One system to rule them all, one system to bind them! Swift!

Swift has been there at the core of cross-border payments for decades if not thousands of years for now and no bank has been able to remove this ring yet.

Society for Worldwide Interbank Financial Telecommunication (SWIFT), formed as a consortium of 239 banks in 1973, is a global network connecting banks to communicate messages about activities like money transfer safely and securely, using a code. SWIFT went live with its messaging services in 1977, replacing the Telex technology and rapidly became the trusted global partner for institutions all around the world. The book- The Pay Off: How Changing the Way We Pay Changes Everything explains this occurred because Citi was developing a proprietary payments network, and its rivals hated the idea of a monopoly sitting in private hands.

Telex service was slow and inefficient and thus, a few banks came together to make the change. Swift now has the monopoly in cross-border today with ~$1 Bn revenue in 2020. Although there are other message services like Fedwire, Ripple, and Clearing House Interbank Payments System (CHIPS), SWIFT continues to retain its dominant position in the market because of its network effects and adoption. The fact that it is formed by different banks makes it very difficult to replace.

But wait, why are we talking about SWIFT? Well, because it dominates the majority of the cross-border transactions and well, it is anything but “swift". The Pay Off notes that until recently Swift’s payments were slow, its costs high, and the utility slow to embrace innovation because it had a bureaucratic culture and weak governance structure.

Now, it is time for someone to replace SWIFT. Unsurprisingly, fintech startups, such as Ripple and Facebook’s Diem project, have come up to create plans to challenge Swift with innovations such as distributed ledger technology (“blockchain”).

Some of Swift’s own members are also challenging it. JPMorgan, for example, is developing a blockchain initiative system called Onyx with a messaging system called Liink. This is already moving “billions each day,” according to some sources.

Blockchain has the potential to disrupt the infrastructure related to cross-border payments but as we discussed, network effects play a strong role, and replacing SWIFT won't be easy. Also, to be totally fair, Swift has also come up with some innovations like Swift GPI in recent times which has significantly increased the speed of transactions in some regions.

Why can blockchain win and what are the constraints?

Ripple's original idea was to replace banks. A payment from A to B in the traditional banking system is simply an update to their respective loan balances to the bank. RipplePay held that one could replace banks by creating a peer-to-peer trust network in which individuals could directly loan each other, and alterations to these loan balances enable payments. Payments, then, are simply updates to these loan balances, provided the system can find a path of relationships from the payer to the recipient.

However, the company has changed significantly since then. In Sep 2020, Ripple's mission on their website was to remove friction from global payments and enable money to move the same way that information does today—digitally and instantly.

Ripple teamed up with Banco Santander in April, 2015 to launch a service based on its blockchain messaging technology that allows the Spanish bank’s customers in the UK, Spain, Poland and Brazil to send money in many currencies around the world. The belief was that blockchain could remove some of the current inefficiencies like transparency, speed and cost of moving money. Swift has, however, made its skepticism clear on the scalability of blockchain.

With CBDCs and stable coins coming into play, some of the earlier problems related to the volatility of crypto are going away.

One criticism of Ripple, however, is that most banks use only half its solution — the messaging part — while shunning its XRP cryptocurrency, which is meant to be a cheap and universal bridge currency, providing an alternative to the expensive nostro and vostro accounts of correspondent banking. Also, the scalability of blockchain and the cost involved in it with such large volumes is still a question.

But has something changed in the last 2-3 years? Well, first is the adoption of crypto.

According to an article in Techcrunch, the market cap of the top 10 cryptocurrencies increased ~3.3x, leading to higher liquidity.

Ripple is now expanding to Asia and the Middle East. Ripple and Tranglo, a Malaysia-based cross-border payments provider announced recently that Tranglo has launched its first live On-Demand Liquidity (ODL) service on RippleNet — Ripple’s global payments network for financial institutions — in the Philippines, with plans for more remittance corridors in the coming months. Ripple’s ODL service uses XRP for liquidity during cross-border transactions.

It will all depend on how fast banks adopt it and how fast the regulations change. It will need a more industry-wide change than happening today, to replace the network effects of Swift.

The other threat to Ripple is that SWIFT is waking up. Six of the world’s biggest banks endorsed a new platform for international payments set for launch in November 2022 by SWIFT, the global interbank messaging network. The new platform is set to include features such as upfront validation of beneficiary details, an extension of SWIFT’s high-speed system to lower-value payments and incorporation of the universal messaging standard for international payments, ISO 20022.

Facebook's Diem Project might soon launch a permissionless payment system based on blockchain technology. It will have a stablecoin Diem and run on its own blockchain network.

These are interesting times and I bet on a blockchain system to replace SWIFT eventually unless SWIFT acts fast, the timelines though are still unclear.