Foreword
Last year, I woke up one morning in New Delhi to find that Narendra Modi declared for demonetization of the two most commonly help banknotes: the 500 rupees and the 1,000 rupee note. Of course, I was okay because I still had my credit cards and the resources to exchange my notes. On the other hand, many people, who had no other choice, had to stand in line for full days to exchange their money. Modi’s hope was to wipe out black money and shift the economy to be less reliant on cash. However, by doing so, he severely injured an entire class of workers in the informal sector who are vulnerable to the slightest monetary or economic movements. For the poor, hard cash is their bloodline and such economic shocks do little to benefit them.
During the following months in India, I had also witnessed the futile attempts of NGOs to empower the poor to partake in the job economy. At the rate that they were moving, it simply was not scalable enough to make a significant impact on the overall population. In that moment, realized that government or even entrepreneurship alone could not break the cycle of poverty for these people. The people had the basic rights to be able to partake in the global economy and have a chance at economic prosperity. The only way I could see economic mobility for them was through direct empowerment technologies tied with economic policies that bring the unbanked into the global economy.
Blockchain will truly serve the poor only when it is implemented by government and financial institutions coupled with complementary economic policies first.
The Underlying Technology of Bitcoin and its Economic Properties
Currently, Zimbabwe faces extreme political and economic uncertainty after the army overtook Robert Mugabe, former Zimbabwean President. As a result, a third of La Maison du Bitcoin’s customers are sending digital money home to Africa. As a way to protect their assets from political turmoil and hyperinflation, residents of Zimbabwe are turning to bitcoin as a safe haven asset. Since bitcoins run on a distributed and secured P2P network that is untouchable by any government or bank, residents place more trust in it.
Bitcoin is a public ledger that runs on a decentralized payment system infrastructure called blockchain. It is the underlying technology of bitcoin that ensures users maintain their anonymity and security on the network. Blockchain, which was built on the notion of distrust, eliminates the middleman in the transaction of value by offering two untrusted parties the ability to reach consensus on a common digital ledger. Due to its low transaction costs and unalterable characteristics, the technology has inspired innovators to implement its infrastructure beyond currency use. The blockchain is able to be a cost-effective solution because it eliminates two key costs: 1) the cost of verification, and 2) the cost of networking. Together, the significant decrease in costs compared to traditional means increases blockchain’s economies of scale and market power.
The exchange of value between buyers and sellers have long gone through intermediaries that reduce any informational asymmetry and the risk of moral hazard through third-party verification. As international marketplaces continue to globalize, these third-party intermediaries have become more valuable and as a result, charge a transaction fee. In the case of Western Union, fees increase as intermediaries gain market power through economic monopolies. Additionally, the privacy of information is not guaranteed. However, with blockchain, market participants no longer need third-party verification and can reach consensus on the network. The computing power required for the blockchain-based transactions is insignificant compared to the costs of going through a traditional financial institute.
The cost of networking is eliminated because blockchain technology operates on underlying incentives, code, and consensus rules. By decreasing the market power of intermediaries and the need for accumulated knowledge and assets, blockchain lowers the barriers to entry significantly for other innovators to enter. Due to competition theory, the low barriers to entry will encourage market innovation and development.
Blockchain Applications for Financial Inclusion
Currently, 2 billion of the world population remains unbanked. This means that they have no formal access to the benefits of financial institutions. The unbanked generally tend to be in rural areas of developing countries where income per capita and transactions are very low. Thus, it is financially infeasible for banks to extend branches or even ATMs to those communities given the high infrastructure costs they would incur paired with a lack of return on investment. However, it is estimated that $380 billion of revenue will be generated by banks by 2020 from unbanked populations within emerging markets. This is in large part due to the wide-spread adoption of mobile payment solutions like m-pesa in countries like Kenya. In five years, m-pesa has been able to transact nearly 50% of Kenya’s GDP and bring capital resources to 20 million unbanked Kenyans. Financial inclusion is a critical step towards global economic inclusion and m-pesa is the proof-of-concept of the economic impact that technologies can have.
