Digital Currencies and Financial Inclusion: 5 Questions

While digital currencies such as Bitcoin pave the way for innovative new businesses like BitPesa, they have also been subject to significant controversy and regulatory questions as authorities try to figure out how to treat them. CGAP’s experience with BitPesa has provided us with a new perspective on some of the key concerns with Bitcoin (especially in emerging markets), which may be effectively mitigated with responsible provider practices, or which may remain subject to debate.

Bitcoin and price volatility

One of the most common concerns with digital currencies is that individuals are assuming significant currency risk, given the high volatility of prices. When an individual buys Bitcoin as an investment, they hold the Bitcoin for an indeterminate period of time and are in fact subject to price fluctuations and the volatility associated with it. By contrast, when an individual uses Bitcoin as a means of payment, such as an individual remitting to his family in the case of BitPesa, they are purchasing and spending the Bitcoin in the same day, or even the same minute. This results in much less exposure to price volatility, and standards on period of exposure to currency risk could ensure payments systems that use Bitcoin mitigate customer risk in this respect.

Bitcoin needs smartphones to work in emerging markets 

While smartphone usage continues to expand rapidly in emerging markets, many consumers will be using feature phones for years to come. So for digital currency-enabled financial services to succeed in reaching the majority of consumers they should be able to interact with these basic handsets. Since BitPesa works through customers’ mobile wallets, it is easily compatible with even the most basic handsets. However, for those on the sending side, access to the internet, either via a smartphone or other web-enabled device, remains necessary to use Bitcoin to remit money at a lower cost.

Bitcoin and criminal activity

A 2014 report from the National Bureau of Economic Research stated that a reduction in cash circulation reduced instances of crime. Digital currencies can help bring more transactions off the black market and into the formal financial sector because using them increasingly means conducting transactions through regulated exchanges tied to bank accounts and credit cards. Purchases of Bitcoin are done online and registered with a timestamp on the blockchain, which is an online ledger that gives a chain of transactions. Tracing IP addresses and other electronic information via the blockchain have helped law enforcement agencies prosecute criminals using Bitcoin, such as the Silk Road drug bust case. Entities such as the Financial Action Task Force (FATF) have played an important role in developing proportional standards for anti-money laundering and combating the financing of terrorism (AML/CFT) in mobile money. Such global bodies could play a similarly important role in balancing protection, inclusion and traceability of transactions where firms are leveraging crypto-currencies to deliver financial services.

Bitcoin and fraud

While any financial system will always be open to fraud risk, the Bitcoin community is improving their fraud mitigation approaches, and further standardization of practices to mitigate fraud should be an immediate priority. The largest Bitcoin exchanges allow users to scan their ID and take a photo of themselves holding their ID from their computer camera. BitPesa requires a scan of a national ID card or passport that is then checked against international sanctions and security lists. Companies such as Edentix and IdentityMind Global are creating solutions that are matched to the unique needs of creating more secure online financial transactions. Since all transactions conducted via Bitcoin are logged and stored on the blockchain, they can be traced, if needed, to see if payments were truly made. Linking this digital record to identity verification practices will help to identify fraudsters after they have struck. However, to address the upfront risks of fraudsters targeting potential Bitcoin purchasers, increased consumer education and awareness is needed. The United States Consumer Financial Protection Bureau has recently released a brief for consumers on virtual currencies that includes substantial treatment of the issue of fraud in Bitcoin, and providers using Bitcoin should take similar steps to inform their consumers and allow them to ascertain the validity of a Bitcoin seller prior to purchase.

Digital currencies and formal regulation

Even as more consumers and startups use digital currencies for increased efficiency or lower-cost transactions across borders, regulators are still approaching these currencies and the providers using them with caution. The unclear regulatory status of digital currencies adds a layer of instability to the emerging sector, which makes partnerships with regulated financial institutions difficult. The issues highlighted above—in particular financial crime and fraud—are some of the more significant issues regulators are concerned with. However, the disruptive potential of digital currencies in overpriced markets such as bank-based remittances make understanding the risks and opportunities of digital currencies a worthwhile pursuit for domestic and global authorities. With the emergence of firms such as BitPesa that are leveraging these currencies, there is a growing evidence base to engage with, learn from, and use to establish standards for these firms’ responsible use of crypto-currencies.

There is still a long way to go before regulatory bodies and providers using digital currencies understand all the potential risks to consumers and have figured out the best approach to mitigating them. However, several of the most cited risks may be manageable with proper protections and increased oversight, and we encourage both providers and regulators to actively engage to learn from these new business models to facilitate products and regulations that both protect consumers and allow them to take advantage of this new currency.