Leveraging DeFi to Disrupt Cross-Border Payments
DeFi (decentralized finance) is slowly penetrating every aspect of the traditional finance world. DeFi is leveraging the capabilities of blockchain technology to provide the same services in an improved, more secure, and more transparent manner. The cross-border payments industry is no exception, and this article discusses how DeFi can disrupt the entire industry in its current form.
The current cross-border payments infrastructure has several critical flaws: lack of reliability, slow settlement speed, and high transaction cost.
FX (Foreign Exchange) Risk
FX risk is a significant problem within the existing infrastructure; making cross-border payments leaves companies vulnerable to fluctuations in the foreign exchange market. Consider the example of a US-based company that wishes to make a payment to their suppliers in Europe. If the payment is due in a week in Euros, the company will constantly have to look for the best FX rate under which they could convert their USD into EUR to make the payment. During that week, if the USD dives against the Euro, the company’s expenditure will increase even though the quantum of goods provided remains the same.
The SWIFT Model
The SWIFT model is at the center of the modern cross-border payment infrastructure. Most international payments are routed through it, and it is such a crucial part of the banking infrastructure that cutting a country off from SWIFT could potentially cripple their economy- as seen in March of 2022 when several major Russian banks were cut off from the network.
Despite being the dominant organizer for international transfers of value since the 1970s, the SWIFT system possesses several drawbacks. Firstly, payments often take a long time to be processed, sometimes running into days or even weeks, depending on what banks and currencies are used. Secondly, the traditional banking industry has multiple red days, holidays and weekends when no transactions are carried out or processed, compounding the delay that firms who wish to make cross-border payments must endure.
Finally, these services are expensive. When banks send money through SWIFT, they charge fees in 2 forms: an exchange rate spread and a processing fee. While the latter ranges from between 3–5% of the transaction depending on the amount being sent, the former is far more significant. It can be a major differentiating factor in companies’ costs for sending cross-border payments.
Lack of Representation for Underserved Communities
Another issue with sending payments through the SWIFT system is that payments can only be sent via correspondent banks, who then forward the settlement to a bank within their correspondent banking network. This further adds to the time and complexity of the transaction and also means that some banks/organizations will not be able to receive funds at all if they do not have a sufficiently large network.
DeFi offers a vastly improved payment rail for international transfers of value, and a growing percentage of cross-border payments are being done on the blockchain. Testament to this is the expanding market cap of stablecoins, currently standing at around $170 billion, which are being used by millions of people all around the globe to make international settlements within minutes for fractions of a cent. Because these payments are being routed through the blockchain, there are no time constraints; the networks are operational twenty-four hours a day, seven days a week. There is no centralized authority/ intermediary to slow down the transaction, and any value can be sent anywhere in the world. Person A can send Person B $1,000,000 within minutes for less than $1. The significance of this for people who rely on cross-border payments has been incredible.
MoneySwitch is an L-a-a-S (Liquidity as a Service) platform that leverages DeFi to address the current issues in the cross-border payment infrastructure. Cross-border payment providers (CPPs) spotted a gap in the market where they could provide value. This led to the proliferation of the pre-funding model, where these large companies would keep funds in bank accounts globally to ensure faster settlements. The capital requirement is enormous, and this operational framework is highly capital inefficient, which has strangled innovation within the industry.
MoneySwitch provides uncollateralized loans to CPPs in the form of stablecoin, moving the industry towards on-demand liquidity instead of pre-funded. CPPs can access the required liquidity instantly with pre-agreed loan terms and use it to make settlements. Because the loans come in the form of USD-denominated stablecoin, there is less FX risk, and the funds can be transferred anywhere globally within minutes. This makes cross-border settlements faster and frees up capital for CPPs to spend productively.
MoneySwitch is leveraging DeFi, an improved payment rail, to facilitate improved cross-border payments addressing the current flaws present within the framework. MoneySwitch provides liquidity to a market segment with an insatiable requirement for liquidity whilst giving investors a way to generate revenue with stablecoins by providing liquidity to the MoneySwitch pools.
MoneySwitch powers the future of cross-border payments.
Want to learn more about MoneySwitch and the changing reality of global payments? Please join us here, and for further information on how to help power the cross-border payments of tomorrow whilst earning yield on your stablecoins, visit us here.