Whitepaper
Revolutionizing Cross-Border Transactions with Permissioned DeFi
This article was produced in collaboration with BCG.
Executive Summary
Cross-border payments make up a vast and often inefficient movement of money around the world. In 2021 alone, some $1.2 trillion in payments crisscrossed the globe. Among the challenges is that these transactions result in significant expenses for both financial institutions and users. Though the system has improved over the years, it remains far from perfect, and payers and payees would welcome a new way of cross-border payment.
A combination of digital assets and permissioned, decentralized finance (DeFi)—a blockchain-based financial technology—may finally support a crossborder payment system that is faster, cheaper, and more verifiable.
This article, coauthored by BCG and Fireblocks, a digital asset security platform, proposes a hypothetical payment model based on permissioned DeFi. For end users who make and take payments, the model offers more flexibility. For institutions that build this model, Know Your Customer (KYC) verification provides more control over payments. We estimate that the average transaction cost in the new model will be 60%–80% cheaper than the cost incurred by traditional models.
Understanding how this new model works and the assets that firms need to participate is key to realizing its potential.
How a Permissioned DeFi Based Model for Cross Border Payments Works
You may already be familiar with a cross-border payments model based on permissionless DeFi. Permissionless DeFi offers advantages over traditional payments, but it also carries risks. (See Appendix A: The Limitations of Traditional Payments and Permissionless DeFi) One of its benefits is the ability to execute a near-instant transfer of actual value across borders. Additional benefits of permissionless DeFi include better traceability (transactions are logged on the blockchain), more user control over their assets, and the ability to interact directly with each other. However, permissionless DeFi transactions are left exposed by insufficient anti-money laundering (AML) and KYC functions, opening the way for fraud and erroneous payments. These weaknesses are why institutions have been reluctant to adopt the technology at scale.
Permissioned DeFi addresses these concerns by combining the efficiencies of the permissionless model with the required risk and compliance controls to offer significant advantages over traditional payments. In the cross-border payment context, these verification functions would help businesses face some of the endless challenges of managing financial risk.
The process for an end user to send a cross-border payment through permissioned DeFi goes through several steps.
Prior to the on-chain transaction, institutions X and Y undergo a KYC process that meets a platform-level KYC standard, conducted by whitelisters, a group that approves users. (See the exhibit.) The whitelister adds their wallets (digital wallets A, B, C, and D, respectively) to the allowed list.
Cross-Border Permissioned DeFi Model
Source: Fireblocks and BCG analysis. Note: AML = anti-money laundering; KYC = Know Your Customer.
Institutions X and Y could either act as whitelisters or appoint third parties to manage whitelisting. Other market participants, such as liquidity providers and arbitrageurs, go through a KYC process with the whitelisters.
The next steps are as follows:
1. A sender triggers a cross-border fiat money transfer.
Once a sender has been successfully KYC-approved, the sender can initiate a crossborder transaction. The sender can be an individual, a business, or an institution.
2. An on-ramp instruction is sent to an on- and off-ramp service provider (OOSP).
OOSPs act as entry and exit points for funds moving from the traditional fiat financial system to a token-based model. The OOSP debits the sender’s fiat balance and credits the sender’s digital wallet with the amount of a specific type of token worth the same value as the fiat amount.
This model can use various types of tokens. These digital assets are tied to the value of a corresponding fiat currency and act as the transaction’s main payment format. In short, these assets are the money that changes hands during the payment. Examples include bank-issued stablecoins and central bank digital currencies (CBDCs). (See Appendix B: Stablecoins, Tokenized Deposits, and Central Bank Digital Currencies)
3. After the token is received in the digital wallet, it must be wrapped by a service provider into a token accepted by the permissioned DeFi model.
Wrapping is a crucial step to enable interoperability across various blockchains. A wrapped token represents a different token existing on another blockchain with equal value.
In the wrapping process, the wrapping platform locks the initial token in the smart contract and mints the same amount of the corresponding wrapped token. Before the wrapped token wallet can accept the token, a whitelister must check that the wallets involved in the transaction are KYC-approved and whitelisted to allow the transaction.
The smart contract then queries the on-chain/off-chain list of approved wallets with the whitelister(s) and confirms wallet B’s approval.
4. The smart contract deployed on the permissioned DeFi protocol handles the transfer of the wrapped token to the receiver side.
This permissioned DeFi model uses an automated market maker (AMM), which are smart contracts that provide a pool of tokens, or a liquidity pool, to determine prices and facilitate trades. Examples of AMMs include Uniswap.
These assets are critical to the speed and stability of permissioned DeFi. AMM smart contracts enable an atomic swap between the two different tokens, ensuring nearinstant settlement. Blockchain and the DeFi protocols built on top of them run 24/7, avoiding issues with settlement risk and fluctuations in traditional foreign exchange during market hours.
As shown in the exhibit in step 4:
- The tokenized US dollars are transferred through wallet B to the liquidity pool.
- The swap function is executed with wallet B as the sender address and wallet C as the recipient address.
- The AMM smart contract then transfers the tokenized euro to wallet C.
6. If the receiver prefers to receive fiat currency, the optional off-ramp or burning step will then be applied, depending on token type, to receive the fiat currency.
This would entail burning the token and crediting of the corresponding value of fiat to the receiver’s bank account.
As the Participants in the cross-border permissioned DeFi model slideshow shows, a number of entities must participate in this cross-border payment model for full effectiveness.
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.
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 crossborder 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.
APPENDIX A
Limitations of Traditional Payments and Permissionless Decentralized Finance
Traditional cross-border payments rely on several actors adding their services to what, on the surface, looks like a simple exchange between payer and payee. Unfortunately, this process can take several days, incurring fees for the payer and payee at each step until the payee finally receives the payment.
For instance, when a sender pays US dollars to a receiver who prefers Japanese yen, the sending bank and receiving bank bookend the transaction. The sending bank typically confirms the transaction path in a corresponding banking network. Foreign exchange operations convert the fiat currencies from one to another.
While these limitations slow down payments, a permissioned DeFi model for cross-border transactions is much faster and more transparent. (See Exhibit B.)
Permissionless DeFi carries several risks that emerge both in cross-border payment and broader financial use cases.
APPENDIX B
Stablecoins, Tokenized Deposits, and Central Bank Digital Currencies
A permissioned model achieves stronger verification in part through stablecoins and central bank digital currencies (CBDCs). These tokens have an inherent level of Know Your Customer KYC) verification applied. The following list of tokens explains the uses and functions of each. (See the exhibit.)
