Crypto and remittances: a match made in heaven?
An often forgotten pillar of the global economy, the remittance market is being transformed by blockchain technology.
The Realistic Optimist provides weekly, in-depth analyses of some of the hottest stories in our now globalized startup world. Subscribe below to receive it directly to your inbox and don’t hesitate to share it with like-minded people :)
A short introduction to remittances
Remittances refer to the non-commercial transfer of money from one country to another. In the vast majority of cases, remittances refer to migrant workers/diaspora communities sending money to loved ones back home. Recipients use that money for all facets of their daily spending, from buying a new motorcycle to paying medical bills.
Remittance flows are divided into so-called ‘corridors’, highlighting the most prevalent ‘sender-recipient’ relationships. Some of the most common corridors include US/Mexico, UAE/India-Pakistan-Bangladesh, and Russia/former USSR-states. All of these major corridors follow a similar pattern, whereby the sender country hosts a considerable number of temporary migrant workers or immigrants from the recipient country.
Remittances are often touted as the ‘hidden engine of globalization’, providing a number of countries with a recurrent, much-needed flow of disposable cash. Contrary to foreign aid, remittances are received by individuals rather than governments, making their impact more immediate and quantifiable. Furthermore, the numbers are unequivocal: global remittance flows reached $589B in 2021, surpassing the sum of foreign direct investment (FDI) and overseas development assistance (ODA). Notably, remittance flows are often ‘counter-cyclical’, meaning they increase instead of decrease during periods of crisis. For example, global remittance flows proved to be surprisingly resilient during the Covid-19 pandemic.
In poorer households, remittances may finance the purchase of basic consumption goods, housing, and children's education and health care. In richer households, they may provide capital for small businesses and entrepreneurial activities. They also help pay for imports and external debt service, and in some countries, banks have been able to raise overseas financing using future remittances as collateral. - IMF
Why the remittance market is broken and anachronistic
Despite its widely agreed crucial role in economic development, the remittance market is far from peak performance. Fees charged by the entities carrying out remittances, namely banks and money transfer operators (MTO’s), drastically reduce remittances' impact. The average cost of sending $200 is 6.9% which, if applied to 2021 global remittance flows, results in a net annual loss of $40B. The problem is so severe that one of the UN’s Sustainable Development Goals for 2030 includes “reducing transaction costs of migrant remittances to less than 3% and eliminating remittance corridors with costs higher than 5%”.
But what makes remittances so expensive? A number of factors explain the fees, which vary considerably across different corridors. These include but are not limited to:
Lack of competition amongst local remittance providers
Increased cost of cash remittances over digital ones
Cost of background checks, such as Know Your Customer (KYC) and Anti-Money Laundering (AML)
Non-transparent margins taken on exchange rates
Some senders try to bypass the high fees by using informal channels, which might relieve them of the fees but may deprive them of access to digital financial services.
The crypto opportunity
Instead of listing out the pros and cons relating to the use of crypto for remittances, I will instead highlight four factors I believe are essential when considering it.
Disintermediation = Faster and cheaper transfers
Sending remittances the ‘traditional way’ involves passing through a convoluted web of different entities, financial institutions, third-party providers, and so forth. In other words: money bounces in and out of multiple accounts before getting to its final destination, with fees piling up for every additional step.
“Most MTOs operate through the network of a larger remittance software provider (RSP), like Western Union (WU) or Moneygram. The MTO may only receive a fraction of the charges it takes from the customer, as the bulk is pocketed by the RSP. Additionally, an MTO may also need to pay other regular charges for installation, subscription, and system maintenance.” - Investopia
One of crypto’s main advantages is disintermediation; when sending crypto, money goes directly from one wallet to another, without passing by numerous opaque and slow financial institutions along the way. In theory, it is as fast and as cheap to send crypto to a person sitting right next to you and to a person 10,000 miles away. The simplicity of P2P crypto transactions makes it an elegant solution to the current way of sending remittances.
Bitcoin&co vs stablecoins
Not all cryptos are born equal. Even a novice in the crypto world is aware of the incredibly volatile nature of cryptocurrencies, Bitcoin being a simple case in point. The question then becomes: how can cryptos be used for remittances if the sender doesn’t know what their transfer will be worth once it arrives?
That is a valid point. In countries with runaway inflation such as Venezuela and Lebanon, the volatility of Bitcoin is less than the volatility of the local currency, making the issue less relevant. However, in countries with relatively stable local currencies, the volatility of crypto severely damages the remittances use case.
Enter stablecoins. Stablecoins are cryptocurrencies pegged to a ‘real-world’ currency or price of a commodity such as the dollar, the euro, gold, etc... Most stablecoins maintain their peg through one of two ways: reserves, whereby the stablecoin issuer keeps fiat reserves to maintain the peg, or through algorithmic formulas meant to control supply. The latter method has come under severe fire recently following the TerraLuna disaster.
That being said, stablecoins do represent a viable solution to the volatility question raised for crypto remittances. Indeed, stablecoins enable users to send dollars or euros while using the speed and low fees associated with crypto’s financial infrastructure. Furthermore, in countries with runaway inflation, receiving stablecoins can be efficient to protect one’s remittance money from devaluating.
