June 23, 2022
3 min read
May 30, 2022
8 min read
Accessibility, like justice and equality, is one of those words that seems like a universal good but, upon closer inspection, becomes much more vexing. Consider: Children should have access to guns, fish should have access to land, or carbon should have access to the atmosphere. Each of these is obviously wrong in a different way. The world of DeFi deploys accessibility as part of its claims to ethical superiority over the closed world of CeFi or TradFi (traditional finance). But to what effect? Does the DeFi variety of increasing access always, purely, and necessarily produce good?
One reads repeatedly that there are nearly 2 billion unbanked adults in the world. DeFi claims that:
a) it can bring the joys of financial services to these people and
b) this is a good thing.
But can DeFi deliver on this promise? Should it deliver on this promise?
It turns out that about two-thirds of unbanked adults have a cell phone, and about half of those cell phones are older generation smartphones, which could, in theory, access dapps. Therefore roughly 650 million of the 2 billion unbanked people could have access to DeFi financial services. But, in fact, there are other hurdles beyond the technological…
In a survey by the World Bank on the unbanked, distrust of financial institutions was found to be a top reason for not having a bank account. In many countries, this distrust is completely rational. Deposits are not always guaranteed by a governing authority and if in theory they are, there is still little reason to trust the government. For instance, Nigeria is in the midst of a multi-year attempt to reform its banking industry after waves of bank failures brought on by lax oversight, under-capitalization, high costs and corruption. While the Nigerian economy has experienced robust growth over the last decade, trust in traditional financial institutions has not kept pace. How does one go about convincing very poor people to trust complex digital technology? Perhaps this is an opportunity to prevail in environments where traditional institutions have very poor records. Notwithstanding such an opportunity, any attempt to provide access to the unbanked will require a serious commitment to addressing the social integration problems that underpin them, and they will be difficult if not impossible to solve solely through digital networks. Further, a major barrier to banking for the poor is simply the cost of the banking services themselves. In many poor regions, transaction fees much in excess of a few cents would be prohibitive. This does not mean such problems are intractable, just that they extend beyond the purely technological.
Let’s suppose these barriers are cleared for a significant number of the unbanked. Is this really such a good idea? Muhhamad Yunus won the Nobel Peace Prize in 2006 for his Grameen bank that pioneered micro-lending. By providing access to small amounts of capital to the unbanked, he hoped to provide a financial engine that would lift families, villages and communities out of poverty. After decades of work and research, it appears that this does not work as we hoped it would. While micro-loans do help some, there has been no evidence of general economic improvement and in many areas, particularly Bangladesh, the system has, in fact, been found to be exploitative due to high interest rates and inflexible repayment schedules. This is not to say micro-lending is a mistake in all cases, just that it is far from the panacea that we hoped it would be. Indeed, when one describes DeFi’s potential contribution as, “bringing debt to 2 billion of the world’s poorest”, its moral clarity seems much less…clear. Considering the costs necessary to overcome the technical and social challenges, the business proposition becomes less rosy. Finally, most of these people have no access to electricity, sanitation and limited access to clean water. While access to financial services could be beneficial, it would not be revolutionary.
OK, so the unbanked is tricky. What about the _under-_banked?
The under-banked make up a significant portion of the world’s population. Many billions of people have access to banks but little or no access to credit, exceptionally high fees and interest rates, corrupt institutions, and governments that strictly regulate financial services. Countries like Argentina and Venezuela have large populations with access to smartphones and computers. They are also better educated on average and are likely to grasp the value proposition of having secure, trustless, financial transactions that cannot be regulated by government authorities. They viscerally grasp the value of the opportunity to hedge against inflation and unstable governments by exchanging national fiat for cryptocurrencies. So while the degree to which DeFi can provide benefits to the unbanked is decently uncertain, perhaps the under-banked won’t present as challenging?
