At Luno we’ve been working in the crypto industry since 2013: We started by building the world’s first fully-integrated crypto pilot system for a major multinational bank, and over time leveraging this infrastructure to build the world’s pre-eminent emerging markets consumer crypto platform.
While it’s been an incredibly exciting journey, we’ve also always remained very cautious — mostly because of the amount of fly-by-night schemes, inexperienced teams and outright scams that beset the crypto world, as is often the case with new technology. Building customer trust and protecting customers from these things has always been at the top of our agenda.
We have always spoken out about the ‘blockchain’ hype in early 2015 before it reached its peak, and likewise, most of the ICO industry, hence not adding them to our platform.** When all the attention moved to ‘stablecoins’, we initially thought it was the same beast, but after much research and introspection, we’ve taken a different view.
In short, stablecoins (or some derivative of the concept, often with other names) are cryptocurrencies that are, in theory, meant to eliminate the volatility with which the more ‘traditional’ cryptocurrencies like Bitcoin are usually associated. There are many different types with a lot of different pros and cons, which we’ll describe in more detail here. Generally speaking, we believe these (or similar) types of crypto instruments are going to have a huge positive impact on the broader industry.
We first got acquainted with the idea of stablecoins when we pitched it to a large government to build on top of ‘colour coins’ technology back in 2014. Our hypothesis was that to do this at scale, only a government could execute and enforce it. The initiative piqued the interest of this particular government, but this was during the Wild West days of crypto, and we were told in no uncertain terms that if something like this had to happen, it would at best take 10, 15 or even 20 years. We retreated.
Since then, a few important things have happened:
Firstly, cryptocurrencies in general have become a lot more well-known and understood by a whole range of important actors in the financial system; all the way from consumers and merchants to banks and regulators. This has paved the way for more experimentation with new applications.
Second, there is a much larger core user base of crypto consumers that can use it and a much broader infrastructure of exchanges and wallets that make it easy for people to access directly. This means that one can potentially directly tap the private market for these kinds of initiatives, instead of doing it via governments.
Third, there is a lot more regulatory clarity, and while not perfect, enough to provide broad guidelines for the legitimate players.
And lastly, there are more scalable ‘token systems’ available that have been tested a lot more and can actually provide the right infrastructure for this. For example, Ethereum’s ERC-20. All of this has set in motion the perfect foundation for stablecoins to exist at scale, whereas when we first started testing the concept, it was way too early in the technology cycle.
A new era has begun, and developing economies are leading the way
Generally speaking, we believe that the large-scale adoption of an application for cryptocurrencies will initially be driven mostly by developing economies.
The first key driver is a demand: These markets have an acute need for a better financial system. When one looks across a broad range of financial applications, it’s absolutely extraordinary how much individuals in these markets effectively get ‘taxed’ for using their money.
Let’s look at Africa as an example of how much using an antiquated financial system actually costs people:
- Remittances: An estimated $40 billion market in 2019, according to a recent report by the KNOMAD, with fees of $4 billion to $8 billion charged to consumers, only in one year. This is often for people who earn very little money in the first place.
- Inter-Africa trade: The cost of conversion of local currencies on the continent. A difficult number to get to as it’s not well-documented, but given the size of the remittance market, it could be 10 or 20 times that number — perhaps even more.
- E-commerce: Research firm Statista estimates that the e-commerce sector generated $16.5 billion in revenue in 2017, and forecasts revenue of $29 billion in Africa by 2022. Fees on this range from 0.1% to 5% in some cases. It’s still quite hard to believe that people will get charged this much for effectively doing a transaction with another party (or indirectly through costs being passed onto the price of goods and services). This also excludes cross-border e-commerce, which is rising fast, especially with Africa buying from China.
- Capital controls: According to research by the UN Economic Commission for Africa (UNECA), if capital controls are relaxed in Africa, inter-Africa trade can increase by over 50%.
