The arrival of blockchain technology has challenged the existing bank clearing systems. Are they good enough to continue providing a global financial messaging service, or are they in danger of becoming obsolete? And, what are the pros and cons of each one?
Created in 1973 by a banking cooperative, the Society for Worldwide Interbank Financial Telecommunication (SWIFT) developed SWIFTNet to deliver an ultra-secure and private network that enables the exchange of financial messages worldwide. Its most essential feature is that it guarantees the security of financial transactions.
SWIFT provides a secure network that allows more than 10,000 financial institutions in 212 different countries to send and receive information about financial transactions to each other. Before the SWIFT network was put in place, banks and financial institutions relied on a system called TELEX to make money transfers. TELEX was slow, and the system lacked the security necessary for a time when technology was making rapid progress.
This is what SWIFT has to say about the advantages of using the network:
•Standard communication over the internet (quick and very secure, enabling very large files to be sent)
•Compatible with the international formats ISO 20022 (SEPA included)
•Integrated personal digital signature
•Adopted by virtually all banks worldwide
•Safe transit guaranteed
The number of institutions use SWIFTNet may be a determining factor in achieving change to another system. According to BIS Statistics, the UK had 682 domestic institutions using SWIFT in 2013 and 793 in 2017. The total number of messages sent via SWIFT in 2013 was 971.8 (million) and by 2017 that had increased to 1,258.75 (million).
What do the global figures look like? In August 2018, SWIFT recorded an average of 29.3 million FIN messages per day. Traffic grew by 10.7 % versus August 2017, which brings the year-to-date growth to +11.6%.
How does SWIFT work?
It is important to remember that the banks and institutions using SWIFTNet don’t actually send any money. All they do is send a payment order between the members of the network using SWIFT codes.
What is the problem with SWIFT?
For one the money order is often not sent directly. Your money will travel from one country to another, but to do that there are often intermediary/correspondent banks involved. Plus, here are some other things to consider:
•Fees are often levied by correspondent and recipient banks
•If your SWIFT transfer involves two currencies, banks often apply poor exchange rates and pocket the difference
•SWIFT transfers can take up to 5 working days in some instances
VisaNet is a different system to SWIFTNet. It started just over 50 years ago when Visa had a vision of a better form of payment for consumers, businesses and governments using a proprietary transaction processing network.
Visa’s set of payment products include credit, debit, commercial, prepaid, mobile and money transfer products — used by financial institutions in 200 countries. It is geared up to delivering the latest innovations in a more mobile society, providing mobile financial services, such as mobile payments, money transfer and top-up services.
It is capable of handling more than 65,000 transaction messages per second and its synchronized, state-of-the-art data centres are connected to the world through 1,600 secure network endpoints linked by 1.2 million miles of fibre optic lines, according to its website visanet.com.
What are the advantages of VisaNet?
The company makes the following claim:
Reliable — near 100% network availability in 15 years
Scalable — processing 80 billion transactions annually
Flexible — domestic processing in 100 plus countries
It is also a payment giant. Visa is currently the second largest global payment card company. RBR’s Global Payment Cards Data and Forecast’s report revealed that the company has a 32 percent market share, second to only China’s UnionPay with 37 percent, and ahead of MasterCard with 20 percent. The company’s website also claims that the network currently authenticates buyers and sellers with 99.7% accuracy in milliseconds, and has processed $6 trillion in 175 currencies, although it doesn’t specify within what time period.
Disadvantages of using VisaNet
One of the issues for consumers with using VisaNet is that the merchant’s and the consumer’s banks must be members of VisaNet for a transaction to be processed. For the merchant there is a cost attached to accepting a Visa card payment, or in fact any similar card. There is also exposure to fraud and liabilities over disputed card payments, with chargebacks being a headache for merchants. Furthermore, like SWIFT, VisaNet is a centralised system operated by Visa and any system that has a single operator puts that organisation in control.
Clearing using blockchain
Blockchain is an open, distributed ledger that can record transactions between two parties in an efficient and verifiable way. Every party can verify the record of its transaction partners directly and without an intermediary, and every transaction (and its associated value) are visible to anyone with access to the system. Plus, the records cannot be altered and the blockchain cannot be corrupted.
A Santander report estimated that inefficiencies in the global collateral management market are estimated to cost banks up to $4bn annually: the blockchain technology can have a huge impact in clearing and settlement.
Adam Ludwin, CEO of Chain, said: “When people say blockchain technology will change clearing and settlement, what that really means is that blockchain technology will make clearing and settlement redundant.”
Does blockchain really pose a threat to banks?
Banking is the industry that has been most opposed to the advent of blockchain technology. Initially, they saw the concept of blockchain as direct competition, actively removing the control they have over the funds and accounts of their customers, however it appears they are gradually warming to the idea.
Banks using blockchain in 2018
Overall there are 200 banks and financial institutions in 2018 that are using, or are about to integrate, blockchain technology. The following provide an example of some of the first adopters from around the world.
According to CEBNet 12 publicly listed banks in China have adopted blockchain for a variety of use cases, such as cross-bank and cross-border loan issuances for small businesses, and testing has been completed for the infrastructure component of a blockchain-based digital wallet. The banks using blockchain include the Bank of China, China Construction Bank and the Agriculture Bank of China.
The Spanish banking group, also one of the leaders in the UK, Grupo Santander is a pioneer in the implementation of blockchain technology in the banking industry. Santander, controlled by Banco Group, has implemented a fully functioning One Pay FX payment system (from Ripple) running on blockchain. The primary goal of the system is to optimize payments between Europe and South America with the use of distributed ledgers.
