The UNCTAD, in its Policy Brief No.100, recently highlighted the unprecedented increase in the use of cryptocurrencies. The brief noted its increasing popularity in African countries and other developing nations. The report warned of the risks posed by widespread unregulated use of digital currencies to Africa’s financial system.
How is cryptocurrency gaining grounds in Africa?
- According to the policy brief, these digital currencies are being used by significant proportions of the African countries’ populations:
- Kenya – 8.5%
- South Africa – 7.5%
- Nigeria – 6.3%
- Recently, the Central African Republic became the 2nd country to adopt Bitcoin as legal tender. The 1st was El Salvador.
Why is cryptocurrency becoming popular in the continent?
- Cryptocurrency is gaining acceptance among the low-income category of the African population. This segment was financially marginalized and lacked access to most of the banks. Even when the banks were accessible, they were discouraged by the high transaction costs.
- These countries are facing economic stagnation– aggravated by debt crises and political instability.
- In addition to this, the rising inflation has been weakening the domestic currencies. This is the case in Nigeria and Kenya.
- In addition to this, there is a colonial angle to the issue. ‘Franc Zone’ countries, like CAR, use franc, which is exchanged into foreign currencies through the Paris exchange market. This is because franc’s convertibility is guaranteed by France. This implies a dependence on Europe.
- On the other hand, cryptocurrencies promise to address the issues of weak domestic currencies and financial exclusion.
- Cryptocurrency can be used by anyone with a mobile phone and internet connection to undertake activities similar to those conducted by financial institutions. These activities include making payments, remittances and investments.
- The investment part is particularly attractive as it allows a person to hold assets, immune from spiking inflation and sinking domestic currency value.
- Cryptocurrencies are easier to use and are also cheaper and quicker to use- compared to the conventional methods. This is thanks to the use of peer-to-peer transactions– rather than dependence on intermediaries.
- These cryptocurrencies were more accessible than the traditional counterparts during the lockdowns.
What are the benefits?
- A significant number of Africans holding cryptocurrencies could facilitate economic activity in the continent. This is because people, without access to traditional banking services, are now able to pay for goods and services using cryptocurrencies.
- Cryptocurrency transactions are believed to be more secure than the traditional methods. One needs access to a private key to access another’s crypto wallet.
- As crypto transactions take place on publicly distributed blockchain ledger, the system would facilitate transparency.
What are the risks?
- Cryptocurrency is a complex technology and requires technological astuteness. Meanwhile, a significant proportion of sub-Saharan Africa’s adult population (i.e. 34.7%) is illiterate. This could potentially turn the ‘inclusivity’ argument on its head.
- While crypto transactions enjoy security because of the private key, the downside is that if one loses the key, there wouldn’t be a way to recover the funds.
- The volatile nature of cryptocurrency is a major risk. This has already affected retail investors– especially those who don’t completely understand this asset class.
- There is also a potential treat to African countries’ monetary sovereignty. If cryptos are more widely used than domestic fiat currency, central banks may lose their ability to steer their economies using monetary policy.
- A widespread use of crypto would weaken effective capital controls. These controls are needed to avoid capital flight from African economies. Weakening of these controls would cause volatility in the currency rates and rapid depreciation of currency value.
- It also poses threats to financial stability. For instance, this could arise from the significant exposure (such as through loans) that banks have to crypto firms. While some countries, like Nigeria, restrict transactions between crypto assets service providers and banks, not all countries have safeguards in place.
What is the way ahead?
- Despite the ongoing market downturn, there are indications that crypto is here to stay in Africa.
- Countries, like CAR and El Salvador, have went as far as to adopt it as legal tender- though the implementation part and the impact on broader economies are facing criticism.
- Meanwhile, countries, like Nigeria, have recognized the need for central bank digital currencies– i.e. state representation of digital currencies.
- While many countries are exploring CBDCs, it is important to note that its uptake in those developing nations that have introduced them is very low. Countries are still investigating the impact of CBDT adoption.
- If crypto is to deliver on its promise, a globally coordinated and holistic approach to its regulation is vital. This is because transactions are global.
- Though some action is already being taken on this front, the current approach is largely fragmented and wouldn’t serve the purpose.
Cryptocurrency represents the future of finance and financial transactions, not only in Africa, but also world-over. If the global economies are to reap its benefits, a coordinated holistic approach is imperative.
Practice Question for Mains
Why are the African countries adopting cryptocurrencies? What are the pros and cons? (250 words)