Tangled International Wires

A Little Bit of Money

Thought Experiments on Cross-Border Payments - Of Couriers, Bankers, and Bitcoiners

Series 22: Tangled International Wires

How Legacy Cross-Border Payments Work Today

Cross-border payments are essential for conducting international business, but the way these payments are processed behind the scenes is not well understood. As per tradition, domestic banks are forced to use a small group of correspondent banks to move money across borders. Only correspondent banks have international branches in multiple locations abroad. Hence, a handful of multinational entities dominate the global payments market.

Banks are Trade Agents of Money

Multinational banking groups are the trading agents of money. They act as the overseas agents for banks and domestic banks use them to service outgoing transaction requests to foreign countries. Local banks have limited access to foreign financial institutions; hence, for international wires, they use these big-name correspondent banks, which have established clearing and settlement accounts with foreign banks.

Correspondent Banks are in an Exclusive Group

Domestic banks that are frequently used by retail customers or SMBs deal with a limited number of agents when moving money. However, the world titans of correspondent banking – the banks that banks go to – include financial behemoths like Bank of America/Merrill Lynch, J.P. Morgan Chase Bank, Citibank, BNP Paribas, Deutsche Bank, and HSBC Bank, to name just a few. These institutions form an exclusive group of global banks that currently control international payments.

Dumping Files vs. Broadcasting or Streaming Content

Wiring money through banks means batching transactions and dumping files. Technically, the delivery method is quite different from broadcasting television content via satellite or streaming videos over the Internet – the flow of changing information about money movements isn’t a steady, dynamic stream of newly updated transaction data. With batching the transaction picture changes in installments rather than continuously in real-time. Usually, banks run semi-frequent batch jobs to reconcile inter-bank accounts. Semi-frequent often means daily, which is considerably longer than the ten minutes generally required to confirm a Bitcoin transaction – or even the sixty minutes that has been suggested as best practice. In the case of Ethereum, clearing and settlement happens in one go and takes just twelve seconds.

Bilateral Agreements and Clearing Houses make Wires among Banks possible

Banks are left to their own devices in terms of both the business logic they use to validate transactions and the means by which accounts are reconciled. When bilateral arrangements are no longer possible or economical (i.e., when three or more banks need to cooperate), banking partners often set up a central utility, called a clearinghouse. Thus, batching international transfers involves an extremely complex web of relationships, requiring individual banks to maintain a multitude of bilateral agreements with other banks, as well as memberships in one or more clearing houses.

To be continued. Further Reading:

M. Andrychowicz, S. Dziembowski, D. Malinowski, and L. Mazurek. “Secure Multiparty Computations on BitCoin.” In 2014 IEEE Symposium on Security and Privacy, pages 443-458, May 18-21, 2014.

S. Meiklejohn et al. “A Fistful of Bitcoins: Characterizing Payments Among Men with No Names.” In Proceedings of the 2013 Conference on Internet Measurement, pages 127-140, 2013.

S. Omohundro. “Cryptocurrencies, smart contracts, and artificial intelligence.” In AI Matters Newsletter, vol. 1, issue 2, pages 19-21, Dec. 2014.

J. Villasenor et al. The 2015 Brookings Financial and Digital Inclusion Project Report: Measuring Progress on Financial Access and Usage. Brookings Institution Press, 2015.

G. Wood. "Ethereum: A secure decentralized generalized transaction ledger." Ethereum Project Yellow Paper (2014).

 Demo AML/KYC-compliant on-boarding in 5 easy steps