No More Snail Rails

VeradiVerdict - Issue #115

"To send a wire transfer, a request needs to be printed, signed in triplicate, sent in, sent back, lost, found, queried, and then manually typed in to what we can only imagine is a DOS system. All before 4pm. And this is before it hits the ODFI, then the ACH, on to the RDFI, back to the ODFI, and then on to the WTF, with each charging a rather delectable fee. In short, the payment rails of today are too slow, too expensive, and too complicated." 

Pantera completed a funding round with Square into Transparent Financial Systems to solve this problem through a decentralized cash settlement platform.

The Legacy of Electronic Bank Transfers

One of the most integral components of the financial ecosystem is the electronic bank transfer –– it is the predominant way that individuals get wages, that bills are paid, and that large payments central to many aspects of personal and professional life are carried out.  

Despite being central to financial life, electronic bank transfers are notoriously slow, inefficient, and outdated. The vast majority of electronic bank-to-bank transfers of funds are carried out through the Automated Clearing House Network, colloquially known as ACH. ACH was developed in 1974 and has not been significantly upgraded since. Nearly fifty years later, ACH transactions can take up to 3-5 business days to settle before funds are released into bank accounts. This outdated settlement process also costs serious money due to how slow it is –– annually, the cost of clearing and settling on ACH is more than $80 billion, a significant proportion of that is due to the roughly $450 to $750 billion that is stuck in transit (and thus, inaccessible by anyone) in the network. On top of the money that is in transit, the median internal cost of processing an ACH payment is $0.29. The ACH volume for 2019 was 24.7B payments – a cost of $7.95B.

What’s the alternative?

In total honesty, there aren’t many. The Clearing House has recently developed a newer payments platform called Real-Time Payments (RTP) Network. In spite of well-publicized campaign to partner with all financial institutions, less than 1% of all US banks use the RTP Network –– and it’s not really “real-time” insofar as clients still can’t transfer money on weekends. FedNow is coming, but with an unknown schedule or roll out plan.

What about things like Venmo and PayPal?

Venmo and PayPal work a little differently from electronic bank transfers –– and generally transfer smaller sums of money between consumers. At a very high level, the way that apps like this work is that you deposit some money from your bank account into a “Venmo account” or a “PayPal account”. Payments on the platform are then run from one Venmo or PayPal digital wallet to another –– within PayPal’s bank account, not interbank between different bank accounts. You can then request to deposit your Venmo or PayPal balance in your bank account, but again, this requires time and fees. Furthermore, customers’ funds held by PayPal are not FDIC-insured. These reasons are why the classic use case P2P services like Venmo and PayPal are for smaller, more menial transactions –– like splitting a bill over dinner –– as opposed to B2B payments like paying wages bills and treasury management. 

So, what’s the solution?

Meet Transparent Financial Systems –– a company that’s been working on an on-demand cash settlement platform, with decentralization and blockchain at its core. Transparent has developed Xand, a digital dollar network that allows for real-time transfers of value, on-demand settlement and B2B payments outside of traditional rails like ACH.  

Compared to ACH, Xand is significantly faster (near-instantaneous, effectively real-time) and requires a fraction of the transaction fees and costs that ACH extracts from their bloated process. The cost of reconciliation is also greatly reduced – once funds are sent, you know the money will arrive. The entire process is cryptographically-secure to ensure that large sums of payments can be securely and efficiently transferred between businesses. 

Check out the explainer video.

How does it work?

Like most blockchain-inspired platforms, the technical specs of Xand can be complex and are beyond the scope of this article. At a high level, the process is as follows: 

Transactional communities of businesses that transact in high volumes and amounts form Xand networks. As members of these Xand networks, businesses can register digital dollars called Xand Claims, which represent US dollars transferred to trust accounts federated across participating banks. Members instantaneously transfer Xand Claims to each other. When they are ready to redeem the Xand Claim, they request the trust account to transfer US dollars into their bank accounts. The registration and redemption happens at a select number of participating banks and requires very little infrastructure to get started.

