In a world with 7.7 billion people, there are still 1.7 billion living underserved by the financial system. This situation is especially severe in countries such as China, India, Pakistan, etc. A more detailed overview can be found in the graph below on where adults lack access to a bank account which visualizes the number of adults without banking in the highest 10 countries. Shockingly, in a country like China still, 224 Million people are unbanked while in the Philippines 43% of the whole population doesn’t have access to banking.

Being one of the 1.7 billion unbanked people has much deeper consequences than just not having a place to store money.

Things that the majority of the global population takes for granted; such as sending and receiving money, taking out loans and mortgages, setting up savings and interest-bearing accounts, and even something as fundamental as receiving a wage, are not available to the unbanked. This lack of banking services leaves an obvious void in the quality of life for many people.

As illustrated in the graph below, the lack of money is the most common barrier to account ownership, followed by not needing an account and the third most cited reason is that accounts are too expensive. The first as well as the third reason for not having a bank account clearly point to the need for more accessible and affordable solutions.

Furthermore, the graph below underlines that money is the biggest differentiator between those who are banked and those who aren’t. As can be seen worldwide 74% of the richest 60% of households are bank customers, while out of the poorest 40% of households 61% are banked resulting in 13 percentage points difference. When observing developed countries this difference shrinks to 6 percentage points while in developing countries the gap is with 15percentage points slightly higher than the worldwide average.

The fact that so many people are unbanked is not just the result of something as simple as the lack of access to brick and mortar banks in rural areas or the lack of money as mentioned previously. A large portion of the global population — as many as 1.1 billion — are ‘invisible to the banks due to their lack of formal identity.

Proximity to banks and identification issues are not the only problems for those looking to be financially included. The banking system is not geared towards supporting the current unbanked population and is not making much effort to change that. Banks are profit-oriented businesses, highly regulated and risk-averse, therefore reluctant to bank anyone who is missing a government-issued ID or a certain amount of income. When asking the unbanked, why they are missing an account, commonly stated reasons are a lack of income, high fees and a lack of trust.

According to the world bank financial inclusion is essential to eradicate poverty in developing countries. Ms. Pazarbasioglu, Senior official at the World Bank correctly stated that “ you need to make sure [finance] serves citizens, the SMEs, and not just the banker, or the wealthy, or the chosen few” (FT 2019).

If traditional finance cannot cater to the unbanked, it might be time for a new system more aligned with the needs of the currently unbanked to fill the void.

Since the emergence of blockchain in 2008 we have seen whole ecosystems built on top of the distributed trustless ledger. One of the most promising trends has been the evolution of Decentralized Finance (DeFi). DeFi essentially is an alternative financial system built on public blockchains such as Ethereum. Thanks to the open-source nature of blockchain systems, anyone can access DeFi applications. Could DeFi help address the problems of the unbanked?

Community and money coming together

To make up for the lack of banking, many unbanked are relying on community-based financial services such as saving clubs, burial societies or interest-free lending and borrowing.

In fact, despite lacking a formal bank account, nearly a third of unbanked adults (28%) reported having saved money in one form or another (see graph below). One way to make up for the lack of formal savings accounts has been money guarding.

People will look for trusted family or community members to hold an amount of money for them to stop the temptation of spending it, while also spreading and distributing the possibility of loss/theft.

Another example of the unbanked making due is reciprocal interest-free lending and borrowing. This is where communities will loan money to one another, free of interest and on the basis of trust that the same service will be reciprocated.

There are countless other examples of unbanked achieving traditional financial services, but through their family and community, in a way that suits them. Nevertheless, these services usually lack the efficiency and monetary power of the traditional banking system, because currently only the traditional banking system is able to provide loans, investment opportunities and secure savings accounts with money amounts exceeding the possibilities of families and communities.

Achieving financial inclusion

It is becoming clear that banking the unbanked is about more than just expanding the current financial system to include them. The legacy banking system is not designed for those who currently don’t have access to it and traditional banks can’t just simply onboard unidentified customers. Even challenger and mobile-only banks still require KYC and are not available in many developing countries.

