If the foreign exchange market starts using DeFi protocols instead of the current centralized systems, the cost of transfers could be reduced according to a Jan. 19 paper jointly published by researchers at Circle and Uniswap, “by as much as 80%.
On-chain Foreign Exchange (FX) is a new model of global value exchange that offers a faster, cheaper and more efficient alternative for cross-border payments.
— Uniswap Labs (@Uniswap) January 19, 2023
The paper, titled “Foreign Exchange and Cross-Border Payments on Chain,” was written by Uniswap data scientist Austin Adams, Circle Chief Economist Gordon Liao, Mary Catherine Lader, David Puth, and Xin Wan.
The authors studied the trading activity of Circle’s US Dollar Coin (USDC) and Euro Coin (EUROC) on Uniswap from July 2022 to January 2023. They found that the pair reached a total volume of $128 million, with some days having volume of up to $8 million.
During this time, the USDC and EUROC stablecoins traded within a few basis points of the exchange rates found in the wholesale foreign exchange market for their USD and EUR backing currencies. In the opinion of the authors, this showed that the DeFi forex market provides a reasonable alternative to traditional forex with good price efficiency, despite the lower volume of trades.
However, the researchers wanted to know if the use of DeFi protocols like Uniswap can bring savings to foreign exchange market participants. So they analyzed the costs associated with the traditional “correspondent banking model” of forex vs. costs associated with Forex DeFi.
They used World Bank estimates to determine the price of transferring $500 through the global banking system. They then compared this to the cost of buying stablecoins (either USDC or EUROC) through an exchange, exchanging them for another coin on Uniswap, sending it to another person, and cashing it out on the exchange.
The researcher concluded that the DeFi model imposes many different fees on users, including exchange commissions, DeFi trading fees, network fees, and fees for transferring cash to and from the exchange. Even so, fees are up to 80% lower than the average cost of remittances, according to World Bank estimates.