Payments in The Crypto Industry: RIF’s Contributions to the Ecosystem
The payments industry is one of the central pillars of global trade and finance. It enables the seamless transfer and settlement of money between local and international peers. The industry has evolved significantly from the time of its inception. In its early days, all payments were cash-settled in person and took days for settlement. Cash transactions have since paved the way for digital transactions. The rise of the internet significantly simplified the payment transfer process.
Payment processing fees have drastically reduced due to the rise of newer innovative methods and technologies. Payment technology companies have bridged the gap between traditional financial institutions and modern payment settlement services. Modern-day payment processing isn’t restricted to the settlement of funds. It also includes financing and providing payment gateway services to clients.
The birth of Bitcoin in 2008 heralded a new era in the payments industry. Digital currencies reduced processing time, made transactions cheaper and reached places derived from banking and financial services for ages.
How Does the Payments Industry Work?
The payment processing ecosystem consists of issuers, acquirers, payment processors, credit card networks and payment gateways. The payment processing cycle begins when the customer initiates a transaction. The issuing bank receives this request from the payment processor. This data is then sent to the credit card network. If the request is approved then the acquiring bank forwards this data to the payment processor and the transaction is complete.
The transaction is complete but the settlement doesn’t happen instantaneously. At the end of working hours, the merchant passes all payment data to its payment processor. This data is then passed on to the acquiring bank. All transactions completed by the merchant are clubbed together and cleared.
Traditionally, payments between merchants were made through checks. These payments took more than two working days for settlement. The payments industry came up with the idea of real-time payment settlement to improve processing speed. By the late 1970s, payments started being batched in groups and processed together.
The dawn of the internet brought a new era for the payments industry. It led to faster processing and reduced fees. Wire transfers became cheaper and more accessible to the global population. Smartphones simplified the world of traditional finance and banking. The wide availability of smartphones and internet connection paved the way for modern fintech companies.
Remittances, Transfers and International Payments
The payments industry can be broadly classified into remittances, transfers and international payments. Remittances, transfers and international payments all relate to the transfer and settlement of funds but are used distinctively.
A remittance is defined as money transferred by one person or party to another. The word is derived from the word remit which means to send back. The term today is mostly used to describe money sent by a worker to his family back in his native country.
Remittances are one of the highest sources of foreign capital inflow for some emerging economies. Money sent by foreign workers back to their home country often helps in raising the standard of living. It also aids the local economy as increased spending results in more jobs and higher production.
According to World Bank estimates, the total remittances to low and middle-income countries in the year prior to the onset of the pandemic were more than $550bn. The amount was a crucial lifeline for many households. Remittances help uplift families out of poverty, improve health and nutrition, provide better educational opportunities and improve lifestyle.
The cost of completing a remittance transfer remains exuberant. In a press release, the World Bank estimated the global cost of sending $200 in remittance stood at 6.8 percent or roughly $14. For example, if a person sent $200 in remittance, his family only received $186 as the remaining $14 was spent on processing and transaction fees.
The two-ATM model widely used in Latin America is another remittance channel. It has one remitter based card and another one with withdrawal rights. A family member can always withdraw funds using the second card.
The processing cost was even higher in the Sub-Saharan Africa region. At 9 percent, it is the highest in the world. In the developed Europe and Central Asia region, the cost to send $200 in remittances averaged 6.48 percent in the first quarter of 2020. The same cost was 5.97 and 7.13 percent respectively in Latin America and the Caribbean, and East Asia and Pacific regions respectively.
Due to the pandemic, global remittances fell to $445bn in 2020. The sharp 19.7 percent drop represented a significant loss of income to a number of households whose livelihood was dependent on remittances. If there are more waves in the future, then the amount sent in remittances could dip even further.
Besides the exuberant processing fee, senders are also vulnerable to hidden transaction costs and forex rate fluctuations. Most payment transfer channels keep their own markup on forex rates which is completely hidden from the sender. They quote a lower than prevailing exchange rate whilst also charging a transaction fee. This adds up to the cost of sending remittances across international borders.
In some cases, payment settlement providers charge different transaction and forex rates depending upon the settlement time. For a payment that needs to be settled immediately, they charge a higher processing fee and offer below-market forex rates. Payments that aren’t settled immediately carry a lower fee.
Role of Money Transfer Operators and Postal Network
Money transfer operators (MTOs) are financial companies that are active in the payments industry but do not have a banking licence. These companies either use their own payment settlement network or rely on another third party settlement system. Some MTOs have their own physical presence across geographies while others rely on intermediaries.
