How DeFi Can Uplift the Poor in Emerging Markets

As of 2020, nearly 2 billion people lack access to basic financial services and remain “unbanked” – most in high-growth emerging markets. The main cause of this phenomenon is the lack of banking infrastructure in these countries, often due to the challenges surrounding the profitability of such customers who typically have lower incomes. Decentralized finance (DeFi) has the potential to provide lower-cost services to these excluded communities and drive greater financial inclusion globally. Economic prosperity and financial security are often linked to financial access. Thus, the unmanned can start doing transactions through a constellation of decentralized platforms based on emerging blockchain technologies and thus participate more in the global and local wealth creation opportunities.

Where is the unbanked?

DeFi is undergoing extraordinary growth, and despite market volatility, it continues to grow at an incredible rate of more than 1,100% in 2022 to surpass a total value of US$212 billion. Although still relatively insignificant compared to the existing financial system, this high growth highlights the tremendous potential of DeFi to drive financial innovation and the possibility to change the way people – especially those in emerging economies – manage their finances .

For many, DeFi represents the first glimpse of a future beyond the traditional centralized financial intermediaries that have failed them so far, but for others it represents a more dangerous trend away from regulated financial products and services, meaning less consumer protection and greater scope for money laundering . However, for both groups, DeFi has transformative power for communities in developing countries.

Almost half of all unbanked adults live in just seven countries.

DeFi Features and Benefits

With DeFi, users can now earn, store, send and trade blockchain-based digital assets (or tokens) and non-fungible tokens (NFTs) assets through digital wallets and decentralized exchanges (DEX) without expensive brokers or banks. They can use even more advanced features if they wish, such as borrowing or lending (typically on a collateral basis) and insurance, while having full control over their assets. It is worth emphasizing that the widespread occurrence of interest-based income or products means that such tokens are considered forbidden by those communities (typically orthodox Muslim, Christian and Jewish faiths) who view interest-based financial practices for debt as unethical and exploitative .

Transparency is a key aspect of most DeFi platforms as the software and protocols are often open source with the underlying code readily available for review and open to auditing. All transactions are naturally recorded on the blockchain, thereby facilitating independent audits, security reviews and transaction verification. However, it must be emphasized that the immature nature of the sector and the volume of new projects still mean that fraud, scams and exploitation remain a risk.

DeFi vs traditional finance

Although a dominant force in the DeFi ecosystem, the market share of smart contract pioneer Ethereum, measured by total value closed (a key DeFi usage metric) in December 2021, fell to around 70% as more competitors entered the DeFi space , such as Terra, Binance Smart Chain, Avalanche and Solana, to name a few. Indeed, there are many new blockchain-based ecosystems emerging, including Ethereum 2.0, and it is unlikely that any chain will become dominant in the near term.

This healthy competition reduces entry barriers and eliminates switching costs. For example, Ethereum-based applications are permissionless, and they have the ability to seamlessly copy and modify (fork) code bases. This lowers barriers to entry for everyday users and positions them as the direct beneficiaries of this innovation – although the “gas” fees on Ethereum make it less attractive for smaller transactions.

The ability to easily move financial assets between different platforms forces DeFi platforms to compete on user experience, utility and transaction costs. The rise of exchange aggregators facilitates consolidation across different applications. These aggregators, using public APIs, split orders between platforms by leveraging different liquidity options to provide end users with the best exchange rate and asset prices, improving efficiency.

This is in sharp contrast to the existing centralized finance (CeFi) consumer banking system, where an account opening and associated facilities can take days or even weeks to complete in some jurisdictions. In combination with other factors, such as minimum balance requirements, high transaction costs and substandard services, all these obstacles discourage consumers from accessing finance, limiting prosperity and growth for SMEs and entrepreneurs, although fully digital “neobanks” are also taking over the incumbents. . In addition, DeFi removes the frictions of asset brokers, especially regarding token transactions across platforms.

