Why Hasn’t P2P FX Taken Off?

Photo Source: Jason Leung

P2P FX refers to a currency exchange transaction conducted between two counterparties without using an intermediary. By eliminating the intermediary, such as a bank or a broker, these counterparties can achieve a better exchange rate since they don’t have to pay the intermediary spread. The concept has been floating around for years, with new entrants popping up to disrupt the industry, but none have taken off so far. Why is this the case?

Two issues stand out:

  • Liquidity: The P2P model is more feasible for major pairs since they are the most liquid – but even with majors, it can be challenging to find a matching counterparty if the notional trade size is large. If a buyer or seller cannot find a matching counterparty, the provider will have to step in and offer liquidity in exchange for an additional fee. Given that even the most prominent banks can only match about a quarter of the FX transactions on their books, smaller players would find it extremely difficult to match deals with any degree of significance given their liquidity limitations.
  • Security: This is where standard due diligence concerns come in on the security side. Are they regulated? Do they have adequate liquidity and financial stability? Do they separate customer funds from their funds to make it easier for customers to recoup the money in the event of bankruptcy? All things being equal, going with an established vendor is the safest bet for many customers. This tendency towards those with a proven track record has made the non-bank FX space extremely concentrated and top-heavy.

Because of these two factors, new entrants trying to market themselves as purely P2P FX providers seem doomed to remain on the market fringes – at least for now.

The most likely path to success for these providers in the retail market. Individuals and small businesses are dealing in small quantities that matching becomes more manageable, especially if the provider is stepping in on the back end to assist with minor shortfalls to make things smoother. This smaller deal flow would allow smaller companies to play in the space since the capital required would be much less relative to the corporate and institutional market. That said, they still will have a steep hill to climb to sell potential customers on the fact that their money is safe. It would probably take the backing of an established player to alleviate those concerns; otherwise, it could take years to develop that reputation on their own – and very few will make it that long in such a commoditized market where competitive advantages are hard to come by,

There is also some interest from buy-side institutions. Still, the difficulty has been drumming up enough counterparties to generate a sustainable two-way market for that kind of volume. Large-cap or even mid-market corporates also deal in significant amounts, so its hard to see how P2P catches on with these participants unless a couple of providers rise to the top and take big chunks of the total market.