MTOs make it easier to transfer money as they have less stringent KYC requirements than a bank or other financial institution. They largely focus on low amounts, but more regular payments. A user does not need to be a part of MTO’s network, open a bank account or own credit cards. Most transactions are initiated in cash by the sender and then received in cash by the payee at the other end.
MTOs could be national or international depending upon their branches and network. Large MTOs operate through a franchise while the smaller ones operate through subagents. A typical money transfer through an MTO begins with the sender depositing cash and details of the recipient with a subagent. This data is forwarded to the payments network and after verification, the money is transferred to a subagent who will hand over the money to the recipient.
Agents record and maintain all relevant payment data. Once a week, agents in the network clear their settlements with the clearing centre. Even though MTOs work differently from a bank they do require a bank for clearing settlements between agents and the clearing centre. The international payments industry comprises various small MTOs that form the backbone of the sector.
Traditionally, post offices were used for domestic payments as they had a wide-reaching network across the country. Over the years, domestic postal networks have built a full-fledged network for cross border payments. In some cases, post offices merely act as an agent for another international money transfer company while others use their own network.
Postal offices have the highest reach among those sending remittances back to their home country. In the absence of a strong banking network, postal offices provide financial services to the last mile. Money orders, a type of remittance transfer provided by postal banks, is widely used. It allows the delivery of cash to the payee’s address in the native country. The recipient doesn’t need to visit a bank branch as he gets cash delivered to his address.
Digital Era of The Payments Industry
Telecom companies revolutionised the slow and laggy payments network. They started using their mobile network to simplify and improve making fund transfers. The sender could simply send a text message with the amount and payee details to initiate a fund transfer.
The telecom company has a network of agents who complete the last-mile delivery of such payments. When a transaction is initiated by a sender, the telecom company uses its network and transfers the amount to an agent. The entire payment is routed through a banking partner and then settled physically. It is important for the sender to have a pre-funded account if he uses a telecom company network for sending funds.
In recent times, direct fund transfer between two virtual accounts has become the norm. These payments aren’t as widely used as other alternatives but are easier to complete. These payments are settled faster, have fewer transaction fee but do not provide cash to the payee. The recipient has to go to a bank or financial institution to encash it.
India’s Unified Payments Interface is a real-time payment settlement system developed by the local National Payments Corporation of India. It is used for instantaneous fund settlements between bank accounts. It provides means for cash transfer through a mobile phone. Every bank account is linked with a UPI ID and it can be accessed through a mobile app.
Challenges of the Payments Industry
The payments industry has faced stringent criticism over high transfer fees, misappropriations in forex rate and delayed settlements. At a more technical level, fraud detection, kickbacks and data security are bigger challenges.
Fraud is the biggest threat to the payments industry. It impacts both customers and financial institutions. Over the years cases of financial crime have seen a continuous rise. Criminals are getting more sophisticated and using technology to their advantage.
The most common type of fraud in the industry is scammers promising gifts and high amounts in return for small amounts. Most users fall for the trap and send funds to the scammer. Once the money is received the scammer stops responding to the victim. Sometimes, people search for a product on the internet and this gets saved in their browser cookies. Scammers intentionally use keywords to show pop-ups to entice the purchaser in buying a product that will never be delivered.
Such frauds are common and cannot be completely eradicated. Developing an advanced fraud detection tool is one possible solution. Payment transfer companies have built systems in place to block accounts that exhibit traits of a probable scam. However, the system is not fool proof and a scammer could always find a loophole.
Not only small users but businesses are also vulnerable to fraud. Scammers send dubious links disguised as payments receivables to businesses. Unknowingly, employees click on them and send money to the scammer. Creating awareness around fraud and scammers is the path forward.
Another pain point of the payments industry is the delay in settlement of funds. For a payment to be settled successfully, it needs to be first processed by the sender’s bank. It is then settled between two banks and then transferred to the payee’s account. In the case of international payment, the difference in time zones could lead to a difference in working hours. The sender may have initiated the payment in his working hours which may not be the same at the receiver’s end. The payee will only be able to receive his funds during his bank’s working hours.
International fund transfers and the SWIFT network
Money transfer services offered by banks are the most efficient and reliable means of cross border fund settlement. Fund transfers through banks include cash transfers, account to account transfer, money orders, banker drafts and cheque clearing. Wire transfer remains the most common and widely used fund transfer method by banks.
