Futures: Virtual currencies in developing countries

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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.

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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?

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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.

 

Remittance Sector in Flux Part Two: Who or What Will Fill the Void of Small Remittance Agencies

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On the 1st of February I wrote an article which outlined the shutdown of traditional remittance services, spurred on by stricter know your customer regulations. These regulations forced banks, who provided the necessary bank accounts to remittance agencies, to know not only the identities of these remittance agencies, but also the customers that they dealt with. This has caused banks such as Westpac and ANZ to cease dealing with remittance agencies in the Pacific. The increase in regulations were motivated by increased fears and evidence of terrorism funding through small remittance agencies. The full article can be found at http://lucaswatt.com/fears-terrorism-funding-shutting-remittance-sector-many-rely-upon/ . This initial article however has only raised more questions in terms of how this affects the remittance sector. The biggest of these is, who or what will fill the void of the now extinct small remittance agencies? Will the void be filled by large remittance agencies such as Western Union or Money Gram? What is the impact of new regulations on these remittance giants? What are the other methods of remitting money without going through a remittance agency? Will mobile remittance services fill the void? Are these equally regulated by the new remittance regulations? These are the questions I investigate in this article.

In the press, opinion suggests that remittance giants Western Union and Moneygram will be relatively unaffected by the new regulations. Only small remittance agencies seem to be cut of the loop by financial institutions and the new remittance regulations. This initially led me to question whether Western Union and Moneygram were perhaps operating as “banks” that can store sender’s money in an internal organisational bank account before being processed to the receiver. This would allow them the access to a bank account without the need of a partner financial institution, leaving them unaffected by the shutdown of remittance accounts by banks. However, with some research it was found that Western Union and Moneygram are not legally classified as “Banks” (however there is evidence that Moneygram has tried to legally classify itself as a bank with no success). As a result they cannot hold an internal organisational bank account where the remittances of senders can be stored before being processed to the receiver. They therefore must have an external registered bank such as Westpac or ANZ to hold a bank account for them to process their transactions. The question therefore needs to be asked why banks still provide bank accounts to these remittance giants and not to small remittance agencies. By all indication, these big remittance agencies do already require their customers to diligently provide identification at their outlets and post offices where transfers can be made. Efficient systems must be in place where customer identification details are passed on to their partner banks. The economies of scale between these large institutions must ensure that it still profitable for the partner bank to provide them such services. A certain degree of long established institutional trust may also exist. Small remittance agencies on the other hand may not have the number or size of transactions for banks to provide such services in a profitable manner. Their institutional trust may also not be well established with banks. The  relative non-effect and continued strength of large remittance agencies has led some to believe that they will stumble into windfall profits as their competition is decimated. There is also concerns that the lack of competition will allow them to increase fee charges to the detriment of their customers.

This is unlikely to occur as there are increasingly new methods of sending remittances that bypass the financial sector and regulations. In my previous article I did highlight the inform remittance sector where they can be delivered personally or by a known intermediary. There is also the “hawala system” whereby an informal intermediary is paid to deliver remittances. This is a system which I envision to be similar to the title picture of this article, wads of cash, in-depth conversations, and mobiles in hands. However there are new innovative systems emerging. One of these is where individuals in developed countries purchase goods and services for relatives at online stores. These include supermarkets or appliance stores. The sender either arranges delivery to the receiver’s house, or the receiver can go pick it up with identification. Because this form of remittance service delivers common goods, and money is received by a known retailer, it is not regulated with the same scrutiny by the financial sector in the same manner as cash remittances. Another method of sending money that bypasses financial regulation is sending money to a registered local organisation that involves itself in local projects such as the building of schools or infrastructure. This project does not benefit the households that migrants have left behind directly, but the wider community which they are a part of. Because money is not directly sent to an unknown entity but rather to a registered and known organisation these transactions are straight forward to process.

