Are you getting ready to purchase Christmas gifts, or are you the type of person to wait until the last minute? Whichever it is, you will likely buy at least a few of your gifts, if not all of them online. Let’s face it the convenience of having things delivered straight to your door and one-click checkout are hard to beat.
What you might not spend much time thinking about is how the miracle of payments actually happens — from your bank account to the merchant who, on Amazon, can sit anywhere in the world.
Long gone are the days where we sent gold across the oceans to settle trade. Nowadays, everything happens electronically, payments included. And what is the money we have in our bank account other than a liability to the bank?
When you pay for goods you buy, your bank is notified and instructed to ensure that you have the necessary funds and credit the money to the recipient’s bank. How does that transfer happen? It involves an organization you probably have heard of but potentially believe to be settling payments: SWIFT.
How SWIFT started
SWIFT is short for the Society of Worldwide Interbank Financial Telecommunications. Yes, you read that right. It’s telecommunications, not transfers.
Before SWIFT, banks and other institutions that needed to settle payments relied on Telex; with Telex, every organization had their specific Telex address and used the system to transmit text-based messages to organizations they had to settle charges with. The system was based on actual wire connections; these transfer types became known as “wire transfers.” We still use the term today.
However, there was no unified system of codes for bank names with Telex, and users freely used message formats. Consequently, receivers of messages spent a significant amount of time interpreting them before they could move on to execute transfers. Needless to say, the system was slow, clunky, and unreliable.
In 1973 239 banks came together in Belgium to create an organization that could replace Telex. The network they created is now used by more than 11,000 members who sent 35 million transactions per day through it in 2020. Earlier this year, SWIFT hit a new message record with 41.5 million messages it handled per day in March 2021. This increase signified a plus of 9.8% Year to date.
How SWIFT works
It’s important to note that SWIFT is not settling payments. As the telecommunications in its name indicates, it’s a messaging network that financial institutions rely on to send and receive information related to money transfers and other financial transactions. Thanks to SWIFT individuals, and businesses can take electronic or card payments even when the parties involved in a transaction are using different banks, even in other countries.
The network works by assigning each bank a unique code that’s either 8 or 11 characters long. If you transfer money internationally, you probably have been asked for the SWIFT code before. Sometimes it’s also referred to as Bank Identifier Code, SWIFT ID, or ISO 9362 code.
To illustrate this with an example, let’s look at the SWIFT code for the Commerzbank in Frankfurt: COBADEFFXXX.
- the first four characters identify the banking institute: Commerzbank
- the following two characters indicate the country: Germany (DE)
- the next two characters identify the location: Frankfurt (FF)
and the last three characters are optional but used to assign codes to individual branches. In this example, the Frankfurt branch is the headquarters and therefore set to XXX. To transfer to the Commerzbank in Nuremberg, the last three characters would change to -100 and so forth for other branches.
With the SWIFT code and the recipient’s bank account number, you can send money from anywhere in the world and ensure that it’ll find its way to the right person. SWIFT is most likely involved in the back-end whenever you make an electronic payment, sending messages between businesses and financial institutions.
IBAN: If you wonder how IBAN and SWIFT are different, SWIFT identifies only a specific bank — whereas IBAN identifies the individual account identified in an international transaction. If you have the IBAN for an account, you won’t need a separate SWIFT code.
Even though other messaging services specialized in the financial industry, such as Fedwire and the clearinghouse payment system (CHIPS), exist, SWIFT remains dominant and continues adding new messaging codes to transmit different financial transactions efficiently. Institutions including banks, brokerages, clearinghouses, exchanges, corporate business houses, and money brokers rely on the network for their payment-related communications.
Challenges SWIFT is facing.
SWIFT handles vast amounts of sensitive information and payment data and consequently has become an attractive target for hackers and other malicious actors.
Hacks
One notable vector for an attack is the authentication process. If a hacker manages to gain access to a bank employee’s credentials, there are no safeguards in the system to stop them from conducting transactions enriching themselves.
And it can even be more straightforward than that. In early 2018, junior employees of the Punjab National Bank in India started sending SWIFT messages that weren’t recorded on the internal system. Over several years, their wrongdoing went unnoticed, ultimately leading to a staggering $1.8 billion being lost.
When hackers managed to take control of a computer inside the Russian central bank, they stole 6 million using SWIFT. In Bangladesh in 2016, Hackers got away with $81 billion from their central bank using SWIFT.
