Where Worlds Collide: Currency Conversion for Cross-Border and Digital Assets
FPC Digital Assets Work Group
The FPC Work Groups acknowledge there are cross pollination opportunities for real-time payments initiatives. Functions and operations that reduce the current 2–3 day payment processing and settlement time to instant funds availability are targets for improvements.
For the Cross-Border Payments and Digital Assets (DAWG) Work Groups the obvious overspill is in currency conversion requirements. Currency exchange is the process of converting one form of currency to another using an agreed upon exchange rate to facilitate cross-border transactions. The service is typically provided via a third-party currency exchange service.
For cross-border transactions, a big component of payment processing is foreign exchange involving multiple correspondent banks and underlying in-country settlement at central banks, not to mention the underlying originating and beneficiary parties. For digital assets, currency conversion needs to support not only fiat foreign exchange (FX) as we know it today, but potentially exchange rates between cryptocurrencies as well. With both currency types there are issues relating to market data (exchange rates) and KYC (know-your-customer). Achieving instant funds availability in cross-border transactions is further complicated by manual processes, regulatory and compliance requirements, and transaction limits which become magnified with various scheme rules and regulations.
Challenges
In the January 2024 blog, the DAWG began to map process flows for digital assets functions using a standard processing template[1]. In the case of digital asset currency conversion, the process flow addressed these four basic components: Provider/Purchase, Agreement, Processing, Funding/Closing.
In mapping the process flow for digital asset currency conversion, the DAWG deduced that the biggest challenges for currency conversion lie in the following areas:
- Payment tracking, distribution, and settlement/movement of the fiat and digital currency with the FX transaction.
- Fees and complexity of transaction
- Currency conversion and rates
Both cross-border transactions and digital assets require a multi-currency cash settlement system and access to real-time currency conversion rates.
- In the cross-border world, foreign exchange (Forex) is supported through a global marketplace that enables currency conversion. Forex operates on behalf of a network of international partners that integrate Forex as a component of their international settlement system to support transactions in the local currency.
- For digital assets, it is more likely that currency conversion will be supported with a digital wallet or some type of cryptocurrency capability. A digital wallet is an electronic storage capability that supports multiple currencies, facilitating payment transactions on a mobile or online platform. Coinbase is a good example. Comparatively, cryptocurrency transactions may be supported directly between parties, circumventing the traditional banking systems and conversion options. At this point in time, however, cryptocurrency transactions do not allow for currency exchange among multiple parties.
Fees and transaction complexity add a layer of difficulty. In addition to standard transaction processing and service costs, currency conversion also entails fees from third-party intermediaries. Leveraging the real-time payment rails will help to counterbalance these fees by providing faster payments availability.
Liquidity tracking will be required for both digital assets and cross-border transactions through some type of marketplace.
Tech Building Blocks
At the conceptual level, the business functions of cross-border payments and digital asset transactions are highly correlated, but there could potentially be a difference in the mechanics of how currency conversion gets done. Technological building blocks at our disposal are being used to bring these capabilities to light:
- Application Programmatic Interfaces (APIs) are critical tools providing real-time foreign exchange rate information and payment tracking.
- AI and machine learning will also grow in importance over time providing enriched data and improved risk management in support of different currencies and approaches.
- Digital wallets and distributed ledger technology will provide the platform for storing the processing agreements, tracking payment activity, monitoring exchange rates, managing cash flow and liquidity requirements, etc.
1. The emergence of a global payment system for digital assets /cash is needed to eliminate settlement risk in currency conversion transactions by providing simultaneous exchange of value.
The model may look like the Continuous Linked Settlement [2](CLS) global payment system for FX transactions. The infrastructure takes input and output sources and settles FX transactions four times per night. CLS has been around for a long time, and it works because the participants trust the system to settle.
Is there a CLS for digital assets? Digital assets require the same infrastructure technology (which can be provided by DLT) but critical mass / widespread acceptance is needed.
2. Currency conversion for digital assets itself is likely to be modeled after FX.
Inevitably there will be some differences in the timing of settlement between cross-border and digital assets, but currency conversion is required for both. The biggest issues for digital assets are that stakeholders need access to a trusted infrastructure, scheme participants and currency conversions. For cross-border currency, traditional sources of FX rates are provided by companies like Reuters and Bloomberg. Where the conversion takes place for digital assets remains to be seen, although it is likely to be housed on DLT. Companies like Ripple, Visa and Mastercard are likely to vie for dominance in this space.
3. Digital asset currency conversion transactions will be supported using a digital wallet.
Industry pundits forecast that within five years, the digital wallet will be the preferred, underlying technology for digital assets. Digital wallets will be designed to support seamless interaction of multiple currencies – both fiat currency and digital cash or crypto. Storing Euros in a wallet, for example, will create an FX behind the scenes which in turn will be settled in local currency. Contenders for this space are yet to be determined.
Digital Assets in the Financial Industry Work Group
Thank you to the members of the FPC Digital Assets Work Group (DAWG) who contributed to this blog.
Digital Assets Work Group Leadership
Bo Berg (Chair), Avenue B Consulting, Inc.
Kevin Barr (Vice Chair), BNY Mellon
Maria Arminio (Work Group Facilitator), Avenue B Consulting, Inc.
Digital Assets Work Group Contributors
Keith Vander Leest, Cross River Bank
Jonathan Shiery, Guidehouse
Kirsten Trusko, Payments as a Lifeline
Steve Wasserman, Photon Commerce
Lou Grilli, PSCU
Peter Tapling, PTap Advisory, LLC
Larry Pruss, Strategic Resource Management Inc. (SRM)
Robert Gallic, The MITRE Corporation
Guest Contributor
Barry Tooker (Chair, Cross-Border Work Group), TransactionBanker.com
About the Digital Assets in the Financial Industry Work Group
Maps out how digital assets relate to the financial industry, focusing specifically on payments made with digital funds – central bank digital currency (CBDC), regulated liabilities and stablecoin.
About the U.S. Faster Payments Council
The U.S. Faster Payments Council (FPC) is an industry-led membership organization whose vision is a world-class payment system where Americans can safely and securely pay anyone, anywhere, at any time and with near-immediate funds availability. By design, the FPC encourages a diverse range of perspectives and is open to all stakeholders in the U.S. payment system. Guided by principles of fairness, inclusiveness, flexibility, and transparency, the FPC uses collaborative, problem-solving approaches to resolve the issues that are inhibiting broad faster payments adoption in this country.