Using Blockchain For Financial Inclusion
One of the biggest stories of 2017 has been the stunning rise in the price of Bitcoin from $1000 to over $19,000. Many astute observers, like Warren Buffet, have warned that this rise may be an unsustainable bubble. That may well be true but even if Bitcoin itself crashes, the underlying technology behind it: the blockchain, holds enormous promise. It represents a new way of organising people and institutions digitally which may help solve major development challenges like financial inclusion.
The blockchain is a distributed ledger that stores a verifiable record of time-stamped transactions. This record is protected by strong cryptographic tools and can only be updated through a consensus mechanism agreed to by a majority of participants. Some blockchains like Ethereum have a feature called “smart contracts” where certain transactions can be automatically executed when specific conditions are met.
Blockchains can create a cross-national network of diverse participants including individuals, companies, NGOs and government bodies. No single entity would control the blockchain unlike a government or corporate database. Every entity would have a verifiable record of all transactions on the blockchain and the record could only be altered through a consensus of participants.
How could this technology be used to expand access to financial services like payments, lending and insurance? In payments, a major opportunity is international remittances to developing countries which were $429 billion in 2016. The cost of sending these remittances is quite high; around 7% of the amount spent, and often higher in some countries in sub-Saharan Africa. Fintech companies like Abra and Bitspark are using blockchain technology to allow migrant workers to transfer money internationally at a lower cost.
Another opportunity is in lending to small and medium enterprises(SME). Such companies form the backbone of many economies and employ bulk workers, particularly in developing countries. However they struggle to raise capital and have limited access to the formal financial system. The blockchain could make lending to such companies more transparent and efficient thereby lowering their cost of capital and allowing them to expand more rapidly.
For example, WishFinance, a fintech company based in Singapore, runs a SME lending platform, built on the blockchain, which makes loans to restaurants, shops, barbers etc. The company connects directly to the point of sale machines of the borrowers allowing them to analyse transactions and run analytics to assess their creditworthiness. The loan portfolios are made available on the blockchain for investors to monitor, without revealing confidential information about the borrowers. The system also automates loan repayments by deducting around 5% from each payment made by customers to the borrower.
Blockchain technology could also help the microfinance sector work more efficiently and lower transaction costs. By aggregating their data on the blockchain, it would allow lenders to ensure that individual borrowers are not borrowing excessively from multiple lenders and also help regulators better monitor the system.
Insurance is another area where the blockchain could greatly expand access. Currently, developing countries struggle to provide adequate insurance to their population; for example in India, less than 20% of the population has health insurance. Farmers are also underinsured for crop failure which increases their risks. Consuelo, a microinsurance company based in Mexico, is already using blockchain technology to offer life and health insurance.
In the long run, blockchain-based insurance platforms could make it easier to measure and price risk through better data sharing. Companies could also use smart contracts to automate payouts. For example, the blockchain could use satellite data to automatically pay farmers after a bad crop. Such automation would reduce transactions costs and insurance fraud and also assure insurance buyers of swift and reliable payouts.
The blockchain clearly has the potential to create value for consumers, financial institutions and government regulators. For consumers, the blockchain will increase transparency and simplify procedures through smart contracts. They could use intelligent software agents who take the best decisions on their behalf by analysing blockchain data. This is especially important in financial inclusion where complex financial products are often difficult to understand and use for less educated customers.
For financial institutions, blockchains can help create open platforms where small companies can compete effectively. IT-based platforms often end up being dominated by a small number of corporate giants like Google and Facebook which control the platform and the valuable data that it generates. A well-designed blockchain can create a level playing field between smaller and larger companies and between incumbents and potential entrants.
It should also lower transactions costs and automate some of the processes through smart contracts. This is again especially important in financial inclusion where one of the major constraints is the shortage of capable staff in rural branches. Finally, it may help financial institutions raise capital at a lower cost since the blockchain will provide investors with a detailed picture of their financial performance and risks.
For regulators, the blockchain will provide greater transparency and data sharing to monitor problems like tax evasion and money laundering. They will have a bird’s-eye view of the whole platform to better monitor for systemic financial risk. In some cases, regulations could be directly coded into the blockchain and automatically enforced without human intervention; this would be especially useful in developing countries where high-quality regulators are in short supply.
For centuries, capitalist economies have struggled to create financial systems that are efficient, innovative, stable and inclusive. The 2008 global financial crisis and the 2 billion unbanked worldwide show that this remains an unfinished task. In the coming decades, the blockchain will be a key technology on the path to a better financial system.
[The author is core faculty in Economics at the Prin. L. N. Welingkar Institute of Management Development and Research (WeSchool), Mumbai]
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