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Benefits and Risks of Cryptocurrencies for International Payments

By Frances Coppola

Though still far from mainstream use, cryptocurrencies continued to mature throughout 2017, and businesses are increasingly exploring the opportunities they offer to improve the efficiency of international payments. Yet key risks remain, including extreme volatility: Bitcoin, for example, the first cryptocurrency, surged past $10,000 in late November 20171 after briefly falling 15 percent in one day to a low of $5,507 in the middle of that month.2

International Payments, the Old-Fashioned Way

 

For centuries, international payments have depended on banks. Networks of correspondent banks enabled international businesses to transact with each other around the world. Until the mid-20th century, this process was very slow, since it depended on postal communications between banks and could fail if payment instructions didn't arrive or the correspondent bank lacked the funds to make the payment.

 

Technological improvements in the last half-century mean that international payments now take days rather than weeks to arrive. The SWIFT international messaging system has replaced faxes and postal communications, speeding up the transmission of payment instructions. And central bank real-time gross settlement (RTGS) systems such as Fedwire and CHAPS (in the U.K.), together with the Continuous Linked Settlement (CLS) system for FX settlement, have eliminated the risk that payments will fail to reach their destination due to lack of funds in intermediary banks.

 

However, there is still a trade-off between speed of settlement and price. Businesses can send USD payments intraday via Fedwire, but the fees are high. Meanwhile, using the cheaper ACH system means payments may not settle for several days. International payments in many other currencies remain slow and expensive.

 

Cryptocurrency Technology is Changing the Face of International Payments

 

Cryptocurrencies are sometimes described as the "Wild West" of the financial system, breaking new technological frontiers and threatening to disrupt existing financial service providers.3 Bypassing traditional bank intermediation, they can enable businesses to transfer funds anywhere in the world quickly and cheaply. Advanced cryptographic techniques protect funds from theft and hacking, and the underlying blockchain technology filters out fraudulent or duplicate transactions. Transaction fees are generally low compared to central bank RTGS fees.

 

The oldest and best-known cryptocurrency is Bitcoin. Other popular cryptocurrencies include Ethereum, Litecoin, Dash and Monero. The international digital payments protocol Ripple has its own native cryptocurrency. Both Ethereum and Bitcoin have "clones" – new cryptocurrencies created by a technical change, known as a "hard fork." Ethereum's clone is Ethereum Classic, and Bitcoin's is Bitcoin Cash. All of these can be used for international payments, though Bitcoin is by far the most widely used.

 

Cryptocurrencies can be particularly useful for cross-currency payments. For example, suppose an American business wishes to pay a Japanese supplier. The American business's main income is in U.S. dollars (USD), but the Japanese supplier wants to be paid in Japanese yen (JPY). Conventionally, either the American business must exchange USD for JPY before making the payment, or the Japanese supplier must make the same exchange on receipt. As the payment can take several days to settle, the USD-JPY exchange rate can move while the payment is in transit, causing losses for one or the other party to the transaction.

 

Typically, businesses use forward contracts or other FX hedging products to protect against this risk. However, if both parties agree that the payment will be made in Bitcoin (BTC), BTC's fast settlement can significantly reduce the risk of adverse exchange rate movements. The American business exchanges USD for BTC and sends BTC to the Japanese business, which exchanges BTC for JPY. If the two businesses use Ripple rather than BTC, conversion into and out of cryptocurrency is automatic.

 

Alternatively, if cash flow allows, both businesses can run BTC accounts, converting to and from their respective currencies when the BTC exchange rate is in their favor. Businesses that send and receive payments in multiple currencies could find using BTC for settlement streamlines cash flow management.