- Currency stability: While hard to quantify, many people in Africa lost a lot of their wealth simply through bad government monetary policy, resulting in high inflation or excessive currency depreciation. If you ask most people in Africa whether they prefer to work with the US Dollar or their own local currency, it’s often the former because of the relative stability. The value destruction of this is billions of dollars, if not trillions over a few generations.
- Interoperability: This one is also very hard to quantify, but generally most people agree that interoperability increases the free flow of capital which has enormous benefits to society. In some studies it could increase the GDP of a country by 1% or more per annum. In developing economies all the more so, given the lack of regulation or financial infrastructure to make this happen faster.
- Unbanked populations: According to some studies there are over a trillion dollars of wealth in Africa that is currency not ‘banked’. Adding this to the financial system has a lot of benefits not just to consumers themselves (from a safety and capital optimisation standpoint), but also to re-invest into the development of these economies. The global opportunity for new revenue streams from the unbanked is estimated at least $380 billion (yes, billion) by Accenture.
- Security: The cost of personal data theft and financial fraud is becoming increasingly prevalent, and the existing system isn’t the most optimal for minimising this risk. While statistics are hard to come by for Africa, we’re already seeing the cost of identity theft alone reaching double-digit billions in the United States alone — a trend that is expected to follow into developing markets as their online presence grows.
- Other hidden costs: When considering moving onto a common currency or financial infrastructure, the Euro is an interesting case study. Besides all of the above, studies have shown a positive impact on things like price transparency, cross-border employment, simplified billing, expanding market opportunities, more financial and macroeconomic stability and lower interest rates — all of which add up to huge value eventually accruing to consumers.
Overall, while it’s very difficult to come up with an exact range of the value an upgraded financial system will generate, we do know that it’s a very big number, certainly billions and potentially trillions of dollars’ worth over a longer time period. The reason why it’s so hard to conceptualise is that individuals lose this value in very small increments over time – a high transaction fee here, a bit more inflation there – you never feel the pain in real time. But, over time it all adds up and over generations the value destruction is huge.
The good news is that a better system of money will allow most of this value to flow back to consumers, whether directly or indirectly. The impact will be enormous.
The second important driver for developing economies is the inherent characteristics in these markets that makes adoption more likely. For example, there is already relatively low trust in governments and currencies, creating a strong potential mental catalyst for change. And most people in these markets already own mobile phones and are connected to the internet, and are used to being early adopters of various technologies — to a large extent also a reflection of the youth in these markets. For example, nearly 60% of people in Africa or younger than 25.
Most importantly, many of these markets have a strong track record in grassroots level change, given that there is usually very little political will to drive change. A good example is the use of mobile phones and the internet, which has arguably done more for democracy, transparency and freedom of speech than almost any African government or policy ever has. The same is likely to happen with a better financial system. For example, there’s already been talk about launching a common African currency for many years, but in our view this is likely to come from the bottom up, rather than from the top down. And the impact of this will be much larger than the internet.
This is, in fact, one of the key competitive advantages cryptocurrencies have against other financial systems and a reason why we believe they will be a core part of the future of finance. Because cryptocurrencies are generally decentralised, it means that they are open for anyone to use, similar to the internet. This results in faster acceptance by people and businesses when a bottom-up approach is more feasible. Not only could crypto systems provide lower transaction costs and a better store of value versus some sovereign currencies, but the traditional financial system’s cost structure often makes it prohibitive to acquire many of these (unbanked) customers, whereas an open financial system that anyone can access, in theory, makes it economically viable to do so.
At a more philosophical level, we also believe that money is at its core a way for value to be communicated between people. Like the sharing of personal information online, over time this will tend to move to systems that are global and frictionless in nature — in essence to take advantage of the huge economies of scale this delivers in an increasingly connected global world. In short, we believe a move towards more common forms of money or shared financial infrastructure is something that is inevitable, and cryptocurrencies are uniquely placed to deliver on this.