Blockchain-based IDs could help address the challenges for unidentified to access banking. Blockchain ID is easy to set up, easy to maintain, trustworthy and immutable. This inclusive ID system allows people to be put onto the map straight away.

The biggest use-case for blockchain though has been the issuance of crypto-currencies. And while crypto certainly has helped people transfer value in an environment with hyperinflation, the high volatility of cryptocurrencies makes them very unattractive for most unbanked.

One possible solution for the volatility of cryptocurrencies is stable coins. These are digital currencies backed by other assets to maintain their value. Most popular stable coins are a 1:1 representation of the value of the US$. While a majority of these stable coins is pegged to fiat-currencies held in custody by the issuer, MakerDao famously managed to create a stable coin that maintains its value around one dollar thanks to a strong community and sophisticated algorithms.

Stable coins could turn out to be a viable solution for unbanked to gain access to something similar to a savings account. As can be seen in the graphic below, most of the unbanked adults are actually saving money. Simply setting up a digital wallet on their phone would be enough for them to manage their savings in a more secure way. And it doesn’t have to end there. Several blockchain companies offer users the possibility to earn interest on their crypto holdings. While compound enables crypto-holders to earn interest on their digital assets, companies like Cred pay holders up to 10% annually on their stable coin holdings, a rate that is above the traditional banking market rate.

While giving the unbanked access to a secure place to store and save their money, is a great start, it just represents a small part of all existing financial services. Another service replicated successfully by decentralized finance companies is lending.

Even though traditional p2p lending platforms have already been successful in offering people easier access to loans, blockchain-based lending adds yet more advantages to the process such as instant settlement, the simplified or no credit checks as well as a possibility to build up a credible transaction history. Furthermore blockchain-based lending can enable access to a bigger pool of possible lenders worldwide, eventually creating an alternative to existing Microfinance. Although the jury on Microfinance is still out, most studies suggest that it can be a powerful tool to reduce poverty. This could in the long run do more for the unbanked than just banking them, but also giving them the means to create their own companies and increase their overall capital.

Lastly, the reliance on blockchain as the backbone to an inclusive financial system for those previously unbanked extends further than just offering an ID and a new form of currency, DeFi is gaining a lot of traction, and fundamentally, is better suited to helping the unbanked who are already reliant on their own, community-based, financial services alternatives. Communities could have the opportunity to leapfrog the banking system entirely and leverage a wallet as a bank account along with DeFi solutions for lending and borrowing products.

Of course, this solution is still very much theoretical, as although a DeFi architecture requires far less infrastructure, there is still a prevalent need for several systems. For one, blockchain banking typically requires a smartphone with access to the internet, which although growing in penetration, is not taken as ubiquitous worldwide. This situation can be seen in the graph below. In countries such as Bangladesh, Pakistan and Nigeria the majority of people do not yet have a mobile phone.

It is important to note that there are early-stage efforts on the part of some companies for mesh networks and enabling offline blockchain transactions. More so, in order for the blockchain and token economy to function, the unbanked need a way to access crypto, which requires a viable gateway for the conversion of fiat money to cryptocurrency. This is being addressed by several companies such as Paxful, that offers more than 300 payment methods, among others the possibility to buy crypto via coupon codes.

Why the Unbanked are ready to be included, but not by the banks

Banks are not able to solve the unbanked problem and are also not willing to. Yet, there is a gap in the market as these people are desperate for financial inclusion. The expenses that keep the banks away can be mitigated with the blockchain, and the evolution of DeFi can leapfrog billions into financial inclusion.

It is surprising that there is not more being done to build this decentralized banking backbone that can encompass the nearly 2 billion people left out in the financial cold. In fact, financial inclusion is such a developmental priority that it is seen as an enabler of other developmental goals, such as poverty eradication and ending hunger.

References:

This is a repost of the Article written by Aly Madhavji and Danish Chaudhry featured March 2020 in Block Journal, Issue 15: https://blockjournal.io