New evidence is emerging that virtual currencies and distributed ledgers, like bitcoin, are gaining strength in emerging economies by cutting out huge fees charged by local banks and financial institutions.
Developed markets make up only 43 percent of global gross domestic product and are generally not required to hold much foreign exchange reserves, yet they have been able to issue 87.5 percent of the world’s bonds. It is emerging market central banks that buy 80 percent of those bonds as foreign exchange reserves to gain market credibility.
Because of financial immaturity, emerging market banks can charge huge fees, and — except for a small band of powerful elites — offer little local access to capital. The general population and the small local merchants remain largely unbanked or underbanked.
The most egregious example of emerging market banks financially hammering the population is the percentage costs for wire transfer and currency exchange fees associated with remittances paid by the more than 250 million people living outside their countries of origin, and the 750 million that live outside their ancestral communities.
The remittance market was $588 billion in 2015 and could reach $1 trillion by 2020, according to the World Bank. Although every country on earth receives remittances, the largest markets were India at $71 billion; China at $64 billion; Philippines at $25 billion; Mexico at $22 billion; Nigeria at $21 billion; Egypt at $17 billion; and Vietnam at $11 billion.
According to the IMF, the percentage cost for receiving $200 remittance transfers in emerging economies averages about 10 percent. But it can be much higher for certain emerging economies:
Germany to Serbia = 20.9 percent
South Africa to Mozambique = 22.4 percent
United Arab Emirates to India = 13.1 percent
United States to Colombia = 17.5 percent
Transaction costs are usually not an issue for international trade, investment, or aid. But severe emerging economies’ overregulation and lack of competition keep bank fees high. Most countries have access to some type of money transfer organization (MTO), like Western Union. But these MTOs are very slow and have a vested interest in shadow pricing banks to maximize their percentage fees.
But these brutal emerging economy costs are motivating local people to embrace virtual currencies and distributed ledgers, because bitcoin transaction costs are almost free. Unlike international banking, which rewards scale transactions with lower fees, the current distributed ledger fee on the “blockchain” for any size digital money transfer and validation is 0.0001 bitcoin, or about 4.2 cents.
This cost arbitrage has created the demand for a huge number of local entrepreneurs to leveraging a dial-up or satellite Internet connection in even remote locations to provide extremely secure, efficient and low-cost remittance transfers.
TechCrunch featured a recent story about this “virtual currency revolution,” which has come to impoverished Africans. BitPesa, for example, started out as an East Africa-based bitcoin remittance service.
Relatives in the U.K. can send money through BitPesa by opening a Bitcoin wallet account, exchanging British pounds for bitcoins, and initiating a transfer. BitPesa then sends a message through their “gateway” to deposit Kenyan shillings into a recipient’s bank or an M-Pesa account.”
By refining prices, improving user interfaces and matching product attributes with consumer needs, the company has become an accepted financial institution in Kenya, Nigeria, Uganda, and Tanzania for millions of local consumers in just four years.
The coming scale of the distributed ledger opportunity associated with a $1 trillion remittance market has spurred major international banks to try extend their ability to drive down transaction costs.
Nine “bulge-bracket” banks – Goldman Sachs, JPMorgan, Credit Suisse, Barclays, Commonwealth Bank of Australia, State Street, Royal Bank of Scotland (RBS), BBVA and UBS – have funded R3, a New York-based group of trading and technology executives, which aims to create a bitcoin-based transaction structure.
In addition to developing commercial applications, the project is seeking to establish consistent standards and protocols for this emerging technology across the financial industry in order to facilitate broader adoption and gain a network effect, according to an R3 press release.
If the banking consortium is successful in designing and engineering “state-of-the-art enterprise-scale shared ledger solutions to meet banking requirements for security, reliability, performance, scalability and audit,” emerging economies and billions of emerging economy residents will gain access to cost-competitive banking solutions.