Blockchain makes sense for financial inclusion for a couple of reasons. First and foremost, users can access their capital on demand because payments and remittances settlements happen rapidly. The technology also supports smart contracts that can transact multiple assets thus giving access to global capital markets as well as bank accounts to the unbanked population. Implementation of blockchain in traditional banks can significantly cut operational costs between $15 - $20 billion per annum by 2022 according to Santander’s predictions. Most importantly, blockchain provides digital ledgers on a decentralized system that is tamper proof. Thus empowering landowners to have public documentation of their land title ownership or citizens to vote fairly, for example.
Blockchain technologies can be that catalyst in its ability to reach economies to scale and reach mobile networks with its own infrastructure independent of the internet. As mentioned briefly, blockchain’s potential reaches far beyond cryptocurrencies and can improve key components of bringing economies closer to economic equality.
A. Identity
The financially under-served are at a disadvantage because they do not have credit scores. Those without proper identity documentation are stopped by high barriers to inclusion for access to capital. This is not only a problem for the developing world but also for the developed. In 2015, large U.S. banks rejected over 600,000 people with New York ID cards as a valid documentation to open bank accounts despite the federal regulators’ approval of using the card. In this case, blockchain accomplishes several factors with identity. First, because barriers to use is so low, it opens up opportunities for unbanked to build their economic trust through transactions on the network. The real beauty, however, is that the user owns their own data and can decide which persona of historical data interacts with different institutions.
B. Remittances
Globally, remittances sent to developing country accounts for over $500 billion USD. For many families abroad this money is critical to their survival and for some countries a significant portion of their GDP. The World Bank estimates that 32% of Nepal’s GDP comes from remittances sent from abroad. On average, the remittances sent from labor workers from UAE support a wide range from 5 to 20 family members from their home country. However, continents like Africa that rely heavily on the lifeblood financial inflows from abroad are subject to $2 billion dollars a year worth of remittance taxes. The International Monetary Fund states that recipients need remittances for basic necessities like food and shelter and thus lifts a “huge number of people out of poverty by support a higher level of consumption than would otherwise be possible.” Not only does remittances contribute to human development and health, it creates a positive spillover effect due to common household expenditure costs. Thus, half a trillion dollars lost to transactions costs poses a significant loss for the growth of developing countries.
The implementation of Blockchain will disintermediate traditional third parties like Western Unions that are pushing their incurred infrastructure and market inefficiency costs on the financially disadvantaged. Due to the underlying technology that allows for simplified frictionless payment processes, Blockchain implementation can destabilize the monopoly of firms with legacy infrastructures that are sucking up vital monetary resources due to inefficiencies.
C. Land Titles
Hernando de Soto, a Peruvian economist whose research revolves around the informal sector, estimates that there is roughly US$ 9.3 trillion globally in dead capital. Dead capital is a term coined by Hernando de Soto to describe an asset that cannot easily be bought, sold, or used as an investment. The idea is that dead capital is expensive due to the “nonmarket transaction costs” such as the resources wasted by tracking down ambiguously documented land ownership, red tape, dispute settlements, and on and on. These headaches are rampant especially in developing economies where the government may not be as transparent and where justice systems are weak. If the very system that is supposed to protect the interests of the citizens is corrupt, where can these citizens, who are at an immense economic disadvantage, turn for basic protection?
The right to owning land creates a powerful opportunity for economic mobility out of poverty. However, it is estimated that over 70% of land is not properly documented in emerging economies. Without proper documentation, “owners” are powerless to land grabs and are excluded from the benefits offered by financial institutions like loans, for example. Since Blockchain is a distributed open ledger, a copy of these records can be access from any point and cannot be tampered by corrupt officials. Landowners can then publically prove their ownership and have the opportunity to apply for loans using their land as collateral in order to take greater entrepreneurial risks. The transparency of an open ledger can especially benefit developing economies like Honduras, where income distribution and land ownership structures are incredibly unequal. Unfortunately, Blockchain is not a sole solution as it will only work if it is part of wider external efforts in influencing policy decisions and governance onto governments that may be hesitant to incur the costs of inclusion.
