[Note: Tim Swanson is the author of Great Chain of Numbers and The Anatomy of a Money-like Informational Commodity.]
Last week the /r/Bitcoin community thought they came up with a clever ad (see image) that revealed the “true” costs of remittances.
Because it lacks a “circular flow of income” in developing countries, Bitcoin, the network, in this instance is just a transmission network. Recipients still have to cash out into local fiat. Or as the Western Union CIO (who mines bitcoins) explained two weeks ago: Bitcoin does not solve the “last mile” problem in money transmission.
Because it does not operate on a public, untrusted network, Western Union does not have a transmission “issue” that Bitcoin directly competes with. There is no vulnerability to a Sybil attack and thus the marginal cost for Western Union to move and secure an electronic signal is negligible because they use a trusted network.
Recall that the original white paper described building a P2P system on a public, untrusted network – the cost structure to run a decentralized network is different than a centralized system. While the nominal cost of sending a bitcoin transaction is technically free (since the “fee” is not mandatory it is probably more accurate to call it a “donation”), the unseen marginal cost is actually significantly higher.
The marginal cost for a satoshi (the smallest denomination of a bitcoin) to be “protected” from Sybil attacks and “transported” in the long run equals its marginal value (MV=MC). Or in other words, it does not cost “only” US$0.01 – the true costs of the network are several orders of magnitude higher (roughly $15 at the time of this writing) and are borne via seigniorage (block rewards) a temporary subsidy, which I and others have written about numerous times (see Chapter 3).
So why then, if the network transmission costs are minimal, does Western Union and its peers charge an average of 9% to move money globally? Do they just hate poor people?
In practice, the two largest components for costs are related to compliance and the agent network, the physical organization on the ground. To quote Western Union from its 10-K form:
“Cost of services primarily consists of agent commissions and expenses for call centers, settlement operations and related information technology costs. Expenses within these functions include personnel, software, equipment, telecommunications, bank fees, depreciation, amortization and other expenses incurred in connection with providing money transfer and other payment services.”
“MTOs derive their revenues primarily through fees (70% to 75%), exchange rate arbitrage (20% to 25%) and other value-added services (0% to 5%). They have a high fixed cost (35% to 45%), which largely comprises expenses to cover salaries, rent, compliance, IT and marketing. The variable cost (55% to 65%) is mostly attributable to agent commissions.
MTOs spend approximately 3% of their revenue on regulatory compliance. Market leader Western Union reportedly employs 600 full-time compliance staff and spends $60 million annually to monitor its money transfer operations.”
This issue was relayed to CoinDesk by Andrew Brown, head of compliance at cross-border payments specialist Earthport, stating that:
“By the time all those obligations have been applied, I don’t think any apparent advantage [for Bitcoin] will be left.”
As Bitcoin remittance companies are finding out the hard way, not only do Bitcoin companies need to hire and maintain some “boots on the ground” in the form of an agent network (sales and customer service staff), they will ultimately have to be compliant with AML/KYC regulations if they want to operate a physical retail location, thus increasing their costs to roughly the same level as incumbents.
After the dust has settled, about the only competitive advantage the Bitcoin network may have had in the short-run over Western Union was that its transmission times may be marginally “faster” – but even then it may not be the case because of the end-to-end AML/KYC procedures for Bitcoin users.
But what about the gimmicky Matrix meme poster? This is fan fiction. Bitcoin is not being built in a vacuum, devoid of competitors. Last quarter Venmo alone processed US$700 million in payments, that is roughly two to three times as much as retail commerce is processed with Bitcoin annually. This could change, but it is bears mentioning that according to AngelList, there are roughly 1,475 digital payments-related startups. That is a lot of potential competition. Some such as Numoni in Singapore and AliPay in China (AliPay is part of the Alibaba group) are quietly onramping underbanked residents in Asia, eschewing the hype and creating real utility today.
But what does payments have to do with remittances?
Recall that a circular flow of income allows fiat to move between market participants, from employer to employee, from retailer to customer, from the top of a supply chain all the down to subcontractors and their vendors.
