Using blockchain and cryptocurrencies in the remittance industry could lower costs for exchanges houses and make it easier for start-ups to enter the market, increasing competition and resulting in lower fees for consumers in the UAE.
Hasan Heider, a partner at global venture capital firm 500 Startups, says there is an opportunity for technologies like blockchain and cryptocurrencies to have a “significant impact” on the region's sizeable remittance market. The UAE and Saudi Arabia are the second and third biggest outward remittance countries in the world behind the US, sending out sending out $46bn (Dh169.2bn) and $35.3bn IN 2018, according to central bank data.
While some associate cryptocurrencies with risky investments, the real opportunity for companies is to use the technology to power back-office functions and provide a simple service for ordinary people to use, says Mr Heider. “There is a massive disruption already taking place in the region with start-ups like Denarii Cash and a few others,” he adds.
One company at the forefront of the global push to use cryptos for remittances is Ripple, best known for XRP, a cryptocurrency designed for international transfers that is about a thousand times faster and cheaper than Bitcoin, the company claims.
The benefits of crypto and blockchain-powered remittances could be far-reaching, says Navin Gupta, managing director at Ripple for South Asia & Mena, with cheaper and quicker transfers, more efficient international payments for businesses and lower error rates and costs for banks and remittance firms.
Blockchain, the technology used for verifying and recording transactions, is a digital chain of transactions linked using cryptography, a mechanism for secure communications. The database is a real-time library of records that are difficult to tamper with.
The current system for transferring money internationally comes with challenges, Mr Gupta says, specifically high error rates that lead to delays and additional costs as well as a pre-funding model that is capital intensive.
Cheaper remittances could also have important social benefits, as blue collar workers typically pay a higher percentage of their wages in remittance fees than a white-collar worker sending a large amount when fixed fees come into play, says Mr Gupta.
“If everybody is paying — say for example — $10 for a remittance, then for somebody who sends $100 that fee is 10 per cent of it, but if somebody is sending $1,000, then it is 1 per cent," he says. "So when a blue collar workers sends $200, and he pays $10 to send his remittance, it's a much larger portion of his salary that is being eaten away as a remittance fee.”
A number of banks and remittance houses in the GCC already use Ripple’s blockchain-based cross border settlement payment rail, designed to cut errors caused by issues such as missing paperwork on the receiver side — a significant contributor to remittance costs and delay, says Mr Gupta. A blockchain settlement system can inform a party before they start a transaction if there are any missing documents, rather than sending a payment only to have it returned hours or days later.
An even bigger transformation, however, could happen if remittance companies use cryptocurrencies for international transactions, buying digital assets in one country before sending them at lightning speed to the next, selling them in the local currency and paying out the receiver.
Mr Gupta says this would lead to significant cost savings, because most international payments rely on a pre-funding model, meaning banks or exchange houses keep pre-funded accounts in the destination countries, which they use to pay out when a customer makes a transfer.
Maintaining pre-funded accounts is expensive, as exchange companies must forecast demand, which can surge around a holiday in one country, and hedge against currency swings, says Osama Al Rahma, chief executive of Al Fardan Exchange.
Using a cryptocurrency such as XRP or Stellar Lumens — another digital asset designed for international payments — would enable the transaction to happen almost instantly, meaning banks or exchange houses would only have capital locked up for a few seconds, slashing costs.
Mr Gupta describes the pre-funding model as “highly capital inefficient". “We believe that removing [pre-funding] will make the overall market very efficient,” he says, adding that exchanges houses are better placed to use cryptocurrencies for remittances than banks as they are subject to less regulatory approval and have a higher cost of funding.
At least one major remittance company is already using cryptocurrencies; MoneyGram — which Ripple paid about $50 million for a 9.95 per cent stake in — said last month it was “moving approximately 10 per cent of its Mexican Peso foreign exchange trading volume through Ripple's on-demand liquidity solution and has already started transacting in four additional cross-border corridors, including Europe and the Philippines.
For a remittance company to use a cryptocurrency to transfer money between currencies, it needs access to an exchange with sufficient volume in both countries to buy and then sell the digital token, something that may slow adoption, says Mauro Romaldini, a FinTech consultant.
In the UAE, licenced cryptocurrency exchanges are on the horizon through the regulatory framework released in The Abu Dhabi Global Market (ADGM) in 2018. Regulators at the financial freezone are expected to grant the first full licences for cryptocurrency exchanges later this year or in 2020, Wai Lum Kwok, executive director of capital markets at the Financial Services Regulatory Authority, told Zawya earlier this year. The regulator has already granted a number of in-principle approvals.
Other potential obstacles around adoption include reputational issues. Bitcoin, for example, first rose to prominence because it was used for illegal transactions on the dark web, an association the cryptocurrency space has struggled to entirely shake off.
However, federal regulations could soon give greater clarity to the broader blockchain space. The UAE's Securities and Commodities Authority said in October it was seeking industry and stakeholder feedback on the regulation of cryptocurrencies in the country, including financial crime prevention measures, information security controls and technology governance norms.
The central banks of the UAE and Saudi Arabia are also working on a pilot project to launch a shared digital currency for facilitating cross-border bank transactions using blockchain technology.
Mr Al Rahma says using cryptocurrencies could slash costs — at least in theory. “Pre-funding costs are really huge, adoption of blockchain technology with proper arrangements can change the whole mechanism of settlement, with efficiency and savings,” he said.
But, there is a “gap” between theory and practice, says Mr Al Rahma, who is also the vice chairman at the Foreign Exchange and Remittance Group. “It only works if the whole ecosystem is accepting that solution," he adds. "This is the main issue. It’s not about bilateral relationships, it’s about the majority of banks accepting the same model.”
And it’s not just regulatory developments in the UAE that remittance houses must contend with if crypto remittances kick off. In the main remittance receiver countries — India, Pakistan, Egypt and the Philippines — only the latter stands out as having made big steps in adopting cryptocurrencies. In India, which receives more than a third of all remittances from the UAE, cryptocurrencies face an uncertain regulatory future with calls from some lawmakers to ban them entirely.
Mr Gupta says the global regulatory environment for cryptos is atomised, but believes that once the benefits from early adopters become clear, "other countries will realise this is a great solution".
One player already in the market is Denarii Cash, a remittance app founded by Jon Santillan, which focuses on expatriates from the Philippines living in Saudi Arabia and the UAE. Mr Santillan says the two main challenges for new remittance companies are fast transaction speeds and high capital costs. “Using crypto will allow new players to enter the market to compete with other incumbent players, and to have fairer pricing for everyone,” he says.
Mr Santillan’s app advertises no fees, which he says is applicable to the first Dh1,000 transferred each month. Business has taken off since the beginning of this year when the company participated in an acceleration programme in Saudi Arabia run by 500 Startups, with word of mouth referrals helping to drive in new business, he says.
The company originally planned to use a digital stable token for transfers from the UAE to the Philippines, before realising this wasn’t supported by current UAE regulations. Instead they use a blockchain ledger for settlement, but the transfers themselves still take place via traditional financial networks.
Mr Santillan says eventually the company would like to use a cryptocurrency for transfers to the Philippines from the UAE, such as Stellar Lumens or XRP.
“We’re still hoping in the future to leverage an existing crypto to move our assets quicker and much more cheaply. Our idea for Denarii Cash is to get all these savings and then pass it to the consumers,” he says.