Crypto Liquidity vs. Cross-Border Payments

The Growing Adoption of Cryptocurrency in Cross-Border Payments

It is increasingly common to observe established financial institutions developing strategies to incorporate cryptocurrency. This trend is understandable given the rising prominence of crypto within mainstream awareness.

Specifically, applications such as cross-border payments have moved beyond experimental phases and are now actively utilized.

Why Cryptocurrency Excels in Cross-Border Transactions

The inherent characteristics of public blockchains and their associated cryptocurrencies make them ideally suited for international payments. These systems are globally accessible, secure, and designed to resist censorship.

Furthermore, transactions can often be completed at a lower cost – contingent on the specific token – and with near-instantaneous settlement, available around the clock, every day of the year.

The Challenge to Traditional Systems

Despite these advantages, the impact of cryptocurrency on the $130 trillion annual cross-border payment industry has been gradual. Existing players, including money-transfer services and large banks, have historically maintained a dominant position.

For instance, a significant portion of Western Union’s income is derived from fees charged on individual cross-border transactions.

Increasing Liquidity and Accessibility

The widespread adoption of crypto hinges on achieving comparable or superior global liquidity to traditional fiat currencies, alongside convenient entry and exit points for users.

Fortunately, indicators suggest positive developments in both of these crucial areas.

On-ramps and off-ramps are becoming more readily available, facilitating easier conversion between fiat and crypto.

This increased accessibility, coupled with growing liquidity, positions cryptocurrency for continued expansion within the cross-border payments landscape.

Traditional Banking Systems Benefit Larger Financial Institutions

The conventional foreign exchange (FX) landscape has experienced limited evolution in recent years. Payment processing is typically restricted to standard banking operational hours. While the SWIFT network facilitates message transmission, actual settlement of funds often requires several days to complete.

This established correspondent banking system involves at least two separate stages. Consequently, transactions are frequently slow, susceptible to errors, expensive, and generally inefficient. Even in high-volume corridors like those between the U.S. and Mexico, consumers still encounter associated costs.

When dealing with currencies outside of the G-20 nations, predicting the arrival time of funds across international borders becomes highly uncertain. Transaction fees in these cases can range from 5% to 10%. This longstanding system has disproportionately benefited large, globally significant banks.

These institutions have historically maintained a monopoly on access to liquidity, accumulating substantial profits – measured in the trillions of dollars – over an extended period.

Prior to 2017, crypto liquidity was confined to a limited number of exchanges, with total trading volume across all digital assets amounting to only a few million dollars. However, this situation has undergone a significant transformation in recent years.

Ripple initially pursued the concept that utilizing crypto for cross-border payment liquidity sourcing would become more cost-effective than traditional fiat methods. This premise hinged on two key factors: (1) a global increase in crypto trading volume, as indicated by exchange liquidity levels, and (2) the capacity to execute larger payment amounts, reflected in order book size.

A vision considered ambitious in 2015 has now become a demonstrable reality.

Facilitating Crypto Liquidity: The Importance of On- and Off-Ramps

Accessing crypto liquidity necessitates readily available on- and off-ramps. These systems allow for the seamless conversion between traditional fiat currencies and cryptocurrencies. Previously, the options for these conversions were limited.

However, the landscape is rapidly evolving, with a proliferation of venues like stablecoins and crypto exchanges. This expansion provides increasingly diverse methods for entering and exiting the crypto market.

Major players, including established money transfer services, card networks, and global crypto exchanges, are now leveraging tokenization to overcome this initial barrier to entry.

The Rise of Fiat-Backed Stablecoins

Fiat-backed stablecoins have become a favored on- and off-ramp solution. They offer a streamlined pathway to crypto, avoiding the immediate need for fiat conversion during transactions.

This approach effectively mitigates potential issues related to conversion taxes and the inherent volatility often associated with cryptocurrencies.

The increasing market capitalization of stablecoins demonstrates their growing popularity. It surged from $4 billion in 2019 to over $100 billion by July 2021.