With Bitcoin today – perhaps this will change in the future – there is no circular flow of bitcoin income, especially in developing countries where Bitcoin advocates continue to point to for the most disruption. It does no good if a Kenyan expat (to use the overused cliché) can send bitcoins from London to his family in Naibrobi, if the family cannot cash out into shillings. Relative to the shilling economy, very few merchants, vendors, stores and most importantly utilities accept bitcoins in that city, let alone country and continent. In fact, in July, William Suk analyzed BitPesa and at that time it was actually cheaper for a Kenyan family to simply send and receive funds via firms like Western Union than it was to use the startup.
That is not to say that there are no margins for growth or that startups cannot find competitive niches in the international payments and remittance market. If SWIFT and the correspondence banking system were to adapt a system such as Ripple or Stellar (or several others in development such as PayWise), there could be some margins for improvement. Yet it should also be noted that the efficiencies gained in this scenario also involve tying existing trusted parties into the fold, thus there is probably no need to use a blockchain as the network is not untrusted.
What about Bitcoin ATMs?
ATM-to-ATM transfer is not necessarily the “silver bullet” either as in practice, all ATM providers charge a fee (because these owners also have costs such as amortization of the ATM, rent, electricity, insurance, etc.) and these fees typically ranges from 5-8% one-way. Thus, in some instances, it may actually be more expensive for bitcoin ATM users to send funds via ATMs end-to-end then it would be to use Western Union.
In theory and in practice
While Bitcoin looked like it could disrupt remittances on paper – and I too fell for this siren call back in March (see Chapter 6) – at the end of the day the question is, what happens in practice. To answer that I recommend listening to Richard Boase’s experience in Kenya and to read the Uganda “faux” report.
The reality is that most “summiteers” (Bitcoin advocates that spend more time at conferences and summits than shipping products) usually have a superficial understanding of remittances. In other cases, it only receives lip service. For instance, in the documentary Rise and Rise of Bitcoin, more than three minutes were spent discussing Silk Road and drugs (from 51:01 – 54:11) and less than 30 seconds spent on “Africa” (from 1:15:30 – 1:16:00).
If Bitcoiners want to tackle international remittances and cross border payments, not only do they need to better understand what the real costs of remittance are (compliance and physical agents on the ground) but also need to build products that reduce frictions with those areas. In some cases it may actually mean getting on an airplane to conduct market research, the kind Boase did earlier this summer. After all, the typical resident in these countries may have bigger needs on Maslow’s hierarchy than a blockchain in permabeta mode.
For instance, according to the GMSA there are approximately 250 mobile money services in over 80 countries, half of them in sub-Saharan Africa. But very few are interoperable, not because of technology but because of legal constraints. An M-Pesa user in Uganda cannot send funds to an M-Pesa user in Kenya, not because of some database limitation but because each country wants to be able to levy tariffs and taxes on that.
In fact, Orange Telecom (and its service, Orange Money) may pull out of Kenya for the same reasons it had to sell its Uganda operations: due to both competitive forces and the legal climate related to exchanging value across borders. If service providers in these verticals can overcome some of those edge-case issues, there may be opportunities to provide services to an underserved population, which has growing access to mobile phones but lack access to traditional financial institutions.
Instead of prematurely patting themselves on the back, why are practical solutions to [the remittance problem] not being discussed at conferences?
It bears mentioning that for telecoms, the issue of remittances has become an oft cited use-case but is either not taken seriously or has been found to be impractical to penetrate. According to the World Bank, the average African migrant is charged 12.4% in remittance fees, thus reducing that fee to even 5% would save Africans from the continent US$4 billion a year. However, the bulk of this remittance activity is comprised of migrants in the Diaspora and not intra-Africa; there are more Africans outside of Africa sending to Africans inside of Africa than Africans within Africa sending to Africans in Africa.
The hurdle then becomes an issue of gateways, which BitPesa in the UK has attempted to resolve. However, as described above, they lack the “other half” of the equation: a physical network on the ground that Orange and others have. Carriers have built a competitive advantage around account management, managing trust and entitlements. How can they leverage this asset (invoice and collections) with distributed technology such as Bitcoin or Ripple or something else altogether?
Is this something that Bitcoin advocates can resolve in a timely fashion and build a company around?
