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Blockchains, Distributed Ledgers and Funds Transfer: an Overview REPORT | AUGUST 2017 Blockchains, Distributed Ledgers and Funds Transfer: An Overview REDUCING POVERTY THROUGH FINANCIAL SECTOR DEVELOPMENT 1 Key points 01 02 03 04 The volume of DLT can help to reduce There are two key ways Bitcoin, as all public DLT remittances is growing the cost of remittances, in which these can be applications, is essentially year by year but prices for increase speed of achieved: (i) the usage of a shared transactional international transfers settlement, reduce public DLT in general, database – in other words, are still relatively settlement risk, decrease and Bitcoin in particular, a shared accounting high. Blockchain and entry barriers for financial as a financial instrument system. The Bitcoin Distributed Ledger institutions, improve and (ii) use of the private application (as some Technology (DLT) the interoperability DLT as a means to clear other cryptocurrencies) presents opportunities for of different financial and settle obligations is focused in particular new ways of performing instruments and enhance between different on value transfers funds transfers, payment the regulatory frameworks financial institutions and thus constitutes settlement and regulatory that oversee funds either domestically or a publicly available oversight, due to its transfers such as Know internationally. payment system. There decentralised, replicated Your Customer (KYC) and are issues associated with and transparent nature. Anti-Money Laundering the scalability, volatility, (AML) processes. governance and legal standing of public distributed ledgers. 05 06 07 08 The principal In comparison with more Accurate and detailed However, this is not impediment to the use traditional, centralised information on straightforward. Reliability of cryptocurrencies in a initiatives, the private individuals is often comes from intrinsic DLT peer-to-peer fashion as a DLT model for inter- reported as a key barrier characteristics (such as means to transfer funds is organisational clearing to credit decision making amend-only transaction the costs at the edge: due and settlement could by financial providers. history across parties and to severely limited access be considered more DLT has the potential to cryptographically secured to cheap cryptocurrency- secure (less opportunity act as a reliable ‘store’ transactions), but not fiat exchanges for systemic fraud), less of identity information exclusively from them. To (intermediaries), the costs costly to set up, and more available in near real- ensure trust and reliability, (and effort) of buying scalable (easier to on- time and as a generator it is important that DLT and selling Bitcoins for board organisations). of dynamically changing solutions are developed remittance purposes may Private DLT solutions identity attributes (such as in accordance with be simply too expensive. could face less politically creditworthiness). national laws and security charged resistance than standards, and take into centralised Real Time consideration the views of Gross Settlement (RTGS) all stakeholders. switches might do. Photos and graphic design: Kristina Just Blockchains, Distributed Ledgers and Funds Transfer: An Overview Blockchains, Distributed Ledgers and Funds Transfer: An Overview BY: SALOME PARULAVA 3 FSD Africa Report Acronyms AML Anti-Money Laundering CDD Customer Due Diligence CFT Combating the Financing of Terrorism CGAP Consultative Group to Assist the Poor CICO Cash-In/Cash-Out FATF Financial Action Task Force ID&V Identification and Verification MFI Microfinance Institution MMO Mobile Money Operator DLT Distributed Ledger Technology Acknowledgements “Blockchains, Distributed Ledgers and Funds Transfer: An Overview” was authored by Salome Parulava, Associate Consultant at Consult Hyperion. She would like to extend her gratitude to the U.K. Department for International Development (DFID) and Financial Sector Deepening Africa (FSD Africa) and to the following for assisting in compiling the report: Paul Makin, Iain Brougham, Joe Huxley, Fundi Ngundi and Martin Namasaka. The views expressed in this report are those of the author, Consult Hyperion, and in no way entirely reflect those of FSD Africa. 