Stablecoins: a key role in DeFi

Due to its volatility, the transition to cryptocurrency can be a daunting task. It is difficult to exit the market or take a risk-off position without converting funds into fiat currencies at high cost and friction. Stablecoins address this problem. Every cryptocurrency is characterized by wild price fluctuations, but stablecoins link their values ​​to stable financial assets such as the US dollar and gold that ensure greater price stability and an ability to keep these “stable” reserves or savings in the cryptoverse. Stablecoins such as USDC and USDT are tokens that are linked to a reference asset such as the US dollar, as they maintain the same value as the currency of the United States. There are now approximately 81 billion USDT and 53 billion USDC in circulation, with both coins representing centralized, fully regulated stablecoins.

Some other benefits of stablecoins include introducing more competitive payment methods to the economy, real-time, secure and lower costs. This makes it safer and more reliable for governments to launch conditional cash transfer initiatives and stimulus money (such as the one by the Nigerian government during Covid-19). It also enables business owners to accept payments in a stable crypto-asset, thus connecting the unbanked segment of the population into a more robust and scalable financial system without the associated volatility and risk.

It is important to emphasize that DeFi-backed stablecoins are an important building block in the entire decentralized financial system in that they support the stability of the ecosystem. However, it remains to be seen whether such coins will be negatively affected by regulation or even rendered redundant by the introduction of central bank digital currencies (CBDCs).

How DeFi Increases Financial Inclusion

DeFi now offers borderless crypto-asset markets for access to larger liquidity pools, significantly lowering the cost of transactions for market participants. Today, several decentralized exchanges offer better and trader-friendly exchange rates for financial assets than seasoned service providers and centralized exchanges.

If done in a way that ensures adequate retail protection, expanding access to crypto-asset markets will lead to more financial inclusion in developing countries. Providing access to digital financial services is one of the United Nations Sustainable Development Goals, and DeFi is at the forefront of this frontier. The UN notes that inclusion is a key enabler to achieving other sustainable development goals, including reducing inequality, eradicating poverty, ending hunger and empowering women economically. Thus, DeFi, with its zero-marginal cost and internet-native services, can serve the marginalized population and access to financial services can support the SDG goals if applied correctly.

Case studies: Zimbabwe and Venezuela

Within emerging markets in the global south, DeFi is often argued to have the potential to transform developing economies plagued by inflation and unstable national currencies. Citizens of these countries, for example in Zimbabwe and Venezuela, suffer from a high degree of monetary mismanagement. Zimbabwe’s inflation has continued to rise since 2017 and reached 557% in 2020. The politically volatile country of Venezuela recorded around 65,000% inflation in 2018, leading the government to limit the lower and credit spending limits in bolivars to maintain the stability of maintain the currency.

For these countries and others in the same category, DeFi offers a safe and rewarding way to bypass unstable national currencies to enjoy financial services that are otherwise inaccessible. While we could focus our discussion on payment for goods and services, DeFi’s proposition is to help those affected by rapidly weakening national currencies and inaccessible essential banking needs to save, trade and invest for their future. However, it threatens the established banks and systems that seek to maintain power despite failing their citizens in the most spectacular way.

The future of decentralized finance

The exponential growth of DeFi in recent years is largely driven by technological, social and macro trends. As more people embrace DeFi and more investment is directed towards developing more DeFi protocols and dApps, volumes will grow and it will become easier to use and more efficient for the mainstream to participate. The future is also likely to see the “gamification” of services where customers will be rewarded with tokens as they use their accounts, support the environment, social causes or other community activities.

DeFi ultimately aspires to provide communities with a seamless and comprehensive financial experience from anywhere in the world. A decentralized ecosystem removes location, status and wealth barriers as it can provide the unbanked individuals with access to new entrepreneurship and wealth creation opportunities, lending and borrowing facilities, remittances, digital payments and other financial services. In the process, DeFi can help moderate the problems of global poverty and make global payments accessible and affordable. In fact, according to PwC, blockchain will reduce the average global remittance fees from 5% to less than 1%.

Like any new technology, it is essential to be wary of the challenges associated with its mass adoption. For now, DeFi is still in its infancy and prone to issues related to anti-money laundering, user interface and hacking risks. While it is difficult to accurately predict DeFi’s future, smart contract-based automated banking and financial activities will usher in operations managed by algorithms and code without costly human intervention. Like self-driving cars, we may see banks that work by themselves in the not-too-distant future.