Bitcoins and Financial Inclusion: Not Much of a Link for Now
"What is a Bitcoin?" If you are asking yourself this question, you are not alone. Turns out the question made it into the Top 10 list of most-searched-for phrases on Google in the "What is" category in 2013. With all of the hype surrounding Bitcoin, policymakers and regulators around the world are trying to figure out the pros and cons of this type of new virtual currency. We're asking similar questions in the development community, where electronic money services such as Kenya's M-PESA are making huge strides in reaching people who have not had access to formal financial services.
Beyond being digital, what does Bitcoin have in common with electronic money and financial inclusion generally? At this point, there seem to be more differences than similarities and it's important not to conflate electronic money with the virtual currency.
Bitcoin, which was launched in 2009, is a virtual, private currency. It is "mined" using computing power in a distributed global network of volunteer software developers. The key is: no central authority controls Bitcoin. The supply is meant to grow slowly and is ultimately capped at 21 million units by a predetermined algorithm. Economic libertarians love this. No central bank that can be manipulated for political purposes; no means to inflate the value of a national currency by just printing more of it. Of course, others could just create competing, new virtual currencies that could affect the value of the original one. In contrast to Bitcoin, e-money is not a separate currency and is overseen by the same central authority that has the monopoly for issuing the national currency.
To obtain Bitcoin, you already have to be "economically included" -- both in terms of Internet and financial access. You participate based on your trust in the private currency and at your own peril. The exchange rate of Bitcoins to U.S. dollars has widely gyrated in its young history. Once you have used conventional dollars and credit or debit cards to buy Bitcoins on a specialized internet-exchange such as Mt.Gox, Bitcoin has two features like good old cash: when you pay for things at places where it is accepted, Bitcoin transactions are largely anonymous and irrevocable. Again, libertarians like this; but law enforcement gets jittery.
Electronic money is a very different concept. It's the extension of a national currency like U.S. dollars or Kenyan shillings for use on a digital channel to lower the costs of handling physical cash estimated to easily exceed 1 percent of GDP. It's essentially the 1-to-1 electronically recorded value issued against the cash receipt of the equivalent amount. E-money issuers are typically overseen by the same central banks as the underlying national currency. To mitigate against systemic and consumer protection risks, the cash against which e-money is issued typically has to be deposited with fully prudentially-regulated financial institutions.
In developing countries such as Kenya, Pakistan, or Bangladesh, electronic money has been a game changer because so many more people have mobile phones than traditional bank accounts. M-PESA, the dominant e-money scheme in Kenya, has achieved virtually full market penetration. But in developed countries, e-money is just another digital form of payment, similar to credit or debit card transactions and wire transfers.
Electronic money has huge potential to help poor people gain access to the financial services they need to improve their lives. The central idea is that only electronic money can lower transactions costs enough to make the low ticket-size payments and savings services viable that poor households in the informal economy of developing countries at the base-of-the-economic pyramid need to capture opportunities and reduce vulnerability. Low-cost, digital retail payment systems also make the execution of other government social policies such as payment transfers for public health or education purposes cheaper and more targeted. In East Africa, where e-money has become ubiquitous, it has triggered innovation in new micro-leasing models that provide solar power to replace kerosene lamps or community-based water stations for the large majority of the population that is not served adequately by public utilities.
Financial regulators, who are rightly concerned about the integrity of financial systems and issues such as money laundering and terrorism finance, have become increasingly comfortable with electronic money. E-money is subject to national customer due diligence regulations and actually brings into the formal financial system money that otherwise would flow through informal channels. Until we know more about Bitcoin and its applications, it's important not to conflate its use with e-money, whose use has been transformational in many developing countries.