Peer-to-peer foreign exchange (P2P FX) is touted as a revolutionary low-cost way to exchange currencies, but the sector faces challenges. Platforms must find a way to differentiate themselves to find long-term success, warn industry experts.
The P2P FX revolution started with the launch of CurrencyFair in May 2010. A number of others followed, including TransferWise, Kantox and Midpoint.
The concept is simple: a platform directly matches buyers and sellers of currencies cutting out the middleman, which would typically be a bank or broker. The customer pays an upfront fee to the platform and in return gets the mid-market rate.
People use TransferWise to transfer £800 million every month, according to a spokesperson.
The matching concept is straightforward, but the reality is somewhat more complex. Most trades on these platforms are not internally matched at all, say industry experts, and have to be completed using back-up liquidity from banks. There is simply not enough flow to internally match every trade.
Liquidity is like a good party, says Brad Bailey, research director at consultancy firm Celent: “You need buyers and sellers there… at the same time.”
“You need to be huge to be able to match above 50%,” he says. “[We] leverage on the [P2P] idea to make our business more understandable to the general public. I don’t think it’s illicit to say so. The client doesn’t care.”
A spokesperson for TransferWise says the majority of the volume is matched on its established two-way routes, but did not give an exact percentage or detail its less established routes.
“Where it isn’t [matched], then we buy the missing currency in,” says the spokesperson.
For now, P2P players are still reliant on the banks they are so keen to disintermediate. The irony is that banks have been internally netting their flows for years; some can truly match close to 100% of their currency flows due to the sheer volume that passes through their hands every day.
However, banks either don’t want to deal with small players or charge them a hefty fee even for a simple currency transaction, hence the rise of P2P platforms that are popular with individuals and now small businesses.
FreemarketFX chief executive Alex Hunn says user experience plays an important role, adding: “From the customer perspective it’s interesting. They care about some of netting, but ultimately it’s about the entire process.
“We deliver technology into an environment that is traditional and very un-tech orientated.”
The UK’s European Union referendum vote on June 23 was a test for P2P platforms. Some were able to remain open for service, others temporarily shut down. TransferWise and Azimo suspended their service, while CurrencyFair, Kantox and freemarketFX remained open. Azimo did not respond to press enquiries.
Volumes on CurrencyFair were six-times higher than normal, says its chief marketing officer Nils Anden. The platform coped, but he believes volatility spikes could pose a challenge to some P2P platforms, depending on how they are set up.
“Some of the P2P platforms look like [they are] moving slightly to an almost hybrid broker model,” he says. “Then if [there is a] lot of volatility and you promise customers a rate before making the exchange, you are of course subject to huge risk.”
The referendum vote triggered huge volatility in currency markets, resulting in sustained weakness in the UK pound. This impacted some customers at TransferWise, which imposes an automatic rate limit of 5% on guaranteed rate transfers. A rate limit can delay a customer’s payment if the rate moves negatively.
“The rate limit resulted in some refunded payments around Brexit, but since then it has been business as usual,” says a spokesperson for TransferWise.
Richard Kimber, chief executive of international payment firm OFX Group, believes there are inherent fragilities in the P2P model. Corporate clients will not tolerate an interruption to their access to markets, he says.
“You can’t have an interruption to service,” adds Kimber. “It is not like a web service; money matters. Businesses don’t want to be exposed to the vagaries of a provider shutting down.”
Indeed, P2P players are keen to drum up more lucrative corporate business. TransferWise for Businesslaunched earlier this year, with tens of thousands of businesses using the platform, according to a spokesperson.
Meanwhile, Kantox has expanded its initial offering to give corporates a broader risk-management offering that incorporates hedging instruments.
P2P platforms need to offer more than just rock-bottom prices. They have proliferated because customers got such a raw deal on price with their banks, but in time banks might respond by becoming more competitive, warns Kantox’s Rami.
“If banks decide to reduce prices, you better have another differentiation than just price to defend your segment,” he says.
Kantox believes banks will, over time, understand fintech better and start to acquire the technology and practices of fintech firms.
“This is a threat that we like to control,” says Rami. “[It is] why we have been trying to add more value in our proposition. If your only competitive advantage is price, you’re in trouble.”
The sector remains unprofitable as platforms focus on attracting investor money and sustaining growth. TransferWise made a loss of £11.4 million in the year to 2015 – it says it is concentrating on growth at the moment instead of profitability.
CurrencyFair made a €3.2 million loss in 2015 due to soaring costs. Kantox is “very close to profitability”, says its COO.
Regardless, there remains huge potential for growth in the P2P FX sector, given that global currency trading volumes average $5.1 trillion a day.