Are blockchain or distributed ledger technologies THE solution for global financial inclusion?
An article published by Miriam Buss on Feb 13th, 2022.
Frankfurt / Main, Germany — February 2022
While I have been working on blockchain topics in the past months, I have observed very diverse and controversial discussions with regard to financial inclusion of un- or underbanked people. Although there are certainly critical developments, and distributed ledger technologies (DLT) is still in an early stage, this technology has a great potential to transform our society and to create a new inclusive approach to finance.
With this article I want to provide an introduction to and overview of this topic and to stimulate further discussion. It represents my personal opinion, independent of my professional employment. For simplification purposes, I use the terms DLT, blockchain and crypto interchangeably.
# 1 — What is financial inclusion and why does it matter?
“Financial inclusion means that individuals and businesses have access to useful and affordable financial products and services that meet their needs — transactions, payments, savings, credit and insurance — delivered in a responsible and sustainable way.” (Worldbank)
Financial products and services are essential for everyone to be able to participate in economic development and growth, and to strengthen resilience. The latter is particularly relevant for individuals, households and SMEs when it comes to external shocks like Covid-19 or consequences of the climate change.
However, a lot of people, particularly in developing countries, are excluded from the financial system and have no or limited access to essential financial services.
Around 1.7 billion people worldwide lack access to financial services, especially in developing and emerging economies (Worldbank).
Adults without a bank account globally (Global Findex, 2017)
# 2 — What are the opportunities of blockchain for financial inclusion?
Blockchain is in its origin a decentral technology without the need of intermediaries and with automate peer-to-peer (P2P) transactions using smart contracts. However, with regard to finance, we have to differentiate between two types of blockchain-based solutions:
- DeFi: completely decentralised finance, provides financial services without intermediaries (like banks) just by the power of code using DLT
- CeFi: centralised finance, also using cryptocurrencies, provided particularly by new fintech companies or traditional banks, which try to build the bridge between the decentral crypto world and our traditional finance system (including fiat money)
For a better understanding, here is a simplified comparison between both:
Simplified comparison between DeFi und CeFi for blockchain-based finance solutions
DeFi and CeFi both have advantages for an inclusive finance system, but sometimes to a different degree. Having the difference in mind, the crypto finance system, may overall have a huge impact on financial inclusion addressing various problems.
- Open access: Geographical access to financial institutions is limited in certain countries, particularly in undeveloped and remote areas without a local banking infrastructure. Cryptocurrencies, DeFi and CeFi are globally accessible through the internet.
- Identification and KYC: In traditional finance, people need personal documentation (ID, passport, proof of income, etc.) and fulfil KYC (Know-your-Customer) requirements to be able to open a bank account or get a credit. For people who lack valid identification such as e. g. refugees or people living in countries without nationwide full-coverage identity certification, this is often an insurmountable obstacle. Crypto wallets and DeFi solutions do not require traditional identification (in contrary to most CeFi solutions) and therefore are accessible by anyone.
- Low fees: DeFi (also partly CeFi) solutions mostly have significantly lower fees than traditional finance products (e. g. bank account or credit card fees). Often, the poorer population cannot afford traditional banking fees. This is particularly the case for remittances where individuals send money to support their families back home. A bitcoin transaction (on the Lightning Network, a layer-two scaling solution) can cost a fraction of a dollar in comparison to sometimes over 30% charge by Western Union.
- Fast transactions: Cryptocurrency transactions take seconds to minutes to be transferred to another wallet, even when transferring it to another continent. Credit card transactions can take days to process and remittance payments even longer.
- Trust: Predominantly in countries with no stable financial system or government, people tend not to trust in financial institutions or products. DeFi and cryptocurrencies (trust in code and consensus mechanisms) may therefore be an alternative to CeFi (trust in crypto companies) besides the traditional finance system (trust in central banks and banks).
These advantages of blockchain-based solutions for financial inclusion are particularly evident in the subsequent use cases.
- Digital payments / remittances: Blockchain-based solutions and cryptocurrency transactions are cheaper, in real-time and permissionless (only DeFi). For digital payments, besides cryptocurrencies like Bitcoin, Central Banks Digital Currencies (CBDC) and stablecoins can play a major role. While cryptocurrencies are decentralized, unbacked and unregulated, CBDCs are the exact opposite (regulated, centralized, backed by a central bank / national currency). Stablecoins (e. g. USDT Tether) are decentralized or centralized, not regulated, but pegged to another currency.
- Saving / invest: For unbanked people, savings are often insecurely stored in cash or physical assets. Using DeFi / CeFi solutions or storing value in cryptocurrencies may be a more secure alternative. Furthermore, decentral investment products can be accessed by people which would otherwise not be able to earn money through investment products (e. g. staking, NFTs, play-to-earn games).