Another innovative way of sending money home is through the use of mobile phones. This can firstly be done by purchasing credit for someone’s mobile back home. This is restricted to phone related uses, therefore reducing its flexibility to be used for the variety of receiver’s needs/wants. However, sometimes the very purpose of such mobile top ups is to ensure that migrants and those that remain in the home country are able to stay in contact. Secondly, mobile remittances are also being facilitated by a variety of start-up companies which allow migrants to send electronic money from their mobile phone to another’s mobile phone back home. The difference here is that the electronic cash received via the mobile can be transformed into physical cash which can be used for whatever the receiver desires. The entire process entails; the sender turning physical cash into electronic cash which is then stored on their mobile, sending the electronic cash via mobile to the receiver’s mobile, the receiver then turning this electronic cash into physical cash again via an agent. Agents are located at small kiosks (as shown below), or the stores of telecommunication providers. The users do not have to come into contact with banks. This type of service is being pursued in the Pacific by a New Zealand based company called Klickex which has partnered with the telecommunication company Digicel Pacific. The amount of remittances sent from developed countries in the region, including New Zealand and Australia, to island states such as Tonga, Samoa, and Fiji are substantial due to large migration flows between these countries. Partnerships such as Klickex-Digicel have great potential for growth and use. With the shutdown of small remittance agencies, perhaps mobile remittance services will increase in prominence.

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A fairly typical mobile money agent kiosk

 

The question that needs to be asked is, how are the regulatory requirements for mobile remittance companies such as the Kilckex-Digicel partnership different to the small remittance agencies? The answer is that they are no different. Firstly, a bank account still needs to be held to process the transactions. The transaction costs for banks in carrying out all the regulatory requirements are therefore equally cumbersome and expensive. As a result we can expect the exclusive participation of big players that have economies of scale and institutional trust such as Digicel and Vodafone, much like Western Union and Moneygram. The presence of small mobile remittance companies is unlikely to emerge. Secondly, know your customer regulations still need to be adhered to. In the mobile remittance system, when the sender signs up to the service, identification is required and this is attached to their mobile number. Any transaction that is processed through that number is therefore associated with their identity. The receiver also must have a Klickex account, or if they don’t, they must show their identity to the agent when collecting the money off their mobile. At first glance such a system seems fairly straight forward with the appropriate identity checks. However, it seems that money could be sent to the mobile of an “innocent” party with contacts that partake in terrorism. The physical cash that this innocent party withdraws could then be transferred to this individual associated with terrorism. The security of the system therefore seems as dubious, (if not more!), as the services provided by small remittance agencies, or by any remittance agency for that matter.

So what is the outcome? Large remittance agencies such Western Union and Moneygram, along with mobile remittance businesses backed by large telecommunication companies such as the Klickex-Digicel partnership, will dominate the market. These agencies will be served by banks, and they will fulfil the regulatory requirements. Their size and institutional trust will ensure that the service is profitable with a more or less safe outcome for the institutions and transactors involved. Small remittance agencies on the other hand will cease to exist. This may have adverse effects as they may have served isolated areas or provided services or a sense of relatedness to customers that big agencies are not able to provide. Informal and innovative remittance services may fill the void, such as mobile remittances or buying food from supermarkets online for relatives back home. However more evidence is required in assessing what, to what extent, or if this void will be filled.

So stay tuned!

Remittance Sector in Flux Part One: Fears of Terrorism Funding are Shutting Down the Remittance Sector that so Many Rely Upon

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A concerning topic has arisen since late November 2014 that remittance services by banks will increasingly cease to be offered in developing countries. Remittances can be classified as international money transfers  that usually originate from migrants in developed countries to family back home in developed countries. Remittances provide a substantially large proportion of money received by developing countries. This is exemplified by the fact that The World Bank has estimated that in 2013 global remittances were estimated at $542 billion dollars with $404 billion of these dollars being sent to developing countries. On a more micro level remittances often provide a large proportion of the incomes of those that live within developing countries. It is estimated that remittances sustain the welfare of 700 million people globally. These remittances are usually set aside for the paying of school fees for children, healthcare, clothing, or can be used as a source of investment in micro-enterprise. Perhaps of equal importance is that remittances sent between family members or friends evokes a sense of social solidarity that can be so easily lost over such large distances. These connections include migrant workers sending money to home and international students receiving money from home. These migrants require such feelings of solidarity when separated from their home families and cultures. Since the importance of remittances is well established and that remittance services are now ceasing to be offered, the following questions need to be asked. What is the role of banks in providing remittance services? How is the threat of terrorism funding affecting the remittance sector? How are new remittance sector regulations causing the cessation of remittance services? Is there a solution in the foreseeable future in restoring remittance services?

