How we managed to not disrupt international payments

As mentioned in our intro post last week, we want to share with you the journey we have taken to build Kable, a blockchain-based international money transfer service for B2B payments. As outlined in the intro, we had identified five core hypotheses we wanted to test: Basic product functionality, transfer speed, cost savings, regulatory setup, customer traction. In this post, we aim to go into detail about these hypotheses, and also share some key problems as well as our plans to overcome them.

Kable home
— How our desk doesn't look when we work on new blog posts

The why – why did we embark on Kable?

Before diving into our hypotheses and the results we found, let us quickly explain why we got interested in the topic of international money transfers for businesses in the first place. When we started building and growing bit4coin in 2013, a platform to sell cryptocurrency and cryptocurrency gift vouchers, we had no idea it was going to take us to international B2B payments eventually.

Some time in 2014 we had businesses approach and ask us if we could provide bitcoin to them so they could pay their suppliers in China. Paying them was quite costly, and they thought of Bitcoin as a better solution. Later in 2015 we had a lengthy discussion at a Bitcoin meet-up with a small Dutch e-commerce company buying beverages from the Caribbean who experiences all kinds of issues with expensive transfers and transfers getting lost "all the time". Their question was if they could somehow use Bitcoin. According to their experience, one out of five international transfers between the Caribbean gets lost and takes months to be "found" again. And even the transfers that don't get lost take over a week and are quite expensive, costing up to 10% in fees.

This anecdotal evidence set us up for the quest to see if the opportunity was there. Mainly, we spent a lot of time understanding global transfers. When banks transfer money internationally today, the amounts are settled through what is called the correspondent banking system. So when a business is sending money to another company abroad, the individual payment does not flow directly to the recipient – instead, the bank of the sender is looking for the best route of mutual bank account transactions to channel the amount towards the recipient's bank, often including central banks, and touching multiple currencies. To make sure the correct values end up on the right accounts, banks exchange SWIFT messages, informing each other of final recipients. On the way, payments are accumulated and netted, values converted in and out of currencies, and differences settled on a daily basis.

The cumbersome route of international payment arrangements Bain distributed ledgers in payments fig 03
— A "simplified" correspondent banking infographic created by Bain & Company (Source: Bain Publications, Distributed Ledgers in Payments: Beyond the Bitcoin Hype, June 13, 2016)

All of the banks in the chain need a little bit of processing time. And if a particular bank decides to do a fraud or compliance check, or the risk limit with another bank is exceeded, payments may need to wait even longer.

Regarding cost, each bank involved in the process takes a (small) cut from the transaction and therefore adds to cost. Each currency conversion (e.g., from Euro to US-Dollar to Hong Kong Dollars) is further adding to the cost as you encounter a bid-ask spread each time. Typically, the US-Dollar (USD) is the most liquid market with other currencies, which is why rates between more "exotic" currencies are usually calculated as cross rates (via USD). Banks are making a lot of money on international transfers. An internal Santander memo leaked to Guardian Money states that Santander made €585 million from money transfers in 2016 – equal to nearly a tenth of its global profit of €6.2 billion that year. (Source) What the documents expose is that the bulk of the profits comes from the FX margin, rather than the fees directly charged. We will go more into detail below in hypothesis 3, "Kable transfers are significantly cheaper…". The documents also reveal that Santander's revenue stream from “correspondent banking” is worth €132 million.

Lastly and stating the obvious, we "found" that the international money transfer market is enormous. McKinsey assumes that B2B cross-border transfers alone account for US$ 160 trillion, bringing in US$ 255 billion, with 95% of that share going to banks.

Revenues from international money transfers as estimated by McKinsey

Mckinsey on payments rethinking correspondent banking 2016 06
— Banks still have 95% share in international business-to-business payments, a market worth US$ 255 billion revenues annually (Source: McKinsey on Payments, Rethinking correspondent banking, Vol. 9 No. 23, June 2016)

The more time we spent analysing the market of international transfers, the more it became clear to us that it is ripe for disruption. For example, why does a payment transaction between a European and an Asian company need to go through the U.S. and the US-Dollar? The problem was just that until a few years ago there was no alternative way to send value and settle balances globally, you had to rely on the banking system. Only now with Bitcoin and blockchain technology a new settlement layer has arrived, the "internet of finance", that allows permission-less innovation on an open platform. For commerce, print media, music and video, we all know how the story unfolded once a new, open, and digital platform arrived.