In order to carry out financial transactions between a variety of different jurisdictions, entities providing remittance services must put in place a variety of compliance requirements. Some of these include Know Your Customer (KYC), Anti-Money-Laundering (AML) or Countering the Financing of Terrorism (CFT) to name a few. All of these measures aim to verify that the transactions flowing through their systems aren’t financing any illicit activity.
The cost of these requirements not only contributes to the high fees charged by MTOs but also leads to a practice known as “de-risking”, whereby banks will refuse to service corridors that they deem “too risky”. This reduces the number of MTOs in states that are often fragile and thus most reliant on remittances, leading to a lack of competition responsible for higher fees.
In this aspect, the use of blockchain technology (indissociable from crypto) could facilitate and streamline such processes. Indeed, one could imagine senders and recipients completing the KYC process once, thereby creating a “digital identity” hosted on an immutable blockchain. Remittance providers could then consult that blockchain when dealing with a certain customer, instead of running their own processes all over again. An interesting project going in that direction is R3, which has already been trialed by a plethora of prominent financial institutions.
Usability of crypto in recipient countries
The elephant in the room remains the fact that crypto in many of the recipient countries is neither practical nor usable. Indeed, cash still remains king for people on the receiving side of remittances, due to digital illiteracy and distrust of financial institutions, among other reasons.
An interesting response to that conundrum comes in the form of the recent partnership between Stellar, a blockchain specializing in cross-border money transfers, and MoneyGram, one of the world’s largest MTOs. The stated goal of the partnership is to combine Stellar’s blockchain-based financial technology with MoneyGram’s legacy network of agents spanning 200 countries.
Here’s how to visualize the steps of this new process:
Sender sends money through MoneyGram with their phone or by depositing cash to a MoneyGram agent.
Money is converted to a stablecoin (USDC) and sent to the recipient’s digital wallet (hosted by MoneyGram) using Stellar’s blockchain infrastructure.
The recipient can go to a MoneyGram agent and convert the USDC they have received into their local currency, in cash. This process is known as an “off-ramp” and has often been referred to as the missing piece to adapt crypto remittances to places where cash is still prevalent.
This approach is interesting, because as one analyst puts it:
“The most interesting aspect of crypto and remittances is not direct consumer adoption of crypto, but rather the ways that the blockchain technology behind crypto could be used for cross-border payment settlements by remittance companies. This has powerful potential to simplify processes and lower costs, offering benefits to the industry as well as to migrant consumers” - The Dialogue
It is important to note that solutions like these are contrary to the original crypto ethos, which call for a complete revamp of the traditional financial infrastructure. This begs the question of whether the “crypto revolution” might simply involve the iterative betterment of the existing financial system rather than its complete overthrow.
Thinking ahead: what this means for the startup world
In my opinion, the use of crypto in remittances is a preface for the wider impact crypto will have on the global financial system: disintermediation, at scale, resulting in the removal of useless middlemen institutions, prompting the rise of a more efficient and more transparent financial system.
In the past 5 years, the startup world has become more and more globalized. American VCs invest in a Brazilian and a Philipino startup during the same afternoon. However, the rails on which this new, globalized startup world is built are outdated. Indeed, most investors still require companies to register another corporate entity and open a bank account in a “friendly” jurisdiction such as Delaware. Startups, especially in emerging markets, then have to transfer the money received in their “new” bank account to their “local” bank account, resulting in a loss of time, money, and efficiency. Furthermore, having two corporate entities, including one in a country founders aren’t familiar with, represents extra paperwork for all matters cap table related.
What could blockchain and crypto do to solve this problem? Here’s what I propose: the construction of a public blockchain, similar to the one used for KYC, whereby startups and investors can agree on share structure, payout rules, etc… In other words: create a common “jurisdiction”, on the blockchain, where investors from across the world can easily view startups, invest in startups, and sell their shares, all powered by the transparency and speed of blockchain technology. For a more in-depth explanation of what I gained inspiration for this idea, check out this great article by Balaji Srinivasan on the concept of “mirrorshares”. Tell me in the comments if you’d be interested in a special piece about this!
This article doesn’t touch upon all aspects of crypto and remittances, with topics for another day including the potential role of central bank digital currencies (CBDCs) and the opportunity crypto remittances represent for digital financial inclusion worldwide. However, I do think I covered the main bases here.
The use of crypto in remittances is inevitable, because of one key factor: the impending, increased use of crypto in our financial system. While often buried under the toxic, speculative “crypto pop culture”, the financial rails powering cryptocurrencies are truly a work of art. Legacy remittance providers are realizing that, and scrambling to position themselves as “innovation leaders” on the topic.
Lastly, one of the keys to running a successful crypto project is omitting the blockchain/crypto part in marketing materials. Indeed, many crypto companies focus exclusively on promoting their use of the ‘blockchain’ when they should focus on the value proposition they are offering to their users. In the crypto remittance space, winners will be the ones marketing ease of use, speed, and cheapness of their services, instead of the ones going on and on about how they use “blockchain”, which is probably unfamiliar to their end user.
NB: A representative from Stellar read over the piece to verify the technical information about the partnership was correct, but they did not influence my opinion on the topic.
The Realistic Optimist provides weekly, in-depth analyses of some of the hottest stories in our now globalized startup world. Subscribe below to receive it directly to your inbox and don’t hesitate to share it with people with like-minded people :)