The future of payment systems

For many years, business owners in Europe have been facing the burden of TARGET2. TARGET2 replaced TARGET (Trans-European Automated Real-time Gross Settlement Express Transfer System) in November 2007. It is “the real-time gross settlement (RTGS) system owned and operated by the Eurosystem.” It is also one of the largest payment systems in the world.

The problem

One of the main features of TARGET is the role of Central Banks. The payment system works as follows:

“A Dutch importer, for example, might place an order with a Spanish company. Payments to and from the accounts of the buyer and seller are channeled via central banks, so the Spanish exporter’s bank gets a credit with the Banco de España, which in turn has a claim on the ECB. The Dutch importer’s bank owes its local central bank, leaving De Nederlandsche Bank with a debit at the ECB.”

This multi-layer payment transaction system makes transfers both slow and costly. Participants can choose between  either “a lower fixed monthly fee + a fixed transaction fee or a higher fixed monthly fee + a degressive transaction fee.” Transactions aren’t always processed, as the TARGET2 system is closed on Saturdays and Sundays and several public holidays. This means business owners miss out on interest and run some liquidity risk during the period they are waiting for a payment to be processed.

The solution?

Cryptocurrencies obviously offer a solution to the previous, as every payment will be a direct transfer of funds to any wallet address worldwide. Depending on the cryptocurrency, this will never take more than a few hours or even just several minutes. For example, Bitcoin has a block target time (confirmation time) of ten minutes. Dogecoin even has a block target time of just one minute. It should be noted that it is common to require six confirmations to assure transactions aren’t invalidated. The network will process transactions originating from anywhere in the world, and regardless of destination, within the defined target time. The transaction fees for this are close to zero. In the case of Dogecoin the fee is 1 DOGE per transaction (about $ 0.000455) .

This eliminates any liquidity risk, although cryptocurrencies generally don’t pay interest. The latter is somewhat compensated by the ultra-low transaction fees, especially for low-value transfers. Overall, cryptocurrencies make TARGET2 look like nothing more than a hopelessly outdated payment system. It seems like a matter of time before cryptocurrencies, or similar technology, will take over.