funds and their security. If these conditions are met, any amount of money can be transferred within minutes for a negligible fee, with no down time, no delay. The superiority is seen clearly. The SWIFT system has become antiquated and no longer fit for purpose in the modern world.
Conclusion
Decentralised finance offers exciting possibilities to the world of western comfort. For those who do not want to trust banks with personal details, or for those who simply do not trust banks and their reckless unchecked behaviour- last example 2008- it offers a safe and secure solution to transfer assets.
But it is really for those who are currently unbanked that decentralised finance offers the greatest boon. For too long parasitic companies like Western Union have profited off low paid workers sending money back to their country of origin- commonly known as remittance- with high fees. Now these people can send any quantity of money, near instantly, with a sliver of the fees. The new age of democratised finance is coming where participants are no longer subject to the whims of banks but can engage in peer-to-peer transfers without the need of an intermediary.
The benefit to large business is also clear who no longer need to tie up capital with pre-funding all over the globe and can instead send funds directly within minutes. The objection of volatility found within cryptocurrency assets is quickly silenced with the introduction of stable coins some of which are pegged to the dollar and offer a stable store of value.
To conclude through the blockchain, which is always active with no opening hours or holidays, participants can now avoid the lengthy delays of international transfers and send money within minutes with a minuscule fee. The new has superseded the old in both speed and cost.
[1] https://www.investopedia.com/articles/personal-finance/050515/how-swift-system-works.asp
[2] https://www.investopedia.com/articles/personal-finance/050515/how-swift-system-works.asp
[3] https://globalfindex.worldbank.org/
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