Rest of the World
ALFA Bank (Russia), Yes Bank (India), United Overseas Bank (Singapore), CommonWealth Bank (Australia), and LatiPay (New Zealand) are among the banks that have collaborated with a US-based blockchain company. In addition, Kotak Bank has partnered with Deloitte & JP Morgan Singapore to developa blockchain-based trade finance operation. Axis Bank, RAK Bank, & Standard Charter Bank have connected with another blockchain network and the Federal Bank of India and Lulu Exchange have partnered with a Bengaluru- based fintech company.
Blockchain is a positive solution for banks
According to a study conducted by the Accenture consulting company, which specializes in strategic planning, over half of all top managers admit that blockchain is going to play a key role in the success of financial companies in the near future. Accenture analysts have found that the world banking sector will save up to $20 billion by 2022 through implementing blockchain.
Blockchain can also provide solutions to current banking problems. For example, the technology provides a high level of safety in storing and transmitting data, an open and transparent network infrastructure, plus decentralisation and lower operational costs.
Furthermore, most credit and financial institutions cannot carry out their work without a number of mediators, explains UniversaBlockchain, a blockchain protocol provider, and this makes their services much more expensive. Blockchain will remove the need for mediators, enabling banks to offer a cheaper service to customers.
UniversaBlockchain also notes that large financial companies and independent financial analysts primarily view blockchain technology in the near future as a possible alternative to the SWIFT bank transfer system and to the current customer requirement for repeating the KYC process with every bank and institution and replace it with a ‘one time only’ solution that can be stored on the distributed ledger.
SWIFT dips its toes in blockchain
SWIFT, in an effort to ensure it doesn’t become obsolete, has been testing the blockchain’s distributed ledger technology (DLT) and Proof of Concept (PoC) with 34 banks and published its results in March 2018. In 2017, it had first announced that it was going to use the Hyperledger platform as a basis for updating its practices of cross-border market payments in collaboration with Australia and New Zealand Banking Group, BNP Paribas, BNY Mellon and others. SWIFT used a DLT sandbox to figure out how a combination of DLT and SWIFT assets could meet “industry-level governance, security and data privacy requirements,” and, according to its press release, the results were successful. SWIFT sees the use of DLT as a strategic priority and going forward its report states that it will encourage its community to begin using real-time liquidity reporting and processing, as well as developing their platform to “complement it with DLT capabilities.”
IBM’s Blockchain World Wire
IBM has also launched a blockchain-based payments system and the new payment network uses digital currency on Stellar’s blockchain to “clear and settle cross-border payments” in near real time. The Stellar network is a distributed, blockchain-based ledger that facilitates cross-asset transfers of value. This IBM product is an important competitor to Ripple’s products such as xCurrent and xRapid.
How does World Wire work?
To use the new payment system, two financial institutions have to agree on the currency — a stablecoin or any digital asset — to be used as a bridge asset between any pair of fiat currencies. The companies will use their existing payment system, connected to World Wire’s API, to convert the first fiat currency in the transaction into a digital asset. World Wire will then convert the digital asset into the second fiat currency simultaneously, completing the transaction. Details of all transactions will be stored on an immutable blockchain established for the clearing system.
Ripple — the first challenger to SWIFT
Ripple has been one of the frontrunners in introducing the blockchain to bank clearing systems. As the Financial Times reported in June 2018, rivalry between Ripple and SWIFT has been heating up. Ripple is a California company created in 2012, promising to make payments faster, cheaper and more reliable using blockchain and cryptocurrency technologies.
Most famously, Ripple and Santander bank have formed a partnership, but Santander is one of over 100 banks that and financial institutions that have signe dup to use Ripple’s xCurrent blockchain-based messaging system that enables money transfers between currencies in seconds.
At the end of September 2018, Ripple’s new xRapid product went live for the first time. This is a cryptocurrency product using Ripple’s XRP token, and it will facilitate cross-border payments. According to CNBC on 1st October 2018: “The development marks the first time XRP will be used in commercial application by financial services firms, and is seen as a critical milestone in Ripple’s bid to make cryptocurrencies and the underlying blockchain technology a part of the financial mainstream. The way in which xRapid works is comparable with IBM’s World Wire service.
Why blockchain clearing is preferable to SWIFTNet and VisaNet
The advantages of using the blockchain compared with the established clearing and payment systems can be reduced to a few simple points.
When you look at SWIFTNet and VisaNet from the banking and financial institutions’ perspective the argument for continuing to use them is based on a “better the devil you know” way of thinking and a prevailing conservatism in the financial world.
However, the downsides of using them for consumers and banks alike are:
•Both are centralised and transactions go through intermediaries, which results in higher costs for both banks and customers
•There are often high fees for merchants with VisaNet
•Transaction information can be altered
•Fraud is more likely and chargebacks on card use negatively affect merchants
•Transactions can take days to clear with SWIFT, i.e. it’s slow
On the other hand, blockchain technology promises to eradicate all the above. The only current issue with blockchain is that it has not yet been widely adopted, yet as we can see, this situation is changing: bank acceptance of blockchain may not be moving at speed, but there is a real sense that more of them are now taking it more seriously and exploring its possibilities, albeit with caution.
However, as Chris Skinner writes in his in-depth exploration of how blockchain will change clearing and settlements, the question is not if the blockchain technology will revolutionise the clearing and settlement industry, it is more a question of when. But it seems safe to say that the revolution is already a work in progress, although when we will see universal adoption of the blockchain in bank clearing is as yet unclear.
SWIFTNet, VisaNet and Blockchain: The Future of Clearing was originally published in Data Driven Investor on Medium, where people are continuing the conversation by highlighting and responding to this story.