Long Take: How Wise disrupted $150T of Cross-Border Payments and earns $1B in revenue
The paradox of building value and reducing your margins
Gm Fintech Architects —
Today we are diving into the following topics:
Summary: Wise launched in 2011 with a bold mission to make moving money across borders instant, free, and convenient. A decade later, the platform facilitates over $130B annually in cross-border payments from 10MM customers, with prices averaging 1/8th those of traditional banks. This week we uncover the strategy fuelling Wise’s growth and the mechanics behind FX transfers. We particularly touch on the paradox of a zero-fee target while growing profitability, and assess the increasing threat of stablecoins in the FX industry.
Topics: Payments, Valuations, Revolut, Western Union, Wise, Stablecoins, DeFi
Special thanks to Michiel for this fantastic analysis
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Disrupting Correspondent Banking
Traditional FX transfers are expensive because currencies are closed-loop systems. This means that, despite their name, money never actually crosses borders during a cross-border transfer. Instead it flows through the global correspondent banking system.
Banks around the world partner with each other to fulfil their respective clients’ orders. These direct relationships are well established for the largest currency pairs (e.g. USD/GBP) but less popular routes often require several large intermediary banks to facilitate the transaction, each of which adds cost and time.
You can think of money traveling in the correspondent banking system as an airplane flying with layovers on the route to its destination. The further you go, the more local legs there will be, the more banks will have to send custom routing instructions.
Charges for this infrastructure are embedded in the exchange rate, which results in an opaque final cost structure for customers. In fact in 2011, the same year Wise launched, the UK Office of Fair Trade opened an investigation into complaints that UK customers were paying £1B annually in aggregated FX fees.
Two Estonians living in the UK, frustrated with this experience, sought a cheaper and faster way of regularly sending money back home. They came up with Wise after realizing they could bypass traditional rails by developing a peer-to-peer platform.
Roughly stated, this is how it works. Suppose a person in the UK wants to send GBP 1,000 to an individual in France who wishes to receive in Euros. Wise will have a bank account in each geography involved. While the users move money locally in their geography, Wise will balance out the supply and demand across its positions in different geographies.
It can also match and net transactions, and distribute currency without the correspondent banking system. Let’s say there’s a person in France who wishes to send money to the UK at the same time. In such a case, Alastair in the UK perceives that he is sending currency to Blaise in France, and Chloe in France perceives that she is sending currency to Declan in the UK; but in reality, Wise is rerouting the capital so that Alastair’s GBP is going to Declan, while Chloe’s capital is delivered to Blaise. The difference is made up on balance sheet. This is all executed within the Wise platform at the mid-market exchange rate, with all fees outlined upfront.
With significantly fewer intermediaries, the transfer is both faster and cheaper. In 2021, a study found that sending 200 GBP to USD could approach nearly 4% using the traditional banking system compared to Wise’s 0.5%. Additionally, it often up to four working days to complete a transfer, whereas Wise may take up to 8 hours.
Today, the Wise platform facilitates transfers from 140+ countries in 40+ currencies. In 2021, now a historical peak in fintech valuations, the company listed on the London Stock Exchange at an $11B valuation. Like many other payments fintechs (e.g. Stripe, Block, etc.), Wise has gradually expanded into other financial verticals such as debit cards, business accounts, and more recently investments.
But its financials show strong growth for the core payment platform. Last year, Wise booked $1.2B in revenues (+60% YoY) with operating profit of $180MM (+200% YoY). Part of the uplift was due to a $170MM increase in interest income on money in user accounts, which are invested in short term money market funds and bonds. But the majority 70% of income comes from its margin on FX transfers.