by Zain Jaffer
According to a May 2024 CNBC report [https://www.cnbc.com/video/2024/05/08/major-banks-test-tokenized-asset-settlement-network-crypto-world.html], some major US banks are now testing the use of a blockchain network between themselves to send funds in a tokenized manner. Banks globally are now under pressure to improve the current traditional finance method of cross border payments, which when compared to newer cryptocurrency systems like Bitcoin and Ethereum, are archaic.
Users of Bitcoin and crypto can often send funds in a matter of seconds or minutes direct to their intended recipient anywhere around the world. Most cryptocurrencies are peer to peer payment systems, meaning that there is no third party company in between the sender and receiver. Instead of banks and people handling these wire transfers manually, a group of servers simultaneously update and keep redundant copies of the transaction in their database in a time sequential manner. Hence the word “blockchain.”
It is like getting married in front of hundreds of people. All the guests and families all witness simultaneously that the wedding “transaction” took place at a certain time and date between Bob and Susan.
Another example is if you all ordered some drinks from the bar and all of you keep a simultaneous updated tally of all the drinks you ordered. That information is no longer reversible or contestable once you all agree, and the bartender or cashier cannot claim that you ordered a Dom Perignon when in fact you and your friends attest that you did not.
This is not currently possible in traditional banking. For example, if you sell some stocks with a broker, the funds might not appear until two days have passed. They refer to this as a T+2 settlement. This is because banks at the moment have their own database that they do not share with other banks. Thus these are updated separately.
The way traditional banks wire money across borders is generally like this. Let us say that a migrant worker in the US wants to send money to their home country somewhere in Asia. Normally the US banks have their own interconnection with other banks here using the US Fedwire system. To wire abroad banks typically use a messaging system called SWIFT which stands for the Society for Worldwide Interbank Financial Telecommunications [https://www.investopedia.com/articles/personal-finance/050515/how-swift-system-works.asp].
Since the US and foreign banks do not have direct relationships with each other, they need to pass their payments through what are called “correspondent” banks. Sort of like passing old fashioned love letters through an intermediary. Many of these banks are based in New York City.
Often, there is a delay associated with each step, and each bank takes a transaction fee. So the sending bank, the correspondent bank, and the receiving bank, all have their respective delays and fees to update their separate databases. The situation has improved somewhat over the past few years, but some only process payments during normal banking hours. So a foreign bank transfer can sometimes take a few days total to process, with currency adjustments and fees.
The key to remember is that unlike blockchains, traditional finance banks and entities all keep their own separate transaction ledgers or databases. So Wells Fargo, JP Morgan, and Bank of America all have separate depositor ledgers/databases. When you issue the debit and credit instructions to effect a transfer across banks it does not all occur simultaneously but sequentially using FedNow or SWIFT messaging, which takes time and each party has its own transaction fee cut.
This has big implications for individuals and businesses who make and receive these payments. In cases of emergencies for example, a recipient who needs to wait a few days may need to take out a personal loan with friends and family until it can be repaid when the actual amount arrives. Businesses who delay shipment of their items until the payment is received a few days later can now ship it out faster.
Blockchain is the future and there is no denying it. Many people make bets against technology, citing tradition and the way they do things. Often they lose that bet over the long term just as they did with the automobile, the airplane, the telephone, the Internet, and other innovations.
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