Capital flight from Latin America:
Unfortunately, helping the under-banked is complicated for still other reasons. One of the most difficult challenges facing a developing country, particularly ones dependent on resource extraction, is capital flight. When a nation’s capital leaves rapidly, national tax revenue falls, capital values decline, long-term investing wanes, and fiscal policy becomes unmanageable. It is easy to point to corruption and government inefficiency as main drivers of capital flight, but even competent and well-meaning governments could face the prospect of billions of dollars of capital flight on even the rumor of instability or a drop in price of a core resource. Further, it is likely the wealthier, better educated citizens who would have DeFi accounts. Any event that triggered capital outflows may create a massive drain on the economy that could, in fact, create a financial crisis. The blunt end of this crisis would be born disproportionately by those who, for whatever reason, did not have sufficient access to the financial system, decentralized or traditional. In such a case, less than universal access could create, rather than reduce, economic suffering. While there is a clear argument that helping people access stable, inflation-resistant investments is valuable, it must be faced that this access may introduce instabilities that contribute to or even cause the economic ills they are meant to cure. One needs to pause and ask, who reaps the rewards and who pays the cost?
What about the developed world?
Access to financial services in developed economies (Europe, Asia and North America) is widespread. However, these services are often expensive and the cost itself creates a barrier to access. For instance, in the US the ‘innovative’ fintech loan companies like Kabbage, OnDeck and SoFi that claim to ‘revolutionize’ consumer and small business lending, charge high fees and interest rates, sometimes exceeding 60%. Also many banks that offer ‘free’ checking also charge overdraft fees in excess of $35, high processing fees, and pay no interest on checking or savings. Or what about TD Ameritrade, which charges variable interest rates on margin debt based on account balance — the less money, the higher the rate. In essence, the poorer you are the more limited and expensive your finance choices become. It is therefore not surprising that 14 million Americans are unbanked.
It’s clear there is a huge opportunity for DeFi in developed economies, but opening markets to new populations often creates new problems. Robinhood, Webull and similar apps have allowed millions of people to participate in the financial markets. Indeed, allowing more people to participate in services previously reserved for the wealthy is one of the great promises of DeFi. However, what, if any, is the responsibility companies should bear to help their users understand the nature of the markets they are accessing? Many companies take this responsibility seriously, others less so. The SEC and other regulatory agencies often perpetuate access restrictions in the name of consumer protection, which also conveniently benefit the larger, well-established legacy TradFi institutions. The burden of KYC, for instance, is so expensive and slow that it essentially precludes small institutions and the non-wealthy from participating in many market opportunities [Ref]. Still, there are legitimate reasons to be concerned about consumer protection when millions of new users are being invited into a world of complex financial instruments. The democratic impulse is to allow everyone to participate and there is clear value in this approach. But increased access also brings with it increased responsibility.
There are, of course, many other products in the DeFi world besides exchanges. Giving people access to lower fees, more choices and new services is compelling. But, in each case, just assuming access = better is naive. As the SEC moves against cryptocurrencies it is easy to be cynical about the motives. However, it is disingenuous to pretend cryptocurrencies and blockchain technology have not been used for money laundering, tax evasion and illegal purchases. And, setting aside these issues, how revolutionary is it to provide relatively wealthy, well-educated citizens of the developed world access to financial services that, while it might make them even wealthier, does little to alter the overall distribution of wealth?
Accessibility, like justice and equality, is one of those words that seems like a universal good but, upon closer inspection, becomes much more vexing. The unbanked need many things, including access to water and sanitation, along with access to banking. And while banking may help, there is little evidence to date that it would be a major transformational force. The under-banked in the developing world similarly stand to benefit from access to DeFi, but the complexities are immense, not least of which is the hazards of increasing capital flight from countries that already struggle with maintaining stable currency values. Even in the developed world, the opportunity of bringing 100s of millions of people into the financial markets is immense, so are the potential risks. If we believe in democracy and participation, freedom of the individual and self-determination, then accessibility is both necessary and good. Yet this potential can only be harnessed with care. Optimism is warranted, but also humility in the face of such a radical change.
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