 

Key Risks to Consider When Using Cryptocurrencies for International Payments

 

However, using cryptocurrencies for international payments is not risk-free. Firstly, there is the problem of exchangeability. Cryptocurrency exchanges such as Coinbase will readily exchange Bitcoin and Ethereum for major currencies such as USD, Japanese yen and euros, but other cryptocurrencies may only be exchangeable for USD or Bitcoin. Clearly, if a British business whose main income is in pounds (GBP) wishes to pay an Australian supplier in Australian dollars (AUD), using a cryptocurrency that can only be exchanged for USD or Bitcoin creates additional FX risk.

 

Secondly, cryptocurrency exchange rates are extremely volatile. Businesses can risk significant losses if they run cash positions in cryptocurrencies for any length of time, though they may of course also profit from exchange rate gains. Opportunities for hedging against adverse exchange rate movements are currently limited: some cryptocurrency futures and options are traded on specialist exchanges, but they can be expensive and volatile. There are also some over-the-counter derivative products, but these can be highly speculative: one such product, the "contract for difference", was recently the subject of a regulatory warning from the U.K.'s Financial Conduct Authority.5

 

However, there are signs that a deeper and more liquid market for cryptocurrency derivatives may be on the way, to the benefit of businesses looking to hedge cryptocurrency cash positions arising from international payments. Recently, mainstream derivatives exchanges CME Group and the Chicago Board Options Exchange (CBOE) decided to offer, respectively, Bitcoin futures6 and options.7 The Nasdaq stock exchange and broker Cantor Fitzgerald followed suit, announcing plans to offer Bitcoin futures from early 2018.8

 

As cryptocurrencies challenge international payments protocol, traditional payments service providers are responding. They are looking for ways of helping businesses to benefit from cryptocurrencies' fast settlement, security and cost-effectiveness while minimizing the FX and cash flow risks. For example, American Express recently announced a joint venture with international payments protocol Ripple and a large British bank to provide fast, secure transatlantic payments for U.S. customers.

 

The

Takeaway:

Using cryptocurrencies for international payments can be attractive for some businesses, particularly those trading in countries that banks regard as risky, and those handling incoming and outgoing payments in multiple currencies. However, cryptocurrency exchange rates are highly volatile, and using cryptocurrencies for settlement can raise FX risks. Businesses may wish to consider the risks as well as the rewards when evaluating a cryptocurrency-based international payments strategy.

Frances Coppola - The Author

The Author

Frances Coppola

With 17 years' experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.

Sources

1. “Bitcoin Hits $10,000 as Sharp Rise Drowns Out Skeptics,” The Wall Street Journal; https://www.wsj.com/articles/bitcoin-hits-10-000-as-sharp-rise-drowns-out-skeptics-1511919295
2. “Bitcoin briefly drops 15% amid debate over digital currency's future,” CNBC; https://www.cnbc.com/2017/11/12/bitcoin-briefly-drops-15-percent-amid-debate-over-digital-currencys-future.html
3. “The new wild west: cryptocurrency and blockchain,” The Catalyst; http://ncfcatalyst.com/the-new-wild-west-cryptocurrency-and-blockchain/
4. “Is it possible to trade Bitcoin options?,” Investopedia; https://www.investopedia.com/articles/investing/033115/it-possible-trade-bitcoin-options.asp
5. “FCA Issues Warning Regarding Cryptocurrency CFDs,” Bitcoin.com; https://news.bitcoin.com/fca-issues-warning-regarding-cryptocurrency-cfds/
6. “CME Group Announces Launch Of Bitcoin Futures,” CME Group; http://www.cmegroup.com/media-room/press-releases/2017/10/31/cme_group_announceslaunchofbitcoinfutures.html
7. “Options exchange CBOE to launch cryptocurrency derivatives in 2017,” Coindesk; https://www.coindesk.com/options-exchange-cboe-launch-cryptocurrency-derivatives-2017/
8. “Nasdaq Plans To Launch Bitcoin Futures In First Half 2018,” The Wall Street Journal; https://www.wsj.com/articles/nasdaq-plans-to-launch-bitcoin-futures-in-first-half-2018-1511968313

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