SWIFT does not take responsibility for such incidents, as it’s just responsible for the security of their systems and leaves the security and access control in the hands of their users. In 2017, the organization added the “Customer Security Controls Framework,” describing a set of security controls. However, banks have to self-attest the level of compliance to that framework.
(Lack of) Automation
As financial transactions become more complex, clients demand automation to facilitate substantial transaction volumes. However, the SWIFT system built over decades is running on many legacy technologies. Adding automation will come at a tremendous cost and add further overhead to an already highly-complex operation.
Connectivity
While the 99.999% availability ensures that messages always go through and aren’t lost when using SWIFT, establishing connectivity from an organization to the SWIFT network is in the customer’s hands.
They will have to invest a significant amount of resources, time, and money to create a secure end-to-end interface between their systems and the banks. Unfortunately, tapping into SWIFT isn’t plug-and-play for organizations. Each interface is unique due to different business needs, country-specific requirements, and local clearing rules.
Ultimately, connectivity with SWIFT is only as strong as its weakest link. If an organization’s mechanism to connect to SWIFT fails, the entire connectivity fails, and that is just one of many potential points of failure.
All these challenges considered, might it be time for a better system?
According to Credit Suisse, the answer is yes. Already in 2017, the bank posted that “Interbank payment systems such as SWIFT are old, inflexible, slow, and increasingly prone to cyberattacks at a time when banks are under tremendous pressure to cut costs and protect customer data from hackers, which blockchain could achieve” (Source)
Blockchain for Interbank Communication
The underlying technology behind Bitcoin could alleviate some of the most significant pain points mentioned above that SWIFT is facing. In 2017, the organization started exploring blockchain, but there hasn’t been any recent news on the status of that initiative.
During a PoC, the blockchain-based system could settle cross-border payments in real-time, but SWIFT’s R&D head mentioned that the biggest caveat for organizations would be that this required a significant overhaul.
In the meantime, other banks such as JP Morgan are actively exploring Blockchain-based solutions, and Ripple — lawsuit aside, is providing services to various financial services with its distributed ledger.
Disintermediation
A blockchain network would allow banks to communicate directly with each other in a peer-to-peer manner without introducing another intermediary and, therefore, a potential vector for attack. While SWIFT has data centers worldwide, relying on just one company to provide the network consistently seems less secure than having a network of nodes potentially ranging into the hundreds to hold up the network. One could imagine a blockchain-based SWIFT alternative. In such a blockchain, every organization that wants to use the service runs a node, giving them access to the network while maintaining it and making it more secure.
Visibility & Efficiency
On a blockchain ledger, any participating organization would be able to track the status of its communications at any point in time. Additionally, banks often spend a significant amount of cost and time on maintaining various ledgers. If one bank owes another bank money, both will track this; if one bank pays the other, both will have to keep the related messaging streams in their system.
One shared ledger across all banks wouldn’t just help reduce cost; it could make it easier to comply with Anti-Money-Laundering, Counter-Terrorism-Financing, and KYC regulations.
More than just messages
When all payments are electronic, what is money other than information? Blockchains aren’t just secure networks to broadcast messages across a set of participants in a trustless manner; they also facilitate the transfer of value.
The current financial system works on an account-based notion. When we transfer money to someone else, our bank will check our account to see if we have sufficient funds to cover the transaction. If we do, they will notify the recipient’s bank and settle the trade. Your recipient then is credited the money in their account. Both banks keep track of these entries in their book.
On a shared ledger, regardless of if the blockchain is running on an account-based model or a UTXO model, both banks would be able not only to share messages but directly settle their client’s transactions without the double book-keeping currently employed.
And there is no limit in what kind of transactions organizations could settle on such a system. With increasing interest and tokenization of real-world assets and securities, it’s not unthinkable that oil futures, gold, and other securities could be settled through blockchain-based systems one day.
So far, SWIFT remains one of the dominant players in the existing financial industry. However, institutions from JP Morgan to the Worldbank are actively researching how blockchain can improve the way we do finance and related communications.
At Minima, we believe that hosting such vital communications and information (monetary) transfers should take place on a quantum secure, highly scalable network. Such a network has to balance functionality with ease of use and hardware requirements carefully. It needs to be complete because how would financial institutions deal with a sudden break in the ledger following a hard fork?
With a complete network that grows in scalability and security with every new node that joins, organizations would have a secure, highly efficient platform requiring minimum overhead to communicate, transfer, and build on.
To learn more about how Minima can help organizations communicate, transact securely and address existing inefficiencies, reach out to us.