D. Government
For a long time now, there has been a constant decline of people’s trust in their government. The increasingly volatile political landscape has fueled this distrust even further ranging from the Greece Debt Crisis to the current turmoil happening in Venezuela. In 1981, Former President Ronald Reagan said in his Inaugural Address that, “Government is not the solution to our problem; government is the problem.” Unsurprisingly, according to a 2011 survey, roughly 44% of Blockchain users agreed and favored the elimination of the state. A decentralized network free from the control of the government and that is driven strictly by supply and demand attracts a certain libertarian to support Blockchain. These libertarians are born from mistrust in the government’s intention regarding their best interests and basic human rights. So, what is the answer? Transparency. Through the use of open ledger technology, all government financial transactions can be tracked in case of misappropriations of charitable funds or FDI, for example. Additionally, by maintaining anonymity, citizens can collectively advocate for their rights on a public, digital ledger that is unalterable and incorruptible. A public digital ledger can even bring about steps towards democracies as elections are more transparent and fair. Perhaps, the implementation of this technology can bring about a “government of the people, by the people, for the people” as Abraham Lincoln once said.
Key Challenges
In an ideal world, blockchain technologies could be easily integrated into society with little challenges. However, despite the strong incentives for blockchain implementation, there are several offsetting factors that pose an obstacle. One of the biggest problems is the issue of scalability especially around currency transactions on the blockchain. To put matters into perspective, Visa can currently process a 1,667 transaction volume per second while Bitcoin can only process 7 transactions per second. This limitation is coded into the Bitcoin protocol in order to ensure that it remains decentralized. If Bitcoin were to allow larger blocks, this would push out small operations by imposing hardships on the miners. Thus hard-coded in its core, Bitcoin has limitations that prevent it from handling global monetary transaction volumes. Additionally, according to Sebastiaan Deetman, an environmental researcher, predicts that by 2020, Bitcoin will consume as much electricity as Denmark. Thus, until a sustainable energy solution is found, it will remain infeasible for wider, institutional adoption.
Another challenge is government regulation in relation to development efforts within the blossoming industry. Outside of the United States, other global economies view cryptocurrency as a threat to their economic power. The most recent case of this is the ban on ICOs as China deemed cryptocurrency possession as illegal. Due to the peer-to-peer anonymity of blockchain specifically, it undermines traditional institutional powers as it gives users the ability to avoid service feeds as well as taxation.
Due to the fact that blockchain is a multifaceted, cross-disciplinary and evolving technology, the barriers to knowledge incredibly high. Even Satoshi Nakamoto struggled to find a digestible explanation as he wrote in 2010, “Writing a description for this thing for general audiences is bloody hard. There’s nothing to relate it to.” The problem is that without understanding the technology, mass adoption, and spurred innovation will be stifled as people will be unable to understand the potential of blockchain.
Going Forward
The question is, as blockchain becomes wider adopted, what does that mean for the current global and does it bring about a new capitalism? Or perhaps, does this mean some of the oldest banking institutions will have to go through a complete restructure to adapt to coexisting with blockchain based transactions? The greatest roles in the widespread economic adoption of blockchain technologies will be reliant on key institutional players. The top key players would be governments, regulators, and financial intuitions.
Regulatory Concerns
The anonymity of blockchain presents a double-edged sword in which the user retains their privacy, however, such environments breed illegal activities whether it be money laundering or terrorist financing. However, it can be argued that due to the public nature (transparency) of bitcoin and blockchain, it will be easier for law enforcement to collect data on suspicious activities. Like money, blockchain technology does not have agency and thus should not be punished for illegal activities. Another concern is the mandatory Know-Your-Customers (KYC) that requires businesses to identity platform users before offering services. While concerns towards KYC requirements seems counterintuitive due to blockchain’s history of illegal activity, such requirements will create greater harm to inclusion of the unbanked by raising the identity information barriers.