So why isn’t everyone using crypto already?
With the most popular cryptocurrencies like Bitcoin and Ethereum, barriers to entry remain. Most of these unsurprisingly revolve around trust: This is a complex combination of a lack of understanding about how it works in general, uncertainty around who is ‘backing’ or supplying it, and regulatory uncertainty. Two of the other main areas for lower acceptance rates is the high volatility for many of these, and generally the high cost of acquisition given the steep learning curve, so essentially a distribution problem.
Scalability is also often cited as an issue, although we believe that this is something that should be solved in most cases for most of the dominant currencies over time. That said, depending on the type of stablecoin, many of them provide better scalability and faster transaction processing times now versus sometime in the future.
Bitcoin and Ethereum have seen surprising growth when you consider all these challenges. But stablecoins do a lot more to lower these barriers. They increase trust significantly by being easier to understand (for example, a USD-backed cryptocurrency is linked to something people already know: the Dollar) and this, in turn, leads to easier acceptance into existing regulatory frameworks. They also largely solve the issue around volatility — hence the name ‘stablecoins’.
As mentioned, depending on the technology they use, they are often also more scalable and can process transactions more efficiently. Where they are still somewhat challenged is that they have to go through the same distribution channels as Bitcoin and Ethereum right now (typically exchanges and wallets). This is not necessarily a bad thing, but will make adoption slower. It should also be noted that all stablecoins are not equal: Their level of success will depend very much on who the issuer is, how it is constructed and so on.
It is also worth noting that stablecoins essentially provide a ‘bridge’ to fully decentralised cryptocurrencies like Bitcoin. Because they are easier to trust and understand, they are effectively a way for people to learn about crypto ‘slowly’ until they are ready to go into the ‘newer’ types like Bitcoin. Because stablecoins are so easy to convert to cryptocurrencies it also means that there will be less friction to enter into these, as more people own stablecoins for whatever reason.
So we see stablecoins as both supplementary and complementary to the Bitcoin ecosystem. And while Bitcoin has always felt like a game-changer, it hasn’t been an imminent consideration; we believe that stablecoins will accelerate the timetable considerably.
Adoption of stablecoins won’t be without some challenges. There will continue to be regulatory hurdles, especially with capital controls which are a reality of life in most developing economies. To enable a broad set of use cases, they will still require traditional fiat currency onramps, or local liquidity of fiat currency being traded to them. While they might be easier to trust and understand than cryptocurrencies like Bitcoin, a lot of education still needs to be done at both a grassroots consumer, and higher institutional level. The good news is that there are many companies, like Luno, working very hard ‘on the ground’ to help deal with these challenges, and we remain upbeat about the prospects.
What about developed markets?
We still see cryptocurrency as very useful in these. For ones like Bitcoin, having it as an alternate store of value versus other asset classes in an increasingly volatile and uncertain world is a great use case. And stablecoins are still very useful for more interoperability across businesses and markets; think PSD2 for everyone, without banks or regulators having to implement it. Most important though, is that for many of the developing market use cases like remittance or cross border e-commerce, the other foot will often be in a developed economy; the one can’t exist without the other, and both sides will ultimately benefit. This is, in fact, one of the reasons why Luno has a strong European footing in addition to our emerging market presence in Africa and Southeast Asia.
The crypto industry is still in its infancy, so a lot can and will still happen. We believe stablecoins are a step in the right direction, not just as a technology in itself, but also because it will broaden the education of and access to other cryptocurrencies like Bitcoin substantially. We believe it’s going to raise the tide for the entire industry, and carve out its own important use cases, just as those that Bitcoin or Ethereum (and others) have.
Hold on, because things are about to start moving even faster.
** we still think there are some legitimate use cases on both blockchain and ICO, but at the time the hype blurred this, and the opportunities remain only a handful. We explain more about it in some of our other posts, but generally speaking we consider it too early for many of these initiatives to work at scale. However, in the future, they will likely be very important.