IMF: Digital currency could remake 'cumbersome' cross-border payments

Banks have woken up to the potential for distributed-ledger technology and cryptocurrencies to improve the old convoluted system of cross-border payments. Now it appears that the International Monetary Fund has come to the same realizations.

In a research note released this week, the IMF dug deep into what it called the "costly" and "cumbersome" correspondent banking system that dominates the landscape of international payments. Remarkably for an establishment institution, the IMF suggested that cryptocurrencies — once considered by devotees to be a radical replacement for banks — may hold the key to better transactions.

The current international payments system has many flaws, according to the note, including slowness and opacity in pricing. Cross-border payments take up to five days to settle and incur fees that the initiating bank often can't know ahead of time. Regulation keeps compliance costs high, which in turn benefit incumbents and suppress competition.

Just as mailing a letter internationally used to cost more and take longer than sending domestic mail, so cross-border payments today are more expensive and sluggish than domestic bank wires. But distributed ledger systems could change all of that, according to the IMF's note, just as email changed the delivery of messages.

"In the age of the internet, instead, there is no distinction between a message going to a domestic or foreign recipient; both take a click," the authors wrote. "A message is a message; might a payment just be a payment in the future?"

San Francisco startup Ripple is one of the companies working to make that vision a reality. Last year, it collaborated with the technology consortium R3 to run a trial in which 12 banks held Ripple's cryptocurrency, XRP, and used it to settle payments with each other.

"Why is it that we can literally stream video from the [International] Space Station, yet I can't move my own money from here to London? The fastest way for you to get money from [San Francisco] to London today is to get on an airplane," said Brad Garlinghouse, Ripple's CEO. "That's kind of a crazy thing in the age of the internet, that there's so much friction in how value moves."

Ripple's long-term plan is for XRP to provide banks with on-demand liquidity when they need to send money across borders. The authors of the IMF note envision a hub-and-spoke model in which users swap fiat currency, such as dollars, for digital currency using ATMs, online exchanges or other means, and the digital currency is then transferred over its own blockchain network to the recipient. The cryptomoney is then turned back into a foreign fiat currency, such as euros or yen.

Such a system would stand a good chance of disrupting entrenched players, according to the IMF. Just as email made people around the world begin thinking of ordinary letter delivery as "snail mail," the note suggests, so in the cryptocurrency-powered future people may think of bank transfers as snail money.

Another cross-border payments model the note explores would require central banks to begin issuing their own digital currencies. Rather than creating new currencies, like bitcoin, the digital tokens created by central banks would be blockchain-based representations of ordinary fiat money.

Jerome Powell, a member of the Federal Reserve's board of governors, recently called such innovations "the 21st-century analog of paper currency." But he cautioned that the Fed was not currently planning to issue its own form of digital cash.

Still, the IMF notes that a cross-border payments system based on a central bank-issued digital currency could have many of the same benefits of a system like the one Ripple is hoping to build. What's more, government sponsorship might inspire greater trust in the technology and help to stabilize the exchange rate.

Blockchain technology is not a slam dunk, however. The IMF staffers note a number of challenges that stand in the way of banks adopting it for payments and the clearing and settlement of other assets, including the difficulty of finding the right balance between privacy and transparency on distributed ledgers.

Another potential barrier is regulation. "The legal status of a digital token and the legal effect of its transfer are not clear," the authors write. "For example, would the transfer of an asset-backed token (e.g., representing a security) on a ledger transfer legal ownership of the security or would registration outside the ledger (e.g., in a corporate share registry) still be required?"

This is an issue with which many blockchain entrepreneurs are now grappling, as the overheated market for digital tokens — typically issued in crowd sales known as "initial coin offerings," or ICOs — reaches its boiling point. Startups and software projects have raised more than $450 million this year alone by selling tokens, which function sort of like equity shares in the services being built.

One company pioneering what it calls a legally compliant ICO is Blockchain Capital, the San Francisco venture capital firm that invests exclusively in blockchain startups.

In April, the firm successfully raised $10 million for its new fund by selling its own token, though in the United States, for regulatory reasons, only accredited investors were allowed to take part. More than 800 investors in 79 countries ultimately participated in the ICO.

"That was pretty exciting," said Bart Stephens, a managing partner at Blockchain Capital, regarding the number and diversity of the ICO's investors. "I never would have guessed that."