Can the upcoming digital currency become the savior of the poor?

Source: Harvard Business Review

Author: Dante Alighieri Disparte, Vice Chairman and Head of Policy and Communications of the Libra Association, member of the National Advisory Committee of the Federal Emergency Management Agency, founder and chairman of the insurance consulting firm Risk Cooperative. In addition, Diparte also serves on the Digital Currency Governance Alliance of the World Economic Forum.

Translation: Yiwei Proofreading: Zhou Qiang

By definition, blockchain technology eliminates intermediaries, relies on networks of users and collective trust, and reduces the need for centralized networks and data storage. This property has made blockchain currencies popular on the dark web, but in addition to hiding transaction paths, blockchain has the potential to do something even more revolutionary: a blockchain-based payment system could help more than 1.7 billion unbanked and underbanked people (including 25% of U.S. residents) enter the formal economy while replacing the expensive loan sharks and informal financial services these people typically rely on to make ends meet. Today, as decades of economic development are being undone by the coronavirus pandemic, the challenge has taken on new urgency.

Currently, more than 70% of central banks around the world are exploring the advantages of digital currencies (electronic forms of national legal tender). This may be more important than you think: currently, currency management is mainly handled by commercial banks, but many consumers are beyond the coverage of physical bank branches or cannot obtain financial services due to poor credit or insufficient funds. National digital currencies can reduce this dependence and increase consumer choice. A decentralized payment system based on blockchain can meet people's four major needs: payment, savings, transfers and fund security.

However, to achieve this, open and interoperable payment frameworks are needed to establish universal, open and user-driven payment networks. Enabling more people to enter the formal economy and reducing the cost of services is not only an altruistic act, but also expands the market and reduces the risks of relying on opaque financial networks.

Ripe for disruption

The cost of living has always been higher for people living in poor, remote, and isolated areas. The issues of price, competition, accessibility, and connectivity in today’s banking and payment networks are like those of the telephone network 50 years ago: Back then, only people living in certain countries and certain regions had access to reliable telephone network services, leaving billions of people without low-cost communication channels.

Breakthroughs in mobile communications and broadband, along with the advent of low-cost mobile devices, have made it possible to expand the scope of human connectivity. Of the 1.7 billion people who do not have access to banking services, more than 1 billion have access to low-cost mobile devices. Now is the time to connect the dots and turn connected phones into regulated mobile payment terminals.

Connected phones are the foundation of economic mobility. Mobile banking has improved financial inclusion, but blockchain-based payment systems have the potential to further reduce costs and promote access. The best example is the global P2P remittances flow of more than $700 billion in 2019. Traditional remittances are expensive and full of friction, with the global average remittance cost of 7% or even higher. The most economically disadvantaged pay the heaviest price, so remittance costs need to be reduced further. The liquidity of funds is also so important that the United Nations has set a target of reducing remittance costs to 3% as part of the Sustainable Development Goals.

However, achieving this goal requires scaling up global payment networks and modernizing open source technologies. Public-private partnerships and central bank digitalization can ensure a balance between necessary compliance and innovation, reducing the cost and complexity of cross-border cash flows.

The way forward

What will an open peer-to-peer payment infrastructure look like in the future? How can central bank digital currencies be applied in it? The first principle is that the entire world cannot be used as a laboratory, especially not on economically disadvantaged people who lack scientific knowledge and barely survive. Specifically, there are two ways to achieve this goal smoothly: 1) Develop stablecoin (a cryptocurrency that is not affected by price fluctuations) projects to enhance regulatory certainty and vigorously promote competition; 2) Create a regulatory sandbox (a security mechanism in the field of computer security, which refers to an isolated environment for running programs for experiments) and use digital currencies for wholesale, retail and other comprehensive experiments, while conducting public-private cooperation to achieve the last mile of application. Just as standardized global information platforms facilitate the connection of billions of users, blockchain-based compliant payment networks can also bring more people into the formal economy and allow economic liquidity to penetrate the grassroots, thereby improving the financial system rather than competing with the existing system.

Second, while most disruptive technologies will address issues as they develop rapidly, blockchain payment systems must first ensure compliance, especially with regard to anti-money laundering and prohibitions on the financing of terrorism or harboring criminals. This requires the development of a regulatory framework that can coordinate global digital assets (including so-called global stablecoins), an area that the Financial Stability Board, the international body responsible for regulating the global financial system, needs to review. The key to expanding the scope of payments includes the development of a hierarchical "KYC" (know your customer) rule to solve the problem of global personal identification. Currently, more than 1 billion residents in the world do not have official identification. The application of blockchain technology and biometrics can also improve many services, including financial access, and identification is a good start. (The Kiva Protocol project in Sierra Leone provides a lot of guidance on digital identification.)

Third, solutions and technologies must be open source. There is often a lack of widespread competition in basic services (especially payment services), so it is necessary to ensure that mobile digital wallets can be freely developed to access blockchain payment systems (whether stablecoins or central bank digital currencies are used), which may have a greater impact than traditional physical finance. Balancing compliance and risk management, carrying out responsible financial service innovation, and bringing more people into the formal economy will not destroy the original system, but provide people with more choices.

There are precedents for how to build such infrastructure among central banks, governments and the private sector. Many low-cost, user-oriented online payment innovations have emerged in Asia and quickly became mainstream. Central banks around the world are studying the risks and opportunities of digitalizing their currencies, and China's central bank clearly wants to be a winner at the retail and household levels. While most central bank digital currencies mainly explore wholesale banking between central banks and private banks, China has focused on peer-to-peer and user-led areas and is ready to welcome a digital currency competition.

The system you need now

Against the backdrop of the global COVID-19 pandemic, the utility of blockchain payment systems has become apparent, not only for international payments, but also for ensuring domestic financial health. The American Care Act has established a $2.2 trillion economic relief plan, including measures such as direct grants to American citizens. In addition, the first draft of the bill also called for the establishment of digital currency and citizen digital wallets to facilitate real-time direct payments. Although this call has not been enacted in a formal bill, its role in enhancing competitiveness, reducing poverty and increasing economic benefits cannot be underestimated. About 51 million people in the United States have lost their jobs due to the new crown, and many people have to rely on payday loans and excessive credit debts. Many financially strapped families have to wait weeks to receive physical checks. For rural communities and other areas, cashing physical checks is like going to offline remittance points to withdraw money, which is troublesome and expensive, and very dangerous during the outbreak of infectious diseases.

Digital currencies and blockchain payment systems alone cannot solve endemic poverty and financial inclusion. Strong governance principles can play a role in digitizing payments, protecting users from fraud, reducing excessive volatility, and strengthening risk management and compliance. These are the problems that have plagued blockchain financial services in the past. Now, the 11-year-old technology is maturing, and after a "crypto winter," it is gaining the transparent regulation it needs around the world. In addition to payment methods, the COVID-19 pandemic has affected every aspect of our lives, highlighting the ubiquity of technology, such as remote education for millions of students via Zoom. In addition, open blockchain payment networks will also mature, and we may one day use stablecoins and digital currencies in blockchain payment networks.