- Credit / lending: In the traditional credit system, scoring models (based on e. g. formal income and credit history) decide whether people are eligible to get a loan or not. Crypto-backed lending, particularly DeFi lending projects, provide access to loans through peer-to-peer transactions, based on automated protocols which facilitate elements from collateral to interest and which are accessible for anyone.
# 3 — Every coin has two sides…
Besides promising opportunities, there are certainly risks and negative aspects which should be taken into consideration when discussing financial inclusion and blockchain.
- Lacking digital and specifically blockchain literacy (in addition to general financial literacy) excludes people from using blockchain-based financial solutions. Blockchain is not an easy-to-understand technology, related products or cryptocurrencies require know-how and education. Providing open access to relevant education and information is therefore fundamental.
- People without or with limited internet access have no possibility to take advantage of this technology. Internet access is often unaffordable in developing countries. In the 46 least-developed countries, almost three-quarters of people have never used the internet. Global internet penetration rate is only around 60%.
- Data and cyber security are a major problem (but not only in DLT). The risk may be higher in CeFi (hackable central database) than in DeFi (flaws in code, also e.g. bridges between different blockchains — e. g. the current Solana Wormhole hack). While in traditional finance victims are usually compensated by the bank, this is not the case in DeFi. Poorer people are hit harder by a hack, relatively speaking, because they are fundamentally dependent on their money. Using a cold wallet is therefore essential to mitigate risks.
- High volatility in cryptocurrencies may hit vulnerable groups harder as they are more reliant on their money. The day-to-day fluctuations can be in the order of 10%. However, in countries with high inflation rates cryptocurrencies might nevertheless be an attractive solution in comparison to fiat money. Moreover, stablecoins or CBDCs are another alternative.
- The decentralization idea of blockchain technologies (the aim of reducing reliance on authorities and central decision makers), could be fundamentally in conflict with interests of governments, which could then prohibit or strictly regulate access to related solutions (which is only to a certain degree possible with regard to DeFi). Countries such as Egypt, Iraq, Qatar, Oman, Morocco, Algeria, Tunisia, Bangladesh and China have all officially banned cryptocurrencies. China is now pushing their own CBDC, the digital Yuan, which they instead of decentral cryptocurrencies, have full control over (see e. g. Fortune).
# 4 — Interesting global developments to observe
There are currently many examples and country use cases where blockchain is being adopted, having an impact on people’s financial inclusion — which are worth observing and learning from, for instance:
- El Salvador: In September 2021 the government introduced Bitcoin as a legal tender within the country. Since the introduction, approximately 50% of the country’s population uses the country’s Bitcoin wallet “Chivo” (which uses the Lightning Network). In comparison, approximately 70% of the population does not have a bank account. The Chivo app is particularly used for remittances (for further details see e. g. Worldbank, PwC).
- Turkey: The financial crisis in Turkey and hyperinflation of Lira above 30% led to mistrust in the official currency and to an increase cryptocurrency adoption. President Erdoğan declared that “we are in a war against Bitcoin” (The Guardian). Already more than 16% of the Turkish population uses cryptocurrencies (Statista).
- Nigeria: The Central Bank of Nigeria launched the country’s CBDC called “eNaira” on October 2021. In the beginning, the eNaira can exclusively be accessed by people with bank accounts. However, this should be expanded to anyone using a mobile phone. Currently, 36% of the Nigerian adult population do not have a bank account (IMF). Nigeria is, by the way, one of the leading countries with regard to cryptocurrency adoption with 32% of the population using cryptocurrencies (Statista).
# 5 — Concluding remarks
Financial inclusion has historically been driven in particular by the work of governments, central banks and international development organisations. With the emergence and growing popularity of DLT and DeFi, a very interesting parallel development can be observed. Promising approaches to an alternative, open and inclusive financial system are arising, some perhaps even unintentionally. Decentralized communities are working towards the transformation of the financial world — DeFi products are developed, tested and already reaching millions of people.
The “crypto world” and the blockchain technologies behind it are certainly still in their infancy. If we look at it as just the beginning of a new open and inclusive financial system, we can agree that it is not perfect yet. But it is heading in the right direction. In any new system, you have to test, fail and learn, and trade-offs are inevitable for development and growth. However, it is worth — even for the most sceptical ones — to observe and learn from these developments, and clarify myths and narratives around these technologies with facts based on experiences.
I hope you enjoyed reading this article. Feedback and further discussion are very much appreciated, either here in the comments or on LinkedIn. Please feel free to connect.
I published this article as part of the DLT Talents program of the Frankfurt School of Finance & Management / Frankfurt School Blockchain Center. DLT Talents is an 18-week mentoring program which fosters leadership in the blockchain, crypto assets and DLT space for ambitious female talents.
#blockchain #sustainability #financialinclusion #SDGs #sustainabledevelopmentgoals #crypto #DLT #distributedledgertechnology #DLTT #DLTtalent
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