Global Regulatory Approach
The blockchain industry is multi-disciplinary and constantly evolving so regulators should implement principle-based approaches to encourage growth within the industry. Localized adjustments policies, like KYC, will be important especially during early adoption until average transaction size increases enough to further due-diligence. Additionally, the money flow data collected from these outreach solutions can provide actionable data into the right lending or credit terms specifically for the unbanked demographic. Since use of the technology has a high potential of integrating the unbanked into the financial system, regulators should also be wary about instituting complex and various jurisdictions’ regulatory approaches that may result in more compliance costs and stifled innovation from firms. As well as discouraging these people from entering into the industry.
The IMF and World Bank
A key influential institution for the unbanked includes International Monetary Fund and The World Bank. Currently, the World Bank and IMF express enthusiasm towards a further investigation into blockchain’s effect on the economy. Specifically, the IMF’s recommendations heavily stress implementation of KYC guidelines and “regulatory sandboxes” to drive mainstream adoption. Regulatory sandboxes are essentially a safe space where innovators can test solutions free from consequences that may arise by engaging with industries or consumers. However, none of their recommendations mentioned internal restructuring.
As a lender, the IMF incurs two main risks: 1) adverse selection; and 2) moral hazard. In order to mitigate these risks, the IMF imposes conditionality terms on borrowers but does so at its own discretion. While this should theoretically mitigate risks, the IMF is often unsuccessful. For example, during the 1997 Asian crisis, the policies imposed on countries like Indonesia, Malaysia and Thailand saw a minor economic slowdown turn into a serious recession paired with high unemployment. Critics have long called for a restructuring of these institutions and for transparency on loan conditions from the IMF, ex-ante conditionality. The World Bank has also extended loans to governments and companies at interest rates lower than private market levels which arguably fuels a less-efficient financial market in each respective nation. With blockchain, the IMF can adapt ex-ante conditionality on a transparent and public ledger in order to build trust and reduce the problem of moral hazard problems in international financial markets. The network allows for consensus where both parties see the same information as everybody else on this digital ledger thus eliminating information asymmetry.
Opinion
While I offer an optimistic outlook on the potential impact of Blockchain on global inclusion, it is only part of a holistic solution to poverty and inequality. In fact, there is so much more research needed in order to properly understand this technology. Blockchain is not meant to be the sole solution to ending global poverty or any type of market imperfection. Times are changing and the rate of technological advancements are only increasing if Moore’s Law continues to hold true. This means that institutions must take leadership in implementing blockchain for the right reasons. The technology is constantly evolving and thus it will be hard for any theory, law, or regulation to continue to evolve at the same rate. Blockchain’s potential will reach far behind any current tool or currency. Socially, it will help change how wealth is distributed. As opposed to distributing wealth from the top down, implementation of this technology can distribute wealth in a way that’s advantageous to all. Perhaps, control of blockchain will require an ideology where different stakeholders approach the technology with a philosophical understanding of the type of world that we want to live in.
References
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Catalini, Christian, and Joshua Gans. “Some Simple Economics of the Blockchain.” 2016, doi:10.3386/w22952.
Tapscott, Don., and Alex Tapscott. Blockchain Revolution: How the Technology Behind Bitcoin Is Changing Money, Business and the World. Toronto: Portfolio/Penguin, 2016.
Baruri, Pani. Blockchain Powered Financial Inclusion, 2016. http://pubdocs.worldbank.org/en/710961476811913780/Session-5C-Pani-Baruri-Blockchain-Financial-Inclusion-Pani.pdf
Dillon, Ian. “How Blockchain Can Make A Positive Impact On Global Issues.” Entrepreneur, 18 Apr. 2017, www.entrepreneur.com/article/292995.