For perspective I reached out to Marco Montes Neri, co-founder of Saldo MX, according to him:
“I see Bitcoin-related startups working in two directions. One is making cash-to-cash transfers more efficient and the second are startups trying to make these types of transfers obsolete altogether. Comparisons to services like Western Union are only helpful in the first case where the marginal costs are trending near zero (and which they often are not). Startups will only take market share if they dramatically improve logistics, create a powerful brand, rely on existing distribution channels or solve identity authentication issues (different from authorization). In general, crypto-related technologies help in logistics as they offer public ledgers (transparency) and systems like Ripple reduce the costs of managing cryptographically secured e-money (float). So a crypto hawala is possible but still faces compliance issues.
"In my view, the three key problems to solve:
Liquidity in markets. Exchanges in developing countries still operate under legal uncertainty and show extremely low trading activity, besides representing a huge counterparty risk (this actually reduces Bitcoin’s fundamental advantage). The majority of payments ultimately also still need to be settled in a local currency such as the Mexican peso or Kenyan shilling;
Marketing. We need to remember that M-Pesa leveraged Safaricom branding and distribution channels. How can digital currency startups in this space find an equivalent partner?
Identity. The biggest issue for MTOs. Financial companies can not only rely on Jumio-like KYC processes. There is a lot of space for improvement here."
As far as making Western Union obsolete, that’s a different conversation altogether.
For additional perspective, I also spoke with Robin Omwega, co-founder of Kenya-based Wageni Tech:
“For myself, I face friction whenever I need to convert from Bitcoin (via Bitpesa) to M-Pesa then on to Tanzanian Shillings via a satellite Kenyan M-Pesa agent here in Arusha. After everything is said and done it ends up costing me between 10% - 15% of the sum total. Part of the challenge here is political (there is historical bad blood between Kenya and Tanzania), but as always, the Tanzanian's do come around.
Another challenge is understanding technology. For example with M-Pesa, at its inception I happened to be working in a mine within Northern Tanzania where I met some tech staff of one of the local MSO's. They vehemently opposed M-Pesa, citing the matter that it would be impossible for anyone to trust value transferred via a mere SMS. Six years down the line, today, the M-Pesa transactional volume in Tanzania rivals its Kenyan counterpart.
While disrupting money transmission has been ‘lip-serviced’ too much, I believe that the blockchain can be used to encapsulate, trade and transfer value, rather than currency, in order to reduce governmental antipathy and fear, which would then provide an entry point for the rest of the attendant services.
An easy example would be the development of a ledger that tracks shares of a stock which enables easier transferability between issuer, recipients and peers, that would forthwith lower the barriers for entry, and exit, of a vast array of people into the investor bracket, while increasing the capital access for local enterprise.
Another good example of ‘lip-service’ would be this: I recently met some functionaries of Meru Community Bank (Mecobs), and actually bought into some of their shares. Their current system relies on paper receipts and thus is not easily transferable nor tradable. While ruminating over it, I privately contacted a few active members within the Bitcoin community of a large Telegram group that claim to have products that could easily solve Mecobs problem. But none have been willing to come forth with a workable plan or paper. I do not know whether to attribute that to their lack of expertise, or a general fearfulness arising form the "game" mentality espoused by most of the community.”
This is a young space and is filled with passionate supporters promoting the diffusion of decentralized applications; applications, which purportedly can disrupt incumbents. Yet despite this enthusiasm, a variety of physical realities and economic costs are routinely ignored. This is not to say that Bitcoin-related technology cannot reduce margins or costs within existing industries. Perhaps in the future, a combination of 37coins and the “sneakernet” API of Coins.ph could resolve the “last mile” issue noted above. We can only know this empirically by building and scaling value and utility – by trying and not just “summiteering.”
[Disclosure: neither I nor anyone in my family owns any equity in any money transmission company nor was I compensated in any manner by a money transmission company for this article. Opinions expressed are solely my own and do not express the views of my employer.]
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Last week the /r/Bitcoin community thought they came up with a clever ad (see image) that revealed the “true” costs of remittances. But this is an apple’s to orange’s comparison. Because it lacks a “ circular flow of income ” in developing countries, Bitcoin, the network, in this instance is just a […]