4 Blockchains, Distributed Ledgers and Funds Transfer: An Overview Contents 1. Introduction 6 1.1 Fund transfers: current situation 6 1.2 Intermediaries, problems they solve and instruments they use 6 1.3 How Blockchain and Distributed Ledger Technology can help 7 2. Technology Classification and Components 8 2.1 Bitcoin, cryptocurrency, Blockchain and Distributed Ledger Technology 8 2.2 DLT in fund transfers (public and private distributed ledgers) 9 3. Fund Transfer Models Based on Public Distributed Ledger Technologies 11 3.1 Remittances 11 3.2 Charities and international aid programmes/dedicated coins 14 3.3 KYC/AML/CFT 14 4. Fund Transfer Model Based on Private Distributed Ledger Technology 16 4.1 Clearing & Settlement 16 4.2 Implications 17 5. Conclusion 19 List of Figures & Tables Figure 1 Average Cost of Remittances, by Product Type, 2015 6 Figure 2 Distributed Ledger Technology Model 7 Figure 3 Hierarchies 9 Figure 4 Third Party-Enabled Bitcoin-Based Remittance Model 12 Figure 5 Third Party-Enabled ‘Invisible Bitcoin’ Remittance Model 13 Figure 6 Correspondent Banking-Enabled Remittance Service 13 Figure 7 AML and KYC (ID&V) Potential of DLT 15 Figure 8 Private DLT for Inter-Organisation Cross-Border Settlement 16 Figure 9 Private DLT for Inter-Organisation Domestic Settlement 17 Figure 10 Settlement Cost, Risk Reduction and Interoperability Potential of DLT 18 Figure 11 Distributed Ledger Architecture and its Potential for Funds Transfer 19 Table 1 Comparison of Two Applications of DLT 10 5 FSD Africa Report 1. Introduction 1.1 Fund transfers: current situation services remain unaffordable and inaccessible for major parts of the population in emerging economies. In the past decade, the financial services industry has The volume of remittances is growing year by year developed significantly across the emerging markets. but prices for international transfers are still relatively Since the introduction of mobile money schemes such as high. According to the World Bank, the average global M-PESA, we have seen a steady stream of change towards cost of sending remittances in the last quarter of 2015 more inclusive financial markets. Research1 carried out was recorded at 7.37%, with commercial bank transfers by CGAP shows that outcomes of financial inclusion are (11.12%) being the most expensive means of remitting directly linked with higher economic growth and better money and online services being the least expensive wellbeing. Nevertheless, many financial instruments and (5.57%).2 Figure 1: Average Cost of Remittances, by Product Type, 2015 (Source: The World Bank) 12% 10% 8% 6% 4% 2% 0% service service Cash to cash Door to door to Door (to any bank) Pre-paid card Mobile service On-line service Account to cash Cash to account Credit/debit card card Credit/debit (within same bank) Account to account account to Account account to Account 1.2 Intermediaries, problems they solve and of the funds and the beneficiaries (receivers), solving instruments they use for them problems of communication (accessibility), logistics and interoperability, as well as reducing The range of entities that can provide financial services, counterparty risk between parties. including fund transfers, are banks (state-owned and For example, a bank could give a person in the UK private), credit unions, cooperatives, microfinance an opportunity to send money to a person in Nigeria, institutions, near-banks,3 MMOs, retailers, post services thus solving communications and logistics problems (including postbanks), and internet giants. Such for the sender and beneficiary (through a network of institutions act as intermediaries between the senders partners). 1 http://www.cgap.org/about/faq/what-impact-financial-inclusion-efforts 2 https://remittanceprices.worldbank.org/sites/default/files/rpw_report_december_2015.pdf 3 Companies that provide front-row online banking services to customers and rely on traditional banks to be the backbone of the financial transactions of their customers. For example, Simple Finance Technology Corporation (US) (https://www.simple.com/) 6 Blockchains, Distributed Ledgers and Funds Transfer: An Overview The financial intermediaries also provide a way to 1.3 How Blockchain and Distributed Ledger convert British Pounds to Nigerian Naira and ensure Technology can help the availability of the funds to the beneficiary in the forms of cash, bank deposit and mobile money In this paper we argue that there are two key ways (solving the interoperability problem). Finally, the in which Blockchain and, more broadly, Distributed sender and receiver do not necessarily need to trust Ledger Technology4 can assist in the area of fund each other in order to complete the transfer as the transfers in emerging markets: intermediary acts as a trusted third party with certain – One approach is based on the usage of public liabilities and dispute resolution authority (reducing distributed ledgers in general, and Bitcoin in par- counterparty risk). ticular, as a financial instrument and as a platform In certain cases of fund transfers these for cross-border, high-speed, low-cost value trans- issues (communication/accessibility, logistics, fers for consumers, businesses and international interoperability, reduction of counterparty risk) are agencies. likely to be quite costly for intermediaries to tackle and – Another
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