Five hypotheses we tested when building Kable

Before we embarked on developing a full new product, we had five key hypotheses we wanted to test as laid out in our last post. Let's dive into the details:

1. Product: "The product would work"

The idea behind Kable's product is quite simple: For an outgoing international transfer, for example, we would exchange the incoming Euro amount into bitcoin, and then have a partner in the destination country who we send the bitcoin amount to. The partner would then convert the bitcoin amount into local currency, and do a local bank transfer to the recipient. In essence, "blockchain" would be used to connect domestic banking networks to each other. Domestic bank networks sharing the same currency tend to be quite efficient when it comes to speed and cost, while foreign currencies and distance rely on the less-efficient correspondent banking system.

Kable customer view
— How a Kable transfer looks for our customers...

So to do the first Kable transfer, we needed a) a partner, and b) a basic transfer purpose to test things out. Thinking about building a minimum viable product (MVP) only, we felt that just one country would suffice for the start. We settled on China, as connecting Euro countries and China is probably one of the most interesting non-U.S. corridors both in value and number of transactions (we didn't back this up with a sophisticated analysis or sources, but it feels about right). When we went out looking for partners, we noticed that similar companies to Kable were forming all over the globe. Somehow the timing early 2017 was perfect – the sentiment from being negative about Bitcoin (its – albeit limited – illicit uses and high volatility) was shifting to turn slightly positive with companies looking for blockchain applications. It turned out that we did find a partner in China, and subsequently many more partners all around the world. That is the beauty and power of an open network like Bitcoin: It allows anyone to build on top of it. And Bitcoin gives us interfaces or "APIs" right out of the box with all of our partners with Bitcoin wallet addresses and Bitcoin transaction IDs, the only parts necessary to transfer value.

Kable internal process flow
— ...and how a Kable transfer works in the background

Second, we needed a purpose for test transfers. As we didn't have any customers while testing, we just made Kable itself its first customer and ordered a bunch of stuff from China 😂. With the help of our Chinese interns (thanks Meng and Ling!), we ended up buying external mobile phone battery packs, Kable branded cups/tumblers, and cushions for use during travel.

With just the test purchases, we already learned a lot about the Chinese banking system – the difference between business and personal accounts, different payment methods within China, and whether export tax rebates apply. But most importantly, Kable transfers worked. We paid the invoices, and got the goods delivered to our office in Amsterdam!

Kable test purchases Kable test purchase battery packs
— Our internal Kable test purchases: 25 branded cushions to use when travelling, 100 branded tumblers, and more than 50 external battery packs for iPhones. We agree the selection is a bit random, but we needed suppliers who were willing to work with us on documenting the payment process and wanted different product categories while still being affordable. And at least "somewhat" useful items.

To us, this is still the mind-boggling power of Bitcoin and Blockchain. We managed to build a global payment service based on an open network, together with our partners, and can now send and receive transfers between 57 countries. As a team of just nine, and as a side business next to bit4coin.

(Note: We are not disclosing any of our partners on purpose – while we understand it's possible to find out who they are, we consider these partnerships to be part of our core assets.)

2. Speed: "Kable transfers are faster than international bank transfers"

We were quite sure that Kable transfers would be faster than international bank transfers using correspondent banking as described above. Instead of the lengthy process involving multiple banks, the time for a typical outgoing Kable transfer can be broken down as follows:

  • The sender pays euros to Kable: Typically 1-2 business days, potentially instant in the future with "instant payments" in the Eurozone, otherwise as low as 4h (a SEPA-transfer initiated by 11.00 in the morning has a chance of arriving at the same day at our account)
  • We convert the incoming amount into bitcoin and send the resulting amount to our partner: less than a minute
  • Our partner converts the bitcoin amount to local currency and initiates the payout: typically in the minutes, depending on the specific partner. In most cases, we also don't need to wait for blockchain confirmations as our partners trust Kable and vice versa which saves a few more minutes.
  • Bank transfer from our partner to the recipient: Depends on the country, from 10 mins in China (still feels like magic every time we do it) to 1-2 business days in Australia.