Tokenization and Systemic Liquidity

Stablecoins provide crucial access and liquidity to crypto exchanges, decentralized finance (DeFi) platforms, and even less accessible fiat-to-fiat currency exchange routes.

This highlights the transformative potential of tokenized assets. As the global trend towards tokenizing various forms of value – including fiat, crypto, identity, loans, and NFTs – continues, the overall liquidity within the system will increase.

Greater liquidity will, in turn, facilitate smoother transitions between different asset classes, fostering a more interconnected and efficient financial ecosystem.

Analyzing the Data on Crypto Liquidity

Let's examine the quantitative evidence demonstrating that obtaining liquidity from cryptocurrencies is becoming increasingly cost-effective compared to traditional fiat currencies over time. A key question arises: at what point does utilizing crypto for sourcing liquidity consistently prove cheaper than conventional fiat foreign exchange (FX) transactions?

The following chart illustrates the growth of crypto volume – a significant indicator of liquidity – over the past five years. This analysis uses data from Bitstamp, focusing on the five leading cryptocurrencies by market capitalization: Bitcoin, Ether, XRP, Litecoin, and Bitcoin Cash, as a representative sample of the broader crypto market.

These selected assets consistently represented approximately 85% of all crypto volume (excluding stablecoins) between 2016 and 2021.

Our investigation specifically considered monthly USD and EUR volume for these five tokens. This data was then compared against the average difference between USD and EUR spot and implied FX rates, alongside the USD and EUR order book size, spanning from April 2016 to June 2021.

Spot rate reflects the immediate FX rate at a given moment, while implied rate indicates the FX rate achieved when bridging sending and destination currencies via an intermediary, such as a cryptocurrency.

As the years progressed, the gap between the spot FX rate and the implied rate narrowed, as shown by the average trend line. This signifies that sending payments through crypto is becoming comparable in cost, or even cheaper, than using fiat.

Projecting this trend line forward, we can anticipate it crossing below zero within the next two years, assuming crypto volume continues to double at its current pace. It's important to acknowledge additional factors, such as the fees charged by payment providers like PayPal or Western Union, which typically range from 0.2% to 1% per fiat transaction.

The chart above demonstrates a rapid increase in order book size over the same period. This indicates a growing capacity to support payments, reaching a total of $4 million in 2021 with these five cryptocurrencies.

The Decline of Traditional Payment Revenue Models

Money-transfer businesses heavily reliant on foreign exchange (FX) transaction fees should be aware of emerging trends indicated by current data.

The increasing adoption of cryptocurrency for cross-border payments isn't solely driven by the inherent benefits of blockchain technology. A key factor is the growing global liquidity now capable of supporting these payments on a substantial scale.

A Shift in Consumer Preference

Consumers who have historically utilized services like PayPal for international transfers are beginning to question their loyalty. The advantages of cryptocurrency – lower costs, increased speed, and comparable, if not superior, security – present a compelling alternative.

This shift necessitates a re-evaluation of revenue strategies for established payment providers. Their current dependence on transaction fees places them at risk of becoming outdated.

Some companies are reacting by increasing fees, as seen with PayPal’s recent adjustments to cross-border merchant payments in Europe and Western Union’s expansion into digital payments. However, these measures are unlikely to halt the ongoing disruption.

Beyond Basic Transactions

Additional services offered by traditional providers, such as compliance and address verification, will likely prove insufficient to maintain their market position. Numerous cryptocurrency firms are already implementing comprehensive anti-money-laundering (AML) and know your customer (KYC) protocols.

While the presented data focuses on Bitcoin (BTC), Ethereum (ETH), Ripple (XRP), Litecoin (LTC), and Bitcoin Cash (BCH) within specific corridors, it serves as a strong indicator of broader market trends.

The Expanding Crypto Market

Currently, the cryptocurrency market capitalization exceeds $2 trillion. Consider the potential impact as this figure rises to $5 trillion or $10 trillion.

The increasing crypto liquidity is fundamentally altering the payments landscape. The question is no longer whether cryptocurrency will disrupt the industry, but rather when this transformation will fully materialize.