An international fund transfer is not sent directly from the sender’s bank account to the beneficiary’s bank account through a wire transfer. The bank forwards the amount to its own branch in the recipient’s country and then to the bank account of the payee.
Online banking services for the transfer of funds are easiest but not widely available. The digital infrastructure required to complete online fund transfers is absent in most developing countries. In order to provide round the clock banking service, banks use the SWIFT network for payment settlements. Society For Worldwide Interbank Financial Telecommunications (SWIFT) is a messaging network used by financial institutions to settle cross border payments.
Financial institutions and banks use the SWIFT messaging network to transmit payment data securely through a standardized set of codes. It provides a unique code to every member financial institution. For a sender to complete a cross border transaction, he needs to know the account number of the payee along with his branch SWIFT code. He can then use this data to initiate a payment request to his bank.
His bank then uses the SWIFT network to send a message to the recipient’s bank informing them about an incoming transaction. The receiving bank then proceeds to deposit the funds in the payee’s account. By using the SWIFT network, banks do not have to settle each transaction. They batch transactions and then close settlements directly between them. This improves speed and efficiency in the payment process. It must be noted that SWIFT is only a messaging network of financial institutions and banks. It does not settle payments directly or on behalf of any member in its network.
Blockchain Technology and Payment Settlements
The SWIFT messaging network is an important component of cross border payment settlement. However, it is not a payment settlement system and has its limitations. A distributed ledger popularly known as blockchain technology is a better alternative to most cross border payment settlement protocols.
A blockchain is an orderly arrangement of data in a timestamped manner linked to each other. It starts with a genesis block which is the first block and then connects to the other preceding blocks. In simple terms, a blockchain is a database. As new data is entered, it is clubbed together in a block and added behind the last block of data in the blockchain.
There are different types of blockchain. It could be a private blockchain that can be accessed only by members of a closed network or a public blockchain that can be accessed by anyone. They could be centralized or decentralized. A centralized blockchain is run and maintained by one central node which alone adds new blocks. In a decentralized blockchain, member nodes maintain individual copies of the blockchain data which improves security. A decentralized blockchain is immutable and records once entered cannot be deleted or edited.
When a new transaction is initiated, it is transmitted throughout the network. Nodes in the network then validate the transaction. If the transaction is validated then it is added to the blockchain. Members who validate transactions in the network are referred to as full nodes. There are multiple full nodes in the network each holding a copy of the blockchain from the genesis block. If one of the full nodes goes down or falls out of sync, then it can rely on other full nodes.
The decentralized nature of blockchain makes it immutable and tamper-proof. If a full node tried to alter information or push random data in the blockchain, other honest nodes would reject it. If the rogue node still tried to continue adding blocks, then the honest nodes would split the chain and fork the network.
Due to blockchain’s decentralized attribute, all transactions in the network are completely visible to everyone. This ensures that there is transparency in the network and also adds security. If anytime there’s a fraud in the network or funds are stolen, then these funds can be tracked publicly on the blockchain.
Cryptocurrency and Digital Tokens for Payments
Bitcoin, the world’s oldest and most widely accepted cryptocurrency was developed by Satoshi Nakamoto. He envisioned a decentralized digital currency. Over the years, other cryptocurrencies, each with their own set of distinct advantages have also come to the fore.
Digital currencies such as Bitcoin (BTC), Ethereum (ETH), Ripple (XRP) and Litecoin (LTC) have transformed the payments industry. Due to the rise of cryptocurrencies, cross border payments have become instantaneous, direct and have low transaction fees. According to Statista, there were more than 360,000 payments processed on the Bitcoin blockchain every day in March 2021.
There are more than 70 million unique Bitcoin wallets sending an average of $7bn in fund transfers every day. When a user sends Bitcoin from one wallet to another, the transaction isn’t verified by nodes immediately. Every new transaction enters and stays in the mempool until it is picked up by miners. Miners batch transactions into a block and then process the entire block simultaneously. There is an estimated time difference of around 10 minutes between two blocks on the Bitcoin blockchain.
The transaction fee to complete payment depends upon the total number of pending transactions in the network. If there are a high number of pending transactions in the mempool then miners will prioritise transactions with a higher fee. At times, this leads to exuberant fees and abnormally long hours for payment settlement.
