Explain it to Me Like I’m 5: Crypto and Cross-Border Payments

When you send money from one country to another, your bank usually doesn’t send the money directly to your friend’s bank. Instead, the money has to go through several steps, like a relay race. Here’s how it works:

1. Your Bank Sends a Message: Your bank sends a message to another bank, saying, “Hey, I need to send $100 to my friend’s bank in another country.” This message is usually sent using a system called SWIFT (Society for Worldwide Interbank Financial Telecommunication).

2. The Message Gets Passed Along: The message might go through several banks before it reaches your friend’s bank. Each bank in the chain plays a part in making sure the money gets to the right place — and each likely extracts a fee for their part.

3. Your Friend’s Bank Receives the Money: Finally, the money reaches your friend’s bank, and they can take it out or use it.

This whole process can take several days, and each bank along the way might charge a small fee. That’s why sending money across borders can sometimes be slow and expensive.

What is SWIFT?

SWIFT is like the post office of the banking world. It doesn’t actually move money but sends important messages that tell banks where the money should go. SWIFT is used by more than 11,000 banks around the world, making it a trusted and widely used system.

However, SWIFT has its downsides:

• Speed: It can take several days for the money to reach its destination.

• Cost: Each intermediary bank can charge a fee, making the transfer expensive.

• Security: While SWIFT is very secure, the more intermediaries involved, the higher the risk of errors or delays.

How Blockchain and Cryptocurrency Can Improve Cross-Border Payments

Now, let’s talk about how blockchain and cryptocurrency can make this process better. Imagine instead of passing the ball through several people, you could just throw it directly to your friend in one go. That’s what blockchain and cryptocurrency aim to do.

What is Blockchain?

Blockchain is like a giant, super-secure notebook that everyone can see but no one can change. Every time you send money using cryptocurrency, a note gets written in this notebook saying, “You sent $100 to your friend.” Everyone can see that the money was sent, so there’s no need for all those intermediary banks — the information is recorded, secure, and accurate.

What is Cryptocurrency?

Cryptocurrency is digital money that lives on the blockchain. Bitcoin and Ethereum are two popular types of cryptocurrency, with another named XRP designed specifically for cross-border payments. When you send cryptocurrency to your friend, it goes directly from you to them, without needing any intermediary banks.

Benefits of Blockchain and Cryptocurrency

• Speed: Cryptocurrency payments can happen in seconds, not days, because there are no intermediary banks slowing things down. Payment systems based on specifically designed cryptocurrencies can handle thousands of transactions in just a few seconds, several orders of magnitude faster than traditional systems.

• Lower Costs: Since you don’t have to pay fees to multiple banks, sending cryptocurrency is usually cheaper. In many cases, even enormous transfers of funds cost only a few pennies to send, which is a massive improvement over current fee structures.

• Security: Blockchain is very secure because every transaction is recorded and verified by multiple systems on the chain, and cannot be changed. This reduces the chances of fraud or errors.

Barriers to Banks Using Cryptocurrency for Cross-Border Payments

If cryptocurrency is so great, why don’t all banks use it for cross-border payments? Well, there are a few reasons why it’s not that simple.

Regulation

Banks are heavily regulated. Governments want to make sure that money isn’t being used for illegal activities, like money laundering or funding terrorism. Because cryptocurrency is still newish and can be harder to track, many governments are cautious about letting banks use it for cross-border payments.

Additionally, in countries such as the U.S., cryptocurrencies’ status as an asset class is still nebulous. Ongoing lawsuits brought by the SEC allege these currencies are securities. While this uncertainty persists, banks are not going to implement crypto payments on a large scale.

Volatility

Most cryptocurrencies’ value lacks the stability of major world currencies like the Dollar, Pound, or Euro. Imagine sending $100 worth of cryptocurrency to your friend, but by the time they get it, it’s only worth $90 because the value dropped. 

This problem is significantly smaller for cryptocurrencies designed for rapid settlement, as they can process thousands of transfers every few seconds. And if the recipient bank maintains a stock of the currency in question, both banks will automatically agree on the value of the transfer instantaneously. But not all crypto can be traded so quickly, so this remains an issue.

Infrastructure

The current banking system, with SWIFT and intermediary banks, has been around for decades. It’s like an old, reliable car. Even though it’s not the fastest or cheapest, everyone knows how to use it. Switching to blockchain and cryptocurrency would be like getting a brand-new car – exciting, but also a little scary because it’s so different. Banks would need to build new systems and train people to use them, which takes time and money.

Accounting for Cryptocurrency

Because of its relative newness and lack of supporting legislation, accounting for cryptocurrency in any scheme is complex at best. Doubly so for cross-border payments.

Lack of Standardized Guidelines

Accounting standards for cryptocurrencies are still evolving, with different countries and organizations having varying guidelines. This creates uncertainty and inconsistency in how cryptocurrencies are reported across different jurisdictions.

Taxation

The tax treatment of cryptocurrencies varies widely, and in some cases, the rules are unclear. This makes it challenging to determine the correct tax liabilities and to plan accordingly.

Security Risks

Cryptocurrencies are susceptible to theft and fraud, so companies must implement strong internal controls to protect their assets. Auditors also face challenges in verifying the existence and ownership of digital assets.

Audit Trail

The pseudonymous nature of many cryptocurrencies can make it difficult to create a clear audit trail, complicating the auditing process.

Currency Conversion

When dealing with multiple cryptocurrencies or when converting to traditional currencies, companies must manage foreign exchange risk and deal with the complexities of accounting for multiple currencies.

International Complications

International transactions raise questions about how to handle different tax jurisdictions, reporting standards, and regulatory requirements — while this is true of standard transactions, adding cryptocurrency ups the ante on complexity.

Asset Classification

There is debate over how cryptocurrencies should be classified on the balance sheet. Should they be treated as cash equivalents, intangible assets, inventory, or something else entirely? Each classification has different implications for accounting treatment.

Revenue Recognition

If a company receives cryptocurrency as payment, it must determine when and how to recognize this revenue. This can be tricky, especially if the value of the cryptocurrency changes significantly before it is converted to a traditional currency.