What is particularly interesting about Xand is that members are empowered to design their own network, including speed, rules and cost. Xand, as a decentralized yet permissioned network, removes the need for the usual clearing intermediary like The Clearing House and usual exorbitant fees, allowing members to equitably share both cost and revenue of their network -- all of this while respecting regulatory requirements.

The current protocol is built with Parity’s Substrate, which provides a flexible and customizable base. The entire process is end-to-end automated. While members of the first instance of the Xand network will be Bank Secrecy Act-regulated financial institutions, members can also be non-financial institutions. Transparent charges no transaction fees, and rather plans to profit from a portion of Network revenue, software licensing, and support contracts. 

What’s next from here?

Technologically, Xand leverages Parity Substrate for enhanced customization and easy extensibility, but the system is built to be blockchain agnostic. Transparent is also building out more robust APIs and deployment systems for easy integration and development, as well as confidentiality systems. They also plan for white-label applications, integration into popular treasury management applications, and tools to support members – making the system as simple as possible and enabling client analytics. Future work will also include enabling Xand Networks overseas, denominated in local currencies, as well as systems to increase throughput and lower member costs.

How credible is the solution?

The entire platform is cryptographically-secured, meaning that all data is cryptographically-verified before any actual settlement takes place. Transparent is working with more than seven financial institutions, ranging in size from OTC desks to large, multinational banks.

The Transparent team has top-tier credentials. The company spun out of Vulcan, Inc. - a company founded by Microsoft co-founder Paul Allen. CEO Alex Fowler previously co-founded Blockstream, did significant work with Zero-Knowledge Systems and the Electronic Frontier Foundation, and held leadership positions at firms like Mozilla and PwC. From a compliance and legal perspective, Chief Legal Officer Patrick Murck has worked with the Harvard University Berkman Klein Center for Internet & Society, and serves on the International Monetary Fund’s High-Level Fintech Advisory Group, and the Fintech Advisory Groups for the Federal Reserve Bank of New York and the Massachusetts Securities Division.

Why is this so important?

Fast, substantial payments are increasingly more and more important for the average American. Nearly 36% of all jobs today are considered part of the “gig economy”, where instantaneous payments are the standard for compensation; this cannot be accomplished through legacy systems like ACH. A report by the Federal Reserve found that 40% of Americans can’t find the money to pay for an emergency expense of $400 immediately –– most are living paycheck-to-paycheck, which makes for an incredibly difficult and risky situation when it takes 2-3 days for paychecks to settle in workers’ bank accounts. It is critical that US banks and financial services find another way to facilitate instant payments, through even B2B services like Xand. Current systems don’t meet the mark – they either cost too much, are unavailable when you need them, or both – and Xand brings much needed competition to an area that hasn’t seen any for 50 years.

Final Thoughts

Xand represents a massive step forward in deprecating the outdated legacy systems like ACH, CHIPS, and Fedwire that limit how fast money can be transferred from bank to bank and extract exorbitant fees (such as TCH’s RTP) from users. Xand utilizes blockchain technology to automate the entire electronic transfer process in a secure, real-time protocol; with the registration of Xand Claims representing US dollars held in trust and the cryptographic and confidential transfer of Xand Claims, Xand is able to guarantee groundbreaking payment speeds that are critical given the current state of the American economy and empower the customer. Moreover, Xand’s technology represents an important growing application of blockchain on a conventional area of finance; much of blockchain tech in recent years has focused on trading, investment, and arbitrage opportunities, but Xand creates a simple way to use the power of blockchain technologies to make significant improvements for the financial life of mainstream American companies. 

- Paul V

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ABOUT ME

Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing in blockchain companies and cryptocurrencies. The firm invests in equity, pre-auction ICOs, and cryptocurrencies on the secondary markets. I focus on early-stage investments and share my thoughts on what’s going on in the industry in this weekly newsletter.