Introducing yet another series of articles that will occur on a regular basis called “Futures”. These articles will analyse new financial technologies that aim to either improve the financial services of the poor or increase their financial inclusion. In this article I will analyse whether virtual currencies can improve the financial services of the poor in developing countries. Due to its dominance in the market we will specifically analyse the virtual currency of Bitcoin. Before we can even analyse their effect we need to ask, what on earth are virtual currencies such as Bitcoin? In short, they have four main characteristics. First of all, Bitcoin is a form of money and therefore aims to fulfil three primary functions. It aims to facilitate the exchange of good and services, to measure the value of these goods and services, and to have the durability and security in order to store value. Second, the “virtual” component means that it is owned, stored, traded on virtual interfaces and networks. Thirdly, all transactions between individuals are peer to peer, eliminating third party handlers such as banks and other financial institutions. This means the transaction costs of transmitting bitcoins is zero. No one is “taking a cut”. These peer to peer transactions are encrypted and therefore very private and essentially untraceable. Fourthly, and perhaps most importantly, virtual currencies such as Bitcoin are not controlled or regulated by national governments or international governance agencies. Therefore the supply of bitcoins in the network is not dependent on how much money Reserve Banks print, or affected by the setting of interest rates. Rather, the creation of bitcoins is determined by a mathematical algorithm. The rate of bitcoins created is tightly controlled by this algorithm and will gradually slow down over time. New bitcoins will cease to be created by 2025. The supply of Bitcoins is relatively fixed unlike national currencies.
These characteristics of Bitcoin have raised questions, for myself and other bloggers on the web, especially in terms of their ability to be utilised in developing countries, and/or their future potential in the developing world. These questions include; can Bitcoin really fulfil the criteria of a sound currency? This is perhaps the most fundamental question as it must establish itself as a sound currency to even be used, whether it be in developing countries or not. What is the potential for Bitcoin to facilitate remittance type transactions? Will the digital divide prevent developing countries from using Bitcoin now or in the future? Is a currency that competes with national currencies desirable?
Bitcoin has yet to prove itself to be a sound currency for a variety of reasons. Firstly the use of Bitcoin to exchange goods and services is nowhere near universal. It is estimated that Bitcoin is accepted by 30,000 businesses, most of these are online businesses. This sounds like a lot, however on the global scale this number is fairly minimal. We can know this intuitively as when we shop online we often don’t see the acceptance of bitcoin. We also cannot go down to the local shop and transfer bitcoins to the shop owner through a devise or through physical forms of bitcoins. Secondly, their limited use prevents the general user knowing how much a bitcoin really is worth. Thirdly, bitcoin has not proven itself to be a sufficient store of value. It has seen great volatility in worth. This volatility has primarily been created by technology enthusiasts speculating on increases and decreases in value. This volatility can be seen in the graph below.
However, there is a strong case for Bitcoin’s future as reliable currency. This is because the amount of bitcoins created is set by mathematical algorithms. The supply of bitcoins cannot unexpectedly rise due to a government deciding to print money or change interest rates. In theory this should make the price of Bitcoin fairly stable in the long run. There is also forms of physical bitcoins coming onto the market which enables it to become a more tangible store of value. These physical forms of Bitcoin can be seen in the header picture. On the coins, there is a number hiding under a covering which can peeled off. This code then can be entered into the bitcoin network, essentially transferring the value of your physical bitcoins to a virtual bitcoin wallet. On the notes there is a Quick Response Code (QR) that can be scanned with a mobile or other devise for it to be transferred to your online wallet. After the transfer is made between physical and virtual forms of the currency, the physical form becomes useless and not re-useable, but at least a physical form of Bitcoin allows for physical trade to occur. There are obvious issues in making a physical bitcoin work, but solutions to these kinks seem to be in a state of development. These kinks need to be worked out because the establishment of a physical Bitcoin is necessary to create a sound reliable virtual currency, especially for developing countries. For instance, users in developing countries may initially need a physical form to reassure themselves of the durability and security of a virtual currency. Overall, Bitcoin can’t claim to be a sound currency right now, but there is potential for it to be in the future if handled correctly.