Bitcoin’s block size and block intervals are 1MB and 10 minutes, respectively. Litecoin has a smaller block interval of 2 minutes 30 seconds which enables the network to process payments faster. One of Bitcoin’s biggest criticisms has been settlement time when the network has high traffic.
A significant number of transactions on the Bitcoin network are microtransactions. If these transactions were settled outside the main chain, it would reduce the load on the network. An off-chain payment settlement medium is a solution to this problem. It would open a payment channel between two users. This payment channel can be used by both users to send and receive funds between them.
In an off-chain payment settlement network, only the ending and closing balances of both the sender and receiver are uploaded on the ledger. In a decentralized blockchain network, every transaction made between the sender and receiver is uploaded to the ledger. This leads to more data being uploaded in each block and also longer payment processing times.
The Lightning Network is an off-chain payment protocol built on top of the Bitcoin blockchain. It is also known as a second layer payment settlement system. Similarly, the Raiden network is a fast, scalable and off-chain settlement system built for the Ethereum network and ERC 20 compatible tokens.
Every digital token has its own blockchain network. These blockchain networks are disconnected from each other and cannot interact or share data between them. Second layer payment settlement systems which are built on top of these blockchains inherit the same issue.
The RIF Payments protocol allows interaction between different off-chain payment networks and any token deployed on the RSK network. This enables fast, scalable and low-cost off-chain payment settlement solutions between different blockchain networks.
RIF Payments’ aim is to let users interact seamlessly between multiple cross-blockchain, off-chain networks. It creates an abstract layer between different payment networks allowing cross-network transactions. RIF Payments API creates a bridge between different off-chain payment networks.
Interoperability is very important for present-day blockchain networks. Blockchain technology is used in digital currencies to maintain and update payment settlement data. Bitcoin is widely used and accepted as the number one digital currency while the Ethereum network is used for building dApps (decentralized applications). There needs to exist a path or tool for users to interact with the Ethereum mainnet through their Bitcoin wallet. Interoperability isn’t a deviation from the sole fundamentals of cryptocurrencies but an extension to the core fundamentals of blockchain.
Blockchain technology and cryptocurrencies deliver a censor-free and control-resistant currency reality. Some digital tokens are used to trade digital assets, others are used as utility tokens, some are used to interact or trigger smart contracts and a majority of them are purely digital currencies.
A user needs to hold different tokens as per where he wants to use them. A second layer, an off-chain payment protocol system built on the foundation of interoperability will eliminate the need to hold multiple tokens. A single token could be used across multiple mainnets. Interoperability isn’t just to send or transfer tokens but to also share data between blockchains and make the entire crypto network more robust. The RIF Payments Protocol makes this a reality.
The RIF Lumino Network
The RIF Lumino network is an off-chain state channel that allows interaction between cross-blockchain networks. It has lower costs, faster payment confirmation times, and supports cross token payments. The protocol is compatible with the Lightning Network (LN) and also provides support for RSK deployed tokens.
The goal of the RIF Lumino Network is to create collaborative Decentralized Sharing Economies (DSE) for individuals to interact. Built on top of RSK, RIF is developing the building blocks needed for a decentralized and interoperable internet.
It is a third layer settlement protocol built on top of the Bitcoin blockchain network and is powered by the RSK sidechain network. The RIF ecosystem comprises the RIF Directory, RIF Payments, RIF Storage, RIF Communications and RIF Gateways. RIF Name Service (RNS) is a decentralized service that allows users to acquire a domain in any given blockchain. It can be used for identifying personal resources.
Rootstock (RSK) offers support for Ethereum’s programming language thereby allowing smart contract developers to utilise their existing code. The RSK mainnet was launched in 2018 and has witnessed a consistent rise in its user base.
The RIF Token
The RIF token allows token holders to consume services compatible with the RIF architecture. It is an RRC677 standard and was deployed to the RSK network on November 9, 2018. The RSK Infrastructure Token is the native utility token of the Rootstock Infrastructure Framework and these tokens exist on the RSK Live mainnet. The RIF token is used to access the payments, storage and domain name services on RIF. The blockchain industry today is split into different types such as computing, storage and payment settlement. The RSK ecosystem brings them together.
RIF’s Role in the Future of the Payments Industry
The RSK infrastructure supports the development of smart contracts. Insurance companies, banks and other financial institutions could develop payment settlement systems as smart contracts on the network. The RIF token would then become the native digital currency of those dApps and be used to pay transaction fees.