So, if you count everything together, we typically have transfer times of four hours in the best case to roughly two to three business days in bad cases. We're working heavily on improving the European side we "control", and instant payments (up to €15,000) will help dramatically with this.

We were a bit surprised to find that some traditional remittance players offer quite fast processing times, in many cases instant transfers for consumers. After knowing the system, the question was how they were doing it? The answer is quite simple: credit. Remittance companies keep enough liquidity in the markets they serve, while their funds travel through the banking system as slowly as everyone else's. We even heard it on stage at the ParisFinTechForum in the session with WorldRemit and UAE Exchange.

Regarding speed, there was a case where Kable was too fast. One of our Dutch e-commerce customers used Kable to pay a new Chinese supplier, only to hear back after a few days that the money seemed not to have arrived. We quickly provided proof of payment and asked the supplier to check again. He came back to our customer and us apologetically, confirming the amount had indeed arrived. He told us he only started looking for the amount on his account after a few days because he "couldn't believe transfers could be made this quickly"!

So, is Kable faster than traditional international transfers? In almost all cases an unequivocal yes, and we won't stop to work on this until we're at "instant".

3. Cost savings: "Kable transfers are significantly cheaper than international bank transfers"

Estimating if and by how much a Kable transfer is cheaper than a traditional international bank transfer proved to be hard to quantify. Also, whenever we talked to customers, many of them had surprisingly little insight on how expensive international bank transfers are in reality. Banks charge customers for transfers in three ways:

  • Fixed fee for the sender. A fixed amount in local currency (or currency of the account money is sent from). This ends up as a "bank charge" as a separate line item on the bank account. Typically, these charges are not extremely high. Often they are fixed (e.g., €9 per transfer), in some cases they have a fixed and variable component with a cap (e.g., €5 plus 0.1% of the transfer amount, maximum €55). Overall, one can expect fees of 0.3-1.0%.
Fee example: ABN AMRO fee table for sending and receiving international payments Abnamro outgoing international transfer fee Abnamro incoming international transfer fee
— Example: ABN AMRO charges a flat €9 for outgoing and incoming international payments (Source: ABN AMRO standard fees for transferring and receiving funds)
  • Fixed fee for the recipient. Obvious – a similar fee deducted from the recipient's account. Again, it varies depending on the country and the specific rate. For example, some UK banks charge an outrageous GBP 25 to receive a transfer in euros. Overall you can expect roughly the same fee level as the sender, another 0.3-1.0%.
  • Exchange rate markup. The big unknown. Typically, banks neither mention which rate they are using nor how it will be calculated. Banks are basically "free" to use any rate that occurred during any of the days during which the transfer happened, a practice known as value dating. And on top of that, banks may add any markup. On average, we found estimates of exchange rate markups of 2-4%.

When you add all fees together, you end up with international transfers costing roughly 3-6%. The burden is highest on small and medium companies, and substantially less for large corporates and multinationals with dedicated treasury units. With Kable, we have been able to drastically lower total cost, saving our customers on average more than 80% of total fees on international transfers. What was specifically interesting is that while our customers didn't really request the speed of transfer in some cases, it fundamentally increased the transparency on the exchange rate. If a transfer takes only a few hours, it is pretty clear what the market exchange rate was during that time and there is far less "opportunity" for value dating. Further, transfer speed significantly reduces counterparty risk and improves working capital.

Still, the problem remains to show our customers exactly how much they save, especially since every first new transfer from a customer with its business partner is unique with regards to the country, currencies and banks involved. Also, it's a question who should reap the benefits of the savings - the sender or the recipient?