Remittance agencies are usually businesses connected to local communities that can provide cheap, affordable, and responsive remittance services to local communities. These include large agencies such as Western Union or Money gram, but also includes a multitude of small scale agencies. These agencies however require bank accounts to receive and withdraw money from. This designates such remittance services as formal because banks are financially regulated by the governments of host countries. Remittances can also be provided by the informal sector such as using family members or friends travelling between countries to act as remittance delivers. In some cases, in particular the Middle East, trusted men of the community are paid to deliver money from town to town. The benefit of formal remittance services is that it can be regulated from who money is received and withdrawn from. This is not true of the informal remittance market and therefore can be used for funding dubious activities such as terrorism without the eyes of the authorities. However it must be noted that the vast majority of these informal remittance services are for genuine livelihood purposes.

It has become clear that the regulation over the formal remittance market has not been very strenuous over the last couple of years. On the 17th of September the financial intelligence agency AUSTRAC suspended the operations of a remittance agency called Bisotel Reih on the suspicion that it was using the company to fund terrorist activities in the Middle East. It is claimed that Bisotel Reih could have handled  as much as $21.3 million over the period January to August 2014 for terrorist related funding before investigation. The company was based in Sydney and had an office in Tripoli (North Lebanon). This location made it a prime candidate to fund extremist activities in nearby Syria. Bisotel Reih was owned by the sister and brother in law of Sydney terrorist Khaled Sharrouf. Khaled is known as the poster boy of Australian based terrorism, in 2005 he was charged over possession of items designated for a large scale terrorist plot. Investigations began after the company often failed to reveal recipients of money to regulators. Since investigation it has been revealed that one individual that was sent money was a US citizen known to be fighting in Syria. It is claimed that this US citizen has been sent $12,000 dollars during this period. Whilst Bisotel Reih was suspended and later deregistered from continuing remittance services it is clear that they had the opportunity to fund terrorist activity for a long time prior to the investigation and of a very high value. It can only be assumed that such cases have been one of the key causes of increased regulation in the remittance sector especially in the Australian and wider Pacific region.

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Above: Hassan El-Sabsabi of Bisotel Reih (brother in law of Khaled Sharrouf) after a raid in Southbrook Melbourne. Photo by: Jason South

The new regulations in the remittance sector have primarily entailed stricter know-your-customer regulations for banks. It not only requires them to know the remittance agency’s identity but also the remitters that the agency deals with. These strict regulations have increased the transaction costs for banks in the remittance sector which many are not willing to shoulder. Banks are also conscious about the personal relations consequences of not adequately fulfilling the necessary counter-terrorism requirements. As a result Banks such as Westpac and ANZ to cease providing bank accounts to remittance agencies that provide such services to many Pacific islands. Westpac has also additionally been forced to cease remittance services because JP Morgan chase, which clears all of its US dollar transactions, is also pressuring it to act in unviable strict accordance to counter terrorism regulations. Regulators have been negotiating with banks encouraging not to cease their services to remittance agencies and to correspond to the new regulations. This has only amounted to temporary reprieves. Westpac for instance will open up remittance services to a select number of companies until March 31st 2015, however a long term solution does not seem to have materialised. This trend is not only occurring within our Pacific region but rather on a global level. In Somalia for instance it has recently been announced that the Merchants Bank of California will drop the accounts of remittance agencies there.

So what is the solution to this remittance crisis? First of it all it can be argued that strict formal regulations in the remittance sector will only slow but not stop terrorist funding. Such remittance services will be offered rather through informal channels that bypass regulatory structures. This argument postulates that genuine remitters are being unjustly punished for no reason as less genuine remitters will still carry out their operations underground. Some call for the return to the status quo. Secondly, it must be asked whether banks have some moral obligation to provide services that are so vital to the livelihoods and emotional welfare of such a large proportion of the global population regardless whether it decreases their profits by a few percentage points or not! One solution therefore is for the banks to take the hit. An unlikely solution. Thirdly, the blame cannot entirely be put on banks. Governments must also shoulder the blame as they have burdened the banks with regulatory requirements and have foregone the financial responsibility themselves. It can be argued that counter terrorism funding activities need to be provided by an industry regulator with a broad enough mandate and power to provide such regulation. Currently regulators do not have this broad mandate or government funding. Government needs to take some responsibility, however where will those required funds come from and at the expense of what? Lastly it can be argued that perhaps alternative regulations need to be offered that both combat terrorist financing activities but also do not cripple banks and remittance agencies with unviable transaction costs. One of these suggestions has been to cap transactions by small remittance agencies. This may not prevent terrorist funding but it will also not prevent those relying on remittances for their livelihoods to be left in the cold. Such a solution offers a balanced approach albeit not a complete solution.

This topic is of particular interest to me and I will continue to track it as solutions and opinions continue to develop.