Could Blockchain Help Emerging Markets Leapfrog Traditional Technologies?

This post is part of the FinDev Gateway blog series, Blockchain in Development, which explores the potential and limitations of blockchain for financial inclusion and development. 

Blockchain — an innovative “distributed ledger” technology that enables members of a network to cooperate and transfer value without a central authority — has received an overwhelming amount of interest in the last couple of years. Its potential to deliver a new mechanism of trust and to significantly limit transaction costs offers great promise for leveraging the technology to boost economic development in emerging markets. Fierce proponents call it a digital revolution, while sceptics dismiss it as at best a combination of existing technologies with exaggerated potential, and at worst, a vehicle for fraud. Despite its detractors, venture capital flowing into blockchain companies grew to $1.3 billion by May of 2018, already double the total investment from the year before, according to Crunchbase (see figure below).

Blockchain’s ability to send blocks of cryptographically-secured, tamper-proof data through a decentralized network holds the promise of a scalable, secure and cost-efficient system for value transfer that can apply to various sectors and asset classes. By its very nature, blockchain is a general-purpose technology that has the potential to deliver productivity gains to multiple industries, from the financial sector to energy markets, supply chains, intellectual property management, the public sector and beyond. Its ability to eliminate intermediaries, improve transparency and increase auditability can significantly reduce costs and provide efficiency into the financial and physical value chains, and even open new markets for financial institutions.

Blockchain holds great potential for emerging market countries, and particularly in financial services. Many emerging markets face challenges in increasing financial inclusion and providing cost-effective financial services, especially in the wake of the financial crisis that left many countries suffering from the impact of de-risking. They may also have less entrenched market players and existing legacy systems, so they may be less resistant to change than advanced economies. The combination of these two factors make emerging markets good candidates for a more rapid adoption of the technology.

The extensive use of mobile-based services, particularly in Africa and Asia, provides an easy avenue for a blockchain-based system to extend its services. Even in developing markets, mobile penetration is extremely high, at 83 percent among the 16-to-65 age bracket. So blockchain may provide emerging markets with an opportunity to leapfrog traditional technologies, as happened with mobile technology in many emerging market regions, particularly Sub-Saharan Africa. And if blockchain manages to provide proof of concept for a viable business model in payments for mobile banks and other financial players, it would advance the longstanding developmental goal of financial inclusion.

If blockchain manages to provide proof of concept for a viable business model in payments for mobile banks and other financial players, it would advance the longstanding developmental goal of financial inclusion.

Taking advantage of these innovative features, the financial services industry has been a pioneer in experimenting with blockchain use cases that can have a direct impact in emerging economies, such as in trade finance, remittances or blockchain-enabled Know-Your-Customer (KYC) applications. In trade finance, advancing from paper ledgers and manual processes to electronic tracking on a distributed ledger reduced errors and transaction times from several days to a few minutes.

In the case of digital identity, the use of distributed ledger technology to store financial information can eliminate errors associated with manual auditing, improve efficiency, reduce reporting costs, and potentially support deeper regulatory oversight in the future. Currently there is no standardization in the identifying information customers must submit to financial institutions, and these institutions often duplicate efforts in performing Know-Your-Customer checks, with burdensome transaction costs on both banks and customers. With a distributed ledger technology, a rigorous professional validation is done once, and this verified identity document can be used for all subsequent transactions. A more cost-effective KYC verification can lower the customer acquisition cost for financial institutions and facilitate the financial inclusion of previously unserved or underserved population segments. 

Despite all its potential, distributed ledger technology is still in an early stage of development and will face numerous hurdles - technical, regulatory and institutional - as it moves toward maturity. Concepts are currently being market-tested and it is unclear yet whether blockchain will live up to its promise. To reach its full network potential will require industry collaboration, common standards, a public-private dialogue and an articulated governance framework. Regulators and industry will have to work together to experiment and learn from each other, so that they may shape the future of the technology in a way that is beneficial to all parties and society as a whole.