Why Libra Won’t Help the Underbanked
From the beginning, Bitcoin, Ethereum, Libra, and blockchain advocates have talked a big game. Digital currency will make you rich, eliminate the need for governments, fund your startup, pay off your student loans, and save the world. That’s a lot of promises. I imagine a few won’t be kept.
I have a rudimentary understanding of blockchain: public ledger, digital scarcity, decentralized database, coin mining, and the rest. So I acknowledge that blockchain is likely the next installment of our digital revolution, but I leave the speculation regarding the many applications of blockchain to the futurists and technologists. However, Libra has explicitly billed itself as a solution for the unbanked and underbanked, an area I feel comfortable speaking on. Yet Libra is a flawed attempt to serve the underbanked. It doesn’t solve many of the primary challenges faced by the underbanked, currency risk, and security.
A primary value driver for Libra is stability. Backed by non-digital assets like government bonds, Libra puts itself in contrast to the hyper volatility of other digital currencies such as bitcoin. This is an appealing aspect to Libra. Currency instability does pose a risk to many poor people, especially in the developing world. And in micro-finance, currency risk is a significant risk for both lenders and borrowers. If Libra were widely accepted, then it could be a means to mitigate currency risk in economies and countries with unstable currency, essentially replacing local currency. But unless Libra becomes ubiquitous, it doesn’t much help reduce the currency risk experienced by low-income and poor people in developing economies. Many developing economies still rely heavily on cash payments. While mobile banking is growing and represents an enormous opportunity to leapfrog traditional payment solutions, Libra is a currency, not a mobile payments platform. If one can’t buy things with Libra, then it doesn’t matter how stable the coin is. One would have to convert Libra to a local potentially unstable currency, potentially losing much of its value and negate the feature of Libra in the first place. Thus a chicken-and-the-egg problem emerges. Libra isn’t useful until it’s accepted everywhere, but people won’t start taking Libra until its useful.
Another problem faced by the unbanked is safety and security. While living in Paraguay, I visited a municipal office, who’s number one safety concern was the stealing of cows. Yup. Crime Number 1: Cow theft. Cow thievery was rampant and devastating. Families in Paraguay often own one or two livestock animals, even if agriculture isn’t their primary income. Cows represented a portion of the wealth a family had accumulated — an investment in the future, and a lifeline in tough times. Cows are unconventional savings or investment accounts. They often appreciated. Pay dividends in the form of milk that can be consumed or sold. And can be sold relatively quickly. But these positive qualities also make cattle ideal for stealing.
Digital currencies are like cash. They live in your digital wallet, and if you lose your wallet, you lose your money. Facebook has suggested that digital wallets would be attached to smartphones, and as smartphones become more and more prevalent around the world, everyone can have access to Libra. This sounds great, except now we’ve replicated the cow problem and put it on a phone.
Being able to secure assets safely is a fundamental feature of a quality financial service industry. This extends to not just the threat of theft but also to essential features like deposit insurance. If one stores Libra on their phone and their phone is stolen, how does one recover their money? If digital currencies and Libra act like cash, then we aren’t creating a more inclusive financial system, we are creating a more complicated cash system with many of the same problems. Furthermore, what is the probability of the technology company that produces the digital wallet going under? Would that prevent people from accessing their assets? Can people forget their password and get locked out of their money? Deposit insurance, stable financial institutions, and banking regulations aren’t just arcane relics. They are foundational for any banking system. These features are just as crucial to the underbanked as the rest of us.
When it comes to building financial services for the poor, a new global currency — and all the democratic pitfalls it brings — might not be required. There are well-documented solutions and features that would make the financial services industry more inclusive. So I want to take some time to outlines both key features necessary for a better solution for banking to the poor and explain who these services would most help.
Features:
- No minimum deposits. No maintenance fees.
In underdeveloped economies with emerging financial systems, banks often require incredibly high minimum deposits or charge some maintenance fee. These barriers to service and prevent even middle-income earners from becoming customers. Free checking could be one of the most important steps towards helping the unbanked.
2. Deposit Insurance
The FDIC (Federal Deposit Insurance Company) was created in the wake of the Great Depression because banks literally lost people’s money. The customer goes to the bank, asks, “Hi, I’d like my money, please.” Bank responds, “Sorry, there is no more money here. I hope that wasn’t your entire life’s savings.”
The above scenario seems crazy, but it happened. Fortunately, because of the FDIC that hasn’t repeated in the United States since. Other countries aren’t so lucky. There was a banking crisis in Latin America as recently as the ’90s, and as a result, trust in banking systems eroded. People don’t believe their money is safe in a bank. This is a fundamental feature of any reliable banking system directed at the unbanked and underbanked. Institutions have to build trust.
3. Re-imagining the Bank branch
One thing Mark Zuckerburg and friends have right is the rise of mobile banking. The developing world is comfortable banking and conducting transactions via mobile devices.
In much of the developing world, people can send money via cellphone provider networks (for a fee). Additionally, customers can deposit the funds to send at the same place they may buy additional cellphone credits, a small street stall, or bodega around the corner. There is an entire network or mini-deposit branches across the developing world. TYpically women, who open a small store next to their home. They can load someone’s pre-paid cell phone. Take a small deposit so that someone can send money via their phone. And even provide a location for a small withdrawal from a cellphone account. This network of independent cell phone vendors has begun to act like mini-banks. There is tremendous room for innovation that builds upon existing systems to bring banking to people without requiring a traditional bank branch.
4. Responsible lending with additional support
When it comes to micro-finance or even medium-finance, lending programs need to be tailored to support customers who may have limited or only poor experiences with banking systems. Many of the most successful microfinance institutions use social ties, financial literacy, business training, or staff from the community to improve lending practices. These programs and efforts improve re-payment, reduce over-indebtedness, and help customers get more on their borrowing. Debt is never without risk but done right. A financial services company can create a superior product for low-income customers that isn’t predatory.
Who Banking Would Help:
Banking isn’t a panacea for poverty. People need to have at least some money before they require a bank account. Banking is a step in climbing the ladder from poverty to the middle class. Farmers, small to micro-business owners, and workers with irregular incomes could all benefit from better banking systems. They require banking for income smoothing, storing money safely, and financing for new ventures. However, banking isn’t always available, especially in developing economies and rural communities.
New banking solutions most serve those individuals who are beginning to find economic traction but still are on the cusp of the mainstream economy. Banking helps provide some security to keep going on their journey to greater financial stability. Banking will not fix the problems of those who are shut out of opportunity or whose labor is being exploited. Those living in extreme poverty have different needs, so any claim by Libra or others needs to recognize the limits of financial services as a solution to poverty. Financial services are one piece of a network of systems required to build greater economic justice in the world.
When it comes to building a banking system for the underserved, the process is similar to any other quality product development. One must build with the customer in mind. What are the needs of the customer? Their pain points? Unnecessary friction?
Libra doesn’t appear to be addressing the well-documented needs of the underbanked. Instead, Libra is adding a layer of complexity that doesn’t solve the root problems of the underbanked.
