These two global money transfer ideas deserve a shot

Nexus or Icebreaker? Two competing ideas are jostling for attention, each promising to reshape the inefficiency-ridden landscape of moving money from one country to another. Instead of trying to choose between them, central banks ought to give both a shot.

The European payment system recently did a trial linkup with Malaysia and Singapore under the Bank for International Settlements' Nexus protocol, designed to transfer funds between bank accounts in different countries under 60 seconds. Meanwhile, the monetary authorities of Israel, Norway and Sweden have tested a separate BIS-backed initiative that achieves the same goal of fast cross-border retail payments. Project Icebreaker uses central bank digital currencies, or CBDCs, instead of bank accounts.

No prizes for guessing which of the two will get going first. Five countries in Southeast Asia, with a combined population of 490 million and gross domestic product of $2.6 trillion, have already decided to connect their domestic instant payment systems. Nexus is the obvious blueprint. Besides, CBDCs are mostly still undergoing pilot runs, or being evaluated for speed, scalability and privacy. Icebreaker can't take off before tokenised versions of official currencies become widely available.

Illustration: TBS

Still, consumers paying an average 6.3% on a $200 transfer will welcome alternatives. Sending payment instructions via the SWIFT messaging system —  a matter of minutes on the fastest routes — can take more than two days on some of the slowest. The late 18th-century technology of correspondent banking that runs with the help of those messages is anachronistic in today's world. In 64 countries, individuals are increasingly whipping out their smartphones to pay from deposit accounts, and expecting results in real time. According to Fidelity National Information Services Inc.'s latest report, payments from one bank account to another will account of 24% of India's e-commerce, 28% of Peru's, 35% of Brazil's and as much as 45% of Thailand's by 2026.

Those transactions, however, will occur in purely domestic settings. International borders complicate things by introducing exchange rates, sanctions lists and money-laundering safeguards, among other hurdles. Sill, retail users and small businesses are tired of paying through their nose for money transfers, as are nations that rely on remittances sent to families back home by their overseas diaspora. Cutting prices by 5 percentage points can save $16 billion a year, according to the World Bank.

Nexus seeks to do just that. It won't be an app, but a common language, like the standard hypertext markup used in documents designed to be displayed in a web browser. It will eliminate the present-day barriers to communication between two national payment systems. If I give someone in another country my phone number, e-mail or virtual ID on which I'm accustomed to receiving a local money transfer, currently they won't be able to use it to pay me because my information is alien to their bank. With Nexus, the protocol will look me up for the sender's bank app, and display my full or partially masked name, so that they have the certainty of paying the right person.

Banks will only show their own currency conversion quotes to customers. Nexus will source buy/sell offers from multiple providers. Fees will be disclosed upfront. In this, Icebreaker will be similar to Nexus, even though it won't work by debiting and crediting deposits. When a transfer is done, the payer will be left with fewer digital tokens in her wallet; the recipient will have more. It will be analogous to a cross-border cash transaction, except that the Icebreaker hub will do the routing instead of the secretive 'hawala' operators who have offered this service in the Middle East and the Indian sub-continent since medieval times.

The cryptographic technique of hashed time-locked contracts, which effectively sets up a digital escrow account, will ensure that the payer's money either reaches the payee or doesn't leave the wallet at all. Funds won't get stuck somewhere in the labyrinth for a silly spelling mistake.

Icebreaker will need more work to allay national authorities' fear of money-laundering and to make the new system easy for legitimate users. As the project's researchers have noted: "How does someone in one country get the wallet address of someone in another?" IBAN is an international standard for bank account numbers. It'll be a big help to have something similar for digital wallets.

The advantage of Icebreaker is that countries exploring CBDCs for domestic use won't have to worry if their choice of distributed ledger technology will come in the way of cross-border payments. The way the project is designed, funds won't physically go abroad; mutually incompatible technical systems can still participate in an exchange of value as long as each can individually connect to the Icebreaker hub.

When it comes to money crossing borders, roughly $1 trillion every year is on account of individuals paying one another and businesses. Financial institutions charge them between 140 to 380 basis points, according to McKinsey & Co. Small businesses aren't as badly fleeced as retail clients, though they still end up paying a steep 35 basis points on their $6 trillion. 

Only large corporations, which account for $90 trillion in annual flows, are able to flex their muscles and restrict the banks' margin to 5 basis points. Technology can level the playing field. Whether it's Nexus, Icebreaker or something entirely different, the speed of experimentation in this area is an encouraging sign: Cheaper transfers that never came to a bank near you are finally arriving on the smartphone in your pocket. 

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services. 

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.