2023 New Value Report

The Trouble With Sending Money

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Money Transfers

Guest post: Arjan Schütte is an investor and writer covering fintech companies serving the underbanked. He’s a senior advisor for the Center for Financial Services Innovation and earned his MS from the Massachusetts Institute of Technology. His New York-based venture fund, Core Innovation Capital, is an investor of Ripple Labs.

In developing economies, the remittance market often represents a country’s largest economic import, driven almost entirely by lower-income people. While the industry is rapidly growing—at three times the pace of the U.S. GDP—the system is burdened by inefficiencies and high costs.

The World Bank now estimates that 200 million migrant workers employed in developed countries remit $370 billion back to their home communities through formal channels (a figure that likely doubles if informal methods are included).

The problem is that the most commonly used type of money transfer is also the least efficient. Most remittances—around 85 percent—are made by a person walking to a physical location such as Western Union and handing over cash. On the receiving end, a similar trip is made by the person receiving the money.

This seemingly simple process is in fact quite costly with typical fees in the range of 9.5 percent of the amount sent—easily three times more expensive than credit card interchange. In 2012, we estimate that $51 billion was sent abroad from the U.S. at a cost of $3.5 billion in fees. Sadly, it’s expensive to be poor.

Why is it so expensive? Two reasons, really: Old habits and legacy infrastructure. This translates into merchant and foreign exchange fees.

The former is the reason a local merchant will accept your cash. Then, through a money transmitter, they’ll make it available at another location, in another currency for the right person, instantly (or after an agreed-upon time). If you eliminate or reduce this fee, it’s likely the merchant will use another money transmitter to make it worth her while.

The latter, foreign exchange, is in part the cost of exchanging the currency of the sender into the currency of the recipient, usually with a markup over that cost (frequently between 1.5-3x). The foreign exchange part can represent as much of 90% of all the fees the sender pays, but averages 20% of total fees for any given transaction.

Similar to the transition from traditional postal services to electronic mail, the solution to onerous fees lies in technological innovation. Distributed networks and protocols can make money transfers frictionless, modern, and compliant, reducing the need for expensive middlemen and providing superior platforms for multi-currency trading.

The best part is that consumers won’t have to change their behaviors to benefit from cheaper, faster service. They’ll still hand cash to a clerk, which the recipient will then pick up locally—business as usual. The money transfer agent will presumably use these digitized systems in lieu of a traditional foreign exchange desk and transfer protocols such as ACH or SWIFT.

Moreover, new technological solutions will bring PayPal-esque simplicity to the process of sending money while, like email in its final form, allow for interoperability between totally different systems, such as MoneyGram and Kenya’s M-Pesa. The end result is a financial system more tightly networked, connecting more people than ever.

So when the remitting masses are ready—we clearly aren’t there yet today, though we’re inching closer—they’ll be able to cut out the merchant and further deliver on the promise of frictionless payments around the world.



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