What is the blockchain doing in microfinance?
Microfinance was first introduced in the 18th century, but it was definitely not in the shape it is today. Furthermore, it didn’t even have the same intentions as it has today. We may all snarl at microfinance platforms saying that they prey on the poor but in reality, the industry taking on a serious issue with lifting people out of poverty with manageable loans and support. But recently, various crypto projects were created to enhance the microfinance sector, even more, did it actually need this addition?
Microfinance introduces Fintech to the unbanked
As already mentioned, microfinance was a tool to lift a large portion of the world’s population out of poverty, but it wasn’t able to succeed in it on a large scale. Sure there are multiple case studies of people using those loans as a means to forward themselves in lives, but most mismanaged those loans and fell even deeper in debt.
This taught microfinance platforms a very painful lesson, that not everybody is eligible for a loan. Soon after that, all of the microfinance platforms started to resemble large banks that prefer their customers to withdraw large debts even if they don’t need them. Even if they applied for small ones, the banks and microfinance and P2P lending platforms would either reject them or increase the interest rate to a point where the borrower had to pay double.
Other issues included:
- Large fees for transactions
- Slow transaction speeds
- Large interest rates
- No criteria
Soon enough this new fintech addition spiraled out of control due to investor pressure, high demand and overall lucrative nature. But the introduction of the Blockchain may be the solution that the industry is yearning for.
The blockchain in microfinance
Cryptocurrencies are primarily designed for finance, there is literally no way around it, but they are still able to contribute to various other platforms in terms of data storage and security and have been used in many a Bitcoin casino test. We’ve also seen this with their inclusion in the Medical industry.
But their role in the microfinance sector would be huge if the adaptation went smoothly. For one, it is a lucrative endeavor, as around 1.7 billion people are considered as unbanked and in desperate need of global market participation.
The second solution would be reduced fees due to transaction fees and low amounts. Even if the platforms didn’t create floating tokens, they’d be able to provide such value with stablecoins (which is designed to have its price always remain the same).
A small loan as mentioned above, is a very hot topic for those in need of them. Small businesses rely on funding to start operations, and due to limited availability, they often make the wrong choice.
Here’s what small business owners neglect when hunting for some funding:
- Investor terms
- Large interest rates
In most cases, we’d see investors asking for parts of the company or just a cut from the revenue. Everyone agrees that selling the company before even starting operations is detrimental to its success, as it becomes very susceptible to corporate influence and greed.
But how would the blockchain solve this?
By its design of course. The blockchain is designed to be anonymous, so long as the third party involved is willing to provide it. Considering the fact that most developing countries, where microfinance is most crucial, don’t have any regulation whatsoever, it would be an achievable feat.
For one, it would be possible by introducing P2P lending platforms with a blockchain system. The provider would just provide the platform and not involve itself in the process of lending. This could be done by just showcasing lender demands as well as borrower capabilities.
Furthermore, it would provide a time-saving as well as a money-saving ecosystem, as neither the borrowers or the lenders would have to run around the world in search of each other.
Due to the P2P platform, there would be a large variety of loans available, and the borrower would have the option to negotiate with the lender on decreasing or increasing the volume by tinkering with the interest rate. Overall it gives a lot more control. Speaking of which.
Control of funds
What microfinance companies usually do is gather large amounts of funds from different investors and lenders and pool them in one big account. Then, once a person applies for a loan they just take out the required amount and pay interest rates by evenly splitting them among investors.
This is not a worthwhile investment for either the lender or the investor. Furthermore, these people lose all of their control over their funds and don’t have the say on who gets to borrow it.
This is done through a guarantee or a belief from the company that the existing traders will one day lose their funds thus scoring the company extra income.
However, according to Monzi, a lending company in Australia, blockchain is not necessarily the only solution to this issue. Much like investment funds, lending companies can simply choose the aggregated accounts option with their banking providers. The blockchain simply makes this process much more transparent and custom.
How can the blockchain solve this?
The blockchain, as mentioned before, is a system designed for anonymity, therefore a platform that is supported by the said system would guarantee control for lenders and investors. In fact, it would be designed for control as the transactions would have to be approved by both sides, which requires them to be aware of the criteria.
Should a lender deem a borrower not eligible or too dangerous for a loan he or she can simply refuse the smart contract. This may provide less value in general, but it would help to verify the ecosystem.
Everyone would have their own terms instead of complying to platform-existing ones, and the borrowers themselves would be able to make their own choice as well.
Furthermore, it would introduce a whole new concept of competition.
The competition in microfinance is virtually non-existent. Lenders and investors just inject funds into the company and then the company does the rest. They all get remuneration according to their investments and the status quo remains.
How does the blockchain introduce competition?
As mentioned in the previous paragraph, the lenders and the investors will be in charge of who they lend their money to and who they refuse. Furthermore, the borrowers themselves would be able to search through the available options and discover the best ones possible.
This will naturally create competition on who can provide the most affordable loans on the platform. The one who does this will have more applicants, and therefore more options for profit. On the other hand, the borrower would get a much more forgiving lending market, which supports their growth through low-interest rate small loans.
Overall, it would introduce a competition-heavy, but a value-rich industry at the same time.
Should the blockchain be incorporated?
The value of that the blockchain can provide for the microfinance platform is admirable, but all of the points mentioned above are a big “if”. It is just a list of potential benefits that this new fintech sector can add to a decades-old industry.
The value of microfinance itself is still to be determined. Countries and corporations themselves need to consider how relevant it is to retain this segment and how beneficial it is to the local population. As already mentioned, the primary issue microfinance was targeting, the incorporation of the unbanked population in the digital economy, was not a success so far.
Furthermore, microfinance companies need to also consider how much large banks are going to allow them to develop. For example, if these companies are able to beat the banks in terms of value provided, the banks can simply introduce negative interest rates and outperform them for a couple of years.
The blockchain, however, even though it may be outperformed by the banks has the ability to provide anonymity on transaction and payment histories. With the incorporation of other benefits such as control over funds and connection to the crypto market, blockchain-based microfinance platforms would still be able to survive the large bank onslaught.