Quantifying the Cost Savings of Permissioned DeFi for Cross-Border Payments
This model offers both payment service providers and end customers considerable potential savings.
Payment providers must account for operational, IT expenses, and compliance costs.
Traditional Payments. The authors have estimated that traditional payment costs reach an average of $8 per transaction for payment service providers like banks. About 80% is related to operational and IT costs—or roughly $6.40. Compliance-related efforts account for about 15%–20% of the $8 of the traditional payment, amounting to approximately $1.20 to $1.60 per transaction.
Permissioned DeFi-Based Payments. For payment service providers using the permissioned model, the combined estimated operational and IT costs per transaction range between $0.05 and $0.09—far less than the $6.40 estimate.
Assuming that compliance costs for a permissioned transaction will be the same as for a traditional payment, the total estimated transaction cost in the permissioned model is $1.25 to $1.69—roughly 80% less expensive than the base cost of a traditional transaction (if the fee structure is in absolute amounts).
The cost-effectiveness of this solution lets financial institutions offer competitive prices, making it possible to charge lower fees compared to traditional models, reaching as low as a fraction of a percent.
Key Considerations for Implementation
Businesses planning to set up or participate in a permissioned DeFi-based model for cross-border payments should keep in mind the following considerations.
Speed. Permissioned DeFi-based payment models can settle transactions rapidly, while wrapping and unwrapping tokens may take a few minutes (depending on the blockchains used in the model). Foreign exchange conducted on smart contracts can occur almost instantly.
Processing duration varies depending on the platform, the type of tokens involved, and the network status. If users exchange within the network, the transaction will be instant. It can take up to an hour if the payment goes from the traditional fiat financial system through the permissioned DeFi-based model.
Smart Contract Risk. There may be flaws in the smart contract code that handles the wrapping and unwrapping of tokens. This could allow for vulnerabilities that result in loss or theft of funds or assets. Extensive auditing and testing can lower the risks of coding errors.
Wallet Security. User wallets that interface with smart contracts to wrap and unwrap tokens must be highly secure. Be mindful that any wallet vulnerability could expose the keys that control assets and allow theft or loss of funds.
Tech Development. Companies can join ecosystems to access various robust verification and operational capabilities required. For example, an ecosystem can provide robust identity management systems essential for transactions on the blockchain.
Capital Efficiency. Transactions in DeFi are always gross settlement transactions, meaning each transaction is executed individually. Netting of different transactions with each user in the network is not possible.
Governance Design. A well-conceived governance model, overseen by a consortium of stakeholders, provides a clear decision-making framework to ensure transparency, fairness, and accountability for the parties involved. Rules will guide conflict resolution and dispute management.
Regulation. As regulation around financial technology, data privacy, and related issues continuously evolves across jurisdictions, adopters should stay prepared to adjust their payment model to comply if and when regulation addresses permissioned DeFi-based models.
Implementation of this model must include integration into existing payment systems through gateways and the creation of related messaging around payment instructions. However, as these setups vary widely, we will not discuss these details in this paper.
Implementing the Model
As business leaders seek to establish a permissioned DeFi-based cross-border payments model, below are a few actions to consider at the onset.
Scope out requirements and key objectives and seek out the necessary infrastructure required. These necessary elements include custody wallets for participants in the transaction; AML/KYT services can screen for illicit transactions from compromised wallets. Analytics services can track the movement of all circulating tokens.
Ensure interoperability with existing payment infrastructure. Financial institutions and senders should integrate the model with their existing orchestration layers and connect to existing messaging layers like SWIFT.
Engage industry coalitions, competitors, regulators, and consumer advocacy groups. Awareness of permissioned DeFi will only grow if adopters inform their ecosystems of the advantages and workings of the model. Finding consensus on functional requirements and standardized processes should be the aim of participants in these payment models.
Permissioned DeFi offers several benefits in the cross-border payment context including lower transaction costs, more accurate foreign exchange conversion, stronger security, and faster transaction times. Due to the greater transparency and efficiency inherent to a permissioned DeFi model, anyone from small financial institutions to multinational banks can transact with any other KYC-approved counterparty around the world—an important step toward a more efficient global financial system.
The authors would like to thank Nikolai Pomortsev for his contribution to this article.