What we always suggest to our customers as the first transaction is a "race". Customers send half of an invoice amount traditionally, and the other half via Kable. We then track how many euros left the bank account, what the fees were, and how much arrived on the other side with the help of the recipient. In addition to tracking cost, we track the time of the transfer as well. And, we're proud to say, Kable has yet to lose one of these races on either dimension. 😊

Of course, there are many other contenders in the money transfer space which also promise to offer better rates. In almost all cases those companies still rely on the banking network to do at least some of the settlement. In comparison to these players, Kable especially shines in the following cases:

  • Transactions involving European businesses trading with companies from Asia / Pacific, Africa, or South America
  • Payments denominated in USD without either sender or recipient being from the U.S.
  • Companies having no foreign currency bank accounts
  • Companies using their main bank or local bank also for international transfers
  • Companies only buying or selling internationally, not both in the same markets

4. Regulation: "We can find a regulatory setup that allows us to operate"

Working in and around Financial Services for some time, we are aware that regulatory compliance is paramount to any financial service, blockchain-based or not. To us Bloomberg's Matt Levine put it best, emphasis ours:

"My generic view of tech businesses trying to disrupt finance is that they tend to think that they are solving a technical or data or customer service problem, but the problems of finance are always and everywhere regulatory problems. The value of a bank is not that it can raise money from savers to lend to borrowers; it's that it has special regulatory status to raise that money in the form of bank deposits. The raising-money-from-savers stuff can be replaced by a web page; the regulatory stuff is more complicated." (Source)

So to make sure Kable's services are compliant, we spent a lot of time and money with our legal advisors, and approached and interacted with our local regulator, the Dutch Central Bank. We do see our regulatory setup as a competitive advantage and do not want to give too much away, but it is one of Kable's core focus areas to turn it into a sustainable business. Needless to say, despite not being officially licensed at this point, we do try to act and operate as if Kable was a regulated financial service company. This includes KYC (Know Your Customer) and anti-money-laundering policies, as well as a risk-based approach when analysing transactions done on Kable's platform.

5. Traction: "We can find initial customers"

As hinted before, finding traction with customers has been the hardest so far. All of our existing customers came through personal contacts, or when meeting us in person at an event. Apparently, there is no "European conference for companies sending money internationally" – maybe a gap in the market? 😉 We have tried to identify different industries that could be interesting, e.g., e-commerce, travel & tourism, food & agriculture, or maritime & shipping. We tried to craft the perfect marketing persona and tried reaching out proactively. We went to a lot of events, all with mixed success so far.

What we found as critical issues to conversion so far is the following:

  • The real cost of money transfer is in-transparent. Many smaller companies we talked to were neither aware of the high cost, nor of the alternatives available with a solution like Kable. In a way it even makes sense: If a company's costs of goods sold (COGS) are 30% of revenues, and out of that 40% is purchased international, and the savings through Kable are 4% on the transfer, then the total savings as a share of revenues are 30% x 40% x 4% = 0.48% of revenues. So it's not game-changing, but on the other hand a low-hanging fruit. And even for companies where speed mattered, few companies ever considered alternatives to using their bank.
  • Trust and risk-reward-mismatch. If a CFO or treasurer uses an alternative money transfer solution and all goes well, the (personal) reward is small. But if something goes wrong and a transfer is lost, the person probably lost their job.
  • Top of mind. A few companies had already decided to use Kable, but then when it comes time to transfer - everything else matters, things become short-notice, and everything stays like it always has been.
  • Sense of urgency. There is no real need to switch to Kable now – you can also do it for the next transfer. Or the one thereafter.
  • Additional communication with the recipient. When switching to Kable, it helps to connect once with the recipient about the change.

So overall we're still fighting these concerns, but retention is giving us hope: Customers who successfully used Kable once have generally kept using it for all of their transfers. So we "only" need to convince more businesses to try us out and do a race. And we have a few tricks up our sleeve to find and convince more leads to try us out!

Outlook – where is Kable heading?

To summarise: We're doubling down, and are already busy improving the product. We will specifically address some of the concerns raised by new leads. Until that is ready, we will continue to share more details and our journey here. So while we did not manage to disrupt international payments with Kable yet, there is still hope!

In the meantime, if you want to become a Kable customer or know someone who would be a good fit, please contact us at [email protected]. Any comments or feedback? We'd love to hear from you at [email protected]! Want to join the team and become part of the Kable story? Please check out the current openings on our bit4coin jobs page!

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By Dolf Diederichsen (Google+)

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