We talk a lot about foreign exchange. The FX (currency) market is one of the most exciting fields to trade in, as currency values are constantly changing according to a number of international factors. There is so much opportunity to make money, and simply following a single currency pair is incredibly interesting. You learn about politics, economics, and sociology in the process.
However, it is easy to forget that foreign exchange does not exist for trading purposes. It is a very practical concern for people who work abroad, who invest abroad, or who own property abroad. People send and receive billions of pounds internationally every single year.
The irony is that trading Forex is a whole lot easier than using FX for practical purposes. We can set up a ton of automated trades using our favourite broker at no cost, while people working internationally lose money every day just from transfer costs.
Let’s take a look at why the system is so archaic and what is being done about it.
Foreign Exchange and Banking
People who rarely send or receive international money transfers will use their bank as their first port of call. Banks have long provided a way of sending and receiving international payments. Today, most banks around the world use the SWIFT network for legal administration of international currency transfers.
If you're not sending a big amount of money, your single transfer experience will not cost you all that much. However, if you are buying property, investing in companies, or simply working internationally, the fees add up.
First of all, you pay SWIFT fees, as SWIFT is an independent network that banks pay to use. In addition, many banks take a commission that amounts to a percentage of your transfer. But that is not where the fees end.
If you look at the exchange rate your bank gives you, you will see that it is inferior to the rate you would get when trading. This is because banks give you a bad deal as a way of hiding extra fees.
By putting this in context of Forex trading, we can see just how expensive international currency transfers can get.
When trading Forex, you have to look at the Forex spread to make the most effective transfers. The spread refers to what you lose between buying and selling a currency. Trading through an FX broker, your spread should be measured in pips.
When actually sending and receiving money internationally, the spread a bank gives you is not measured in pips. Rather, it is measured in full percentage points!
How much can banks charge? Some banks charge as much as 2.5% on every currency transfer you make. This means that if you transferred the same amount between the UK and the EU a mere 40 times, you would have spent the full value of the transfer.
In addition, you may pay set transfer fees of £10 to £15 for transfers over a certain size. While our example is hypothetical, it does show how the fees add up over time. What may seem like a small price to pay becomes a major factor the more money you transfer.
But we live in an age in which the traditional financial institutions are creaking. Fintech startups are changing the finance world, and there are alternatives for just about every banking function.
What alternatives exist for people who are doing international money transfers regularly? Meet currency brokers.
There have been money transfer services for over a hundred years. The Western Union Telegraph Company (simply Western Union now) was founded in the US back in 1851. They launched the first wire transfer service in 1872.
Since then, many big companies offering wire transfers have come and gone. Over time, those with bank and government support had the most staying power, rather than those who innovated. As such, wire transfers continued to be carried out in archaic ways until banks started offering the service.
Wire transfer companies did continue to change, but were not particularly innovative. Many became monoliths who considered themselves too big to fail, and as such did not try to evolve even as technology changed at a rapid pace.
The most pertinent example of the new wave of currency brokerages is the story of Wise (formerly TransferWise). Wise was started by two Estonian friends who were working internationally. They had to deal with high transfer fees that dug into their income every single month, and realised this was a widespread problem.
They created Wise to provide an alternative. Wise used innovative ways to transfer money at a minimal cost. They offered the best possible exchange rates and the shortest turnaround times. The need for companies like them was demonstrated in their rapid success. In their first year of operations, they processed €10 million worth of transfers.
The way Wise works is similar to the “hawala” system which originated in India over a thousand years ago. Instead of moving money through expensive transfer networks, they match up payments with those going in the other direction. So, if you transfer abroad, your money doesn’t leave the country but is rerouted to someone receiving money on your end. Money being sent on the other end will then go to the person who is meant to receive your payment in that country. This makes transfers essentially free and processing times minimal.
Of course, the success of Wise paved the way for many more fintech startups to enter the international money transfer arena. These startups used similar or alternative innovative ways to transfer money at a fraction of the price. This in turn led to old wire transfer institutions to wake up to the twenty-first century, although banks still have not caught up.
In other words, there are now many companies, big and small, that offer international money transfers. Some of the biggest examples in the UK include Currencies Direct, Moneycorp, and TorFX. While Wise has continued to grow from strength to strength, and in July 2021 publicly listed on the London Stock Exchange at a value of $11 billion, many experts no longer consider them among the best options available.
No company could see continued success in 2021 simply by sending and receiving transfers at a low price. Innovation has continued and international currency brokerages now offer a range of extra features.
These features are particularly useful for individuals and businesses making regular transfers. As currency pairings fluctuate, many entities want to be sure that they are receiving the same value on every payment. For this reason, money transfer companies offer features like future contracts, which sets the current exchange rate for future transfers.
As a trader, features like this may seem undesirable. After all, the money you make trading is due to the volatility of the FX market. However, if you need to pay salaries or bills every month with a certain budget, the risk of losing money due to the exchange rate is more pertinent than the possibility that you will make extra money from it.
Trading Forex is a great way to make money because of how volatile the market is. This, however, presents problems for people who need to send and receive money on a regular basis. While the big banks still use expensive transfer systems with significant fees, a number of currency brokerages have popped up over the past decade. They offer brand new ways of transferring money at a minimal cost.
This does not impact us as traders all that much, but as the world becomes ever more globalised, the need for international money transfers is inevitable even for those of us who are still strictly local.