Many articles on the web have claimed that Bitcoin has great potential to facilitate international remittances between developed and developing countries. Currently, sending remittances via a financial intermediary such as Western Union or Money Gram is very expensive. Even mobile money services which are also deemed to be the future of sending international remittances come at a cost. Peer to Peer transfers of Bitcoin on the other hand have no transaction cost. This means that a migrant based in a developed country is able to send remittances back home to a family member or friend in their home country without any charge. None of the amount remitted is taken by a financial intermediary. They therefore are able to remit a greater amount of money back home due to the zero cost of the transfer. This is crucial as many people in developing countries rely upon remittances from family members in developed countries. Furthermore, regulations are tightening up around formal remittance channels and is basically driving small remittance agencies out of business. Analysis of this can be found in previous articles on this website here and here. The transfer of remittances via Bitcoin is not subject to these stricter regulations as it is a currency that is not (and cannot) be regulated by governments. As a result, Bitcoin could fill the gap of these lost remittance channels in the future.
Aren’t we getting a little ahead of ourselves though? There is a digital divide between the developed and developing world that prevents developing countries from utilising Bitcoin as a financial service. The broadband infrastructure in developing countries is fairly minimal, especially in Africa. Education on the use of computers as well as financial literacy in these countries can also be quite low. As this article has probably shown, Bitcoin is not a straight forward concept to understand for anyone! Is it really realistic to start making claims that Bitcoin can be used by the common user in any of these countries? I think not. However the development industry is increasingly allocating more and more funds into technological and financial education in the third world. Just think of the work carried out by the Bill and Melinda Gates Foundation. Companies such as Digicel are also targeting rural areas for infrastructure investment. No other telecommunication company has sufficiently invested in rural areas in the past. Digicel sees a market to be captured unlike these other companies and is setting up towers and broadband networks in these areas. Even though the requirements for the use of Bitcoin in the developing world are not yet present, they are developing slowly. There is a future for virtual currencies in developing countries, however it is a distant future.
The last question to be addressed is whether an unregulated virtual currency like Bitcoin has benefits or disadvantages for users in the developing world. Anything that is unregulated has the potential to be used for immoral purposes. For instance, Bitcoin has been used for online black market purchases of drugs, child pornography, and even for assassin rings. Bitcoin enables these despicable transactions to occur because their encrypted Peer to Peer transactions are untraceable. The Bitcoin black market topic has potential for an article by itself, however this article will focus on the potential positives of an unregulated virtual currency in developing countries. In a report by Roskilde University it is claimed that virtual currencies such as Bitcoin provide a more stable and reliable form of currency than some national currencies. It claims that some currencies such as the Argentine Peso has been so volatile that citizens have started to look for other ways of storing value. This has included buying the USA dollar (which the Argentine government has since made illegal), and the purchasing of bitcoins. This report by Roskilde University is unique in that it offers narratives from Argentine Bitcoin users on why they have started to use it. These stories reveal that these users do not want to be adversely affected by Argentine monetary policy. They want to be liberated from the effects of Argentina’s inept monetary governance. This is one case study, but we can see its transferability to other countries that have struggled or are struggling with monetary policy. These include Zimbabwe and various post-soviet countries in the 1990s, whose currencies underwent hyperinflation. Most of these recent cases of hyperinflation have occurred in countries that can be considered as “developing”. In these periods of hyperinflation would you want to lug around wads of worthless cash like in the picture below? Or would you want bitcoins that cannot be manipulated by government monetary policy? The answer is obvious, however a more fundamental question then arises. Is bypassing a government that is responsible for protecting the rights of its citizens a beneficial future?
So is there potential for Bitcoin in developing countries? And will it be beneficial for its users? The answer is a tentative yes. It will provide a cheaper source of transmitting remittances. It will also give users another method of storing and transferring wealth that is not affected by national monetary policy. However, its use in developing countries is still a very distant future. Further financial and technological education is needed in these countries, as well as the construction of network infrastructures especially in rural areas. There are also potential negatives such as the use of Bitcoin in shady online black market trading and the undermining of governments that need to be more thoroughly considered. These potential negatives will be more thoroughly addressed in a part two of this article coming soon. But there is promise that Bitcoin can improve the quality of financial services for those living in developing countries in the distant future.