Lessons from the trenches
After spending over a year building a Bitcoin based remittance service into Indonesia, it became evident that Bitcoin or cryptocurrencies systems are unlikely to deliver on the promise of cheap remittances. This is likely to be the case for other remittance target countries facing the same challenges that we encountered in Indonesia.
The allure of a $600 billion market
As Bitcoin started to gain interest in the Fin-tech startups and VC circles, remittances seemed a logical target; nearly a 600 billion market, with some corridors in the double-digit percentage cost, Bitcoin, with ultra low fees and promise to remove the middle man appeared as an irresistable proposition. While cryptocurrencies do offer these advantages, they also introduces some costs and hurdles that can nullify any efficiency gains.
Bitcoin as a remittance transport
The idea of using Bitcoin as a remittance medium is some variation of converting fiat to crypto on the source remitting country and back from crypto into the local fiat at the destination country.
While Bitcoin allows for a direct peer to peer transfer of a remittances without a need of a remittance service, in practice these intermediaries are necessary in certain destination countries like Indonesia where most Indonesian migrant workers are hired as low income domestic or service workers and typical lack technical sophistication or even awareness of Bitcoin. A service such as the one provided by Artabit in Indonesia not only hides the complexity but also to neutralizes the volatility that these cryptocurrencies exhibit through connections to cryptocurrencies exchanges and other liquidity providers.
The operating model of Artabit is to focus on the crypto to Indonesian Rupiah (IDR) cash-out segment of the flow while relying on partners like Bitspark in Hong Kong from the source remitting countries to accept remittance destined to Indonesia.
Challenges for crypto based remittances
The actual technical and engineering challenges to implement a crypto based remittance service are manageable. The operating cost and regulatory uncertainty are the true challenges
Direct peer to peer transfer or via a remittance service have cost related to acquiring bitcoins in the source country and converting back to fiat on the destination country (i.e execution fees, withdrawals fees and bid/ask spreads). Liquidity of the Bitcoin with the local fiat pair e.g BTC/HKD and BTC/IDR for the Hong-Kong to Indonesia corridor directly affects this liquidity cost. Typically this cost is higher at the destination where the local cryptocurrency market tend to also be less developed. In some corridors both ends can incur large liquidity cost e.g Malaysia to Indonesia corridor.
Liquidity cost quickly degrades with size, imposing an implicit limit on the remittance size. For example in Indonesia, at the current liquidity environment for Bitcoin this implicit limit is around $1,000 via a regular exchange.
A less obvious cost, is the added trading costs during periods of large volatility where spreads widen. In extreme cases such as the Mt.Gox colapse or Bitstamp temporary closure liquidity cost will spike. It’s easy to dismiss these as rare event but it would only take a few of these events to wipe out profits accumulated over large periods of ‘normal’ volatility regime
New entrants into the remittance space seem to forget that the remittance market is not a static cryptocurrencies based remittances not only need to compete against incumbents but also other non-cryptocurrency based innovations
Globally, the World Bank reports downward trend on remittances costs, although there are still persistently inefficient corridors such as many intra-African and some intra-Asian corridors, cryptocurrencies based solutions are still challenged in these corridors as they face illiquid cryptocurrencies markets for the local fiat currency
Many central banks in Asia, like in other regions, have yet to fully clarify regulatory stance on remittances, some are requiring similar compliance requirements as existing money services adding barriers to new entrants as remitting source partners. When the cost of compliance is added the differences with traditional services the perceived price advantage may evaporate
Micro-remittances, a niche opportunity
Since the viability of cryptocurrency based remittances is largely dependent on remittance size, as a consequence of liquidity dependence to neutralize volatility, the challenges listed in this post diminish for small sized remittances. Transactions bellow certain amount may also be bellow regulatory triggers reducing the compliance burden. In Indonesia, remittances bellow $100 are more competitive compared to conventional methods, below $50 double digit percentage savings can be achieved and below $5 there is practically no competition as alt system impose a flat fee. Note that due to network fees there is a lower bound as well for viability so micro-micro transactions are not feasible. This limit is roughly around $2 for Indonesia.
Permissioned distributed ledgers
Tim Swanson, on his distributed ledger systems report, makes a conceptual distinction between cryptocurrency systems like Bitcoin, and permissioned distributed ledgers (PDL) like Hyperledger or Eris. In the scenario where remitting source countries partner with destination partner such as Artabit, the value of Bitcoin as a transport diminishes as all parties already have established a trust level for up to a given amount. Crypto-tokens would mainly serve as an accounting for bilateral clearing to track and net individual transactions prior to settlement. The benefit PLD systems bring is the removal of the volatility problem that creates the need for liquidity. The additional benefit they bring is speed. Bitcoin and similar cryptocurrencies introduce transaction delays due to the underlying infrastructure constrain to remove the need to trust anonymous validators. Since such requirements is absent in PDL systems, transactions can be near instantaneous.
Banks and other financial institutions who have been displaced by smaller competitors as well as larger incumbents who are under threat to lose dominance have here an advantage as they already have a network of ‘trusted’ nodes where a PDL solution can be deployed.
The approach of simply converting fiat to a crypto currency and back to fiat introduces costs, risks and hurdles eroding the advantages of low network fees and dis-intermediation. Micro-remittance are less effected by these factors but still need to contend with other non-crypto innovations solutions as well as the improvements being brought by incumbents. Permissioned distributed ledger systems, may avoid some of these obstacles making them a better fit than cryptocurrency systems. Financial entities with already legal framework in place can benefit the most as they can reap almost immediately the speed and efficiency gains these ledger platforms bring. On the next post will explore the applicability of one of the permissioned ledger, in the remittance market.