The pressure to digitalize our economies and adopt a new generation of monetary policies may be legitimate but the risks are also real. How can governments navigate this delicate balance between digital economy penetration, financial inclusion and monetary policy? Can governments in East Africa continue riding behind the tide?
By Moses Kulaba, Governance and Economic Policy Centre
@digitaleconomies @cryptocurrencies @financial inclusion @mkulaba2000
Globally, there is a debate and desire for the adoption of blockchain technology and cryptocurrency as medium for financial transactions yet in East Africa, government uptake and regulation are moving at a snail’s pace. In this first of a two-part series of our short analytical economic policy and governance policy briefings, we re-explore and unpack the future of blockchain and crypto currency penetration and the risk considerations shaping debate and monetary policy terrain in East Africa. We will later discuss how the EAC governments can leverage monetary policy and regulation to harness the dividends of blockchain and cryptocurrencies to advance financial inclusion in the region.
Generally, there is limited understanding of blockchain and crypto currency technology. The debate on the risks that these new digital currencies portend to the public and national economies is ongoing. So far there is no consensus amongst citizens, economic policy makers and central banks on which directions governments must take. The common view is that adopting block chain and crypto as a form of legal currencies should be approached with utmost care and heavy regulation. It is argued that the risks are high if crypto is adopted as legal tender as some African Central Banks have attempted to do. Moreover, if crypto assets are held or accepted by the government as means of payment, it could put monetary policy and public finances at risk.
Despite, these reservations trading in crypto currencies has continued alongside the formal currencies and could become a major part of our global financial system in the future.
All over East Africa, digital currency platforms exist, despite the bans and young digital entrepreneurs have signed up, traded and transacted in crypto with some success, while others have equally horrendous stories to tell of failure, and counting losses. According to global reports, so far Kenya, Ghana, Nigeria and South Africa are leading with Tanzania following closely along.
The driving factors crypto adoption and penetration among young people is widespread unemployment and joblessness pushing mostly young people and new unemployed graduates to look for a living online. For speculative investors the driver is that digital currencies have provided a seemingly a good alternative store of speculative value than local African legal tenders, as they experience inflationary and forex exchange pressures. Between 2020 and 2021 transactions increased by 567 percent to $15.8 trillion between before declining in 2022 after the largest crypto exchange FTX crush in 2022.
Despite the loses, the appetite to transact in crypto still continues. According to the online financial reporting resource, Statista, the Cryptocurrencies market in Tanzania is projected to grow by 10.36% (2024-2028) resulting in a market volume of €4.97m by 2028. With this trend, there are suggestions for governments to regularize and formalize crypto currencies as part of a new generation of monetary policy promoting digital economies, and advancing financial inclusion rather than banning their total use all together.
What is blockchain technology and cryptocurrency.
As a way of kicking off and unpacking this further, we will re-explore what is blockchain technology and crypto currency. Blockchain technology is an advanced database mechanism that allows transparent but secure information sharing within a business network. A blockchain database stores data in blocks that are linked together in a chain. Blockchain is a method of recording information that makes it impossible or difficult for the system to be changed, hacked, or manipulated and therefore provide the infrastructure on which crypto currencies are transacted.
The oxford online dictionary defines crypto as a digital currency in which transactions are verified and records maintained by a decentralized system using cryptography, rather than by a centralized authority. The Reserve Bank of Australia has defined cryptocurrencies as digital tokens. They are a type of digital currency that allows people to make payments directly to each other through an online system.
Cryptocurrencies have no legislated or intrinsic value; they are simply worth what people are willing to pay for them in the market. This is in contrast to national currencies, which get part of their value from being legislated as legal tender.
Cryptocurrency (or “crypto”) is therefore a digital currency that can be used to buy goods and services or traded for a profit. There are four major types of cryptocurrencies and these are; Payment cryptocurrency, Utility tokens, stablecoins and Central Bank Digital Currencies (CBDC). Bitcoin and Ether are the most widely used cryptocurrency.
How Cryptocurrency transactions operate.
Cryptocurrency transactions occur through electronic messages that are sent to the entire network with instructions about the transaction. The instructions include information such as the electronic addresses of the parties involved, the quantity of currency to be traded, and a time stamp. The transactions are run across multiple systems of computers using a blockchain technology, where data is stored in blocks linked together and securely shared across interlinked business networks for connected ‘miners’ to transact and trade.
How large is crypto in Africa and East Africa?
According to China Analysis reports, by 2022 Africa was one of the fastest-growing crypto markets in the world, with crypto transactions peaking at $20 billion per month in mid-2021. Kenya, Nigeria, Ghana and South Africa had the highest number of users in the region, with other countries following closely. So far, some people have used crypto assets for commercial payments. It is not clear yet whether this number has increased since 2022 after the large crypto currency crush. However, it is evident that new platforms and mediums of exchange have emerged including the Tether USDT accepted by China and other major buyers.
The Tether (USDT) also known as a “Stablecoin” is a cryptocurrency designed to provide a stable price point at all times. The USDT cryptocurrency was created by Tether Limited to function as the internet’s Digital Dollar, with each token worth $1.00 USD and backed by $1.00 USD in physical reserves. According to crypto traders, despite the controversy, Tether has become more popular because it is pegged to the dollar and fluctuating in value with the U.S. dollar and backed by Tether’s dollar reserves.
Who owns crypto in East Africa?
In 2021 market or financial research institutions estimated that the number of crypto owners in East Africa currently was almost 12 million. A Singaporean cryptocurrency research firm, Tripple-A, estimated that 11.7 million East Africans owned cryptocurrencies. Out of these 6.1 million were in Kenya, 2.3 million in Tanzania and two million in the Democratic Republic of Congo.
The numbers are potentially higher given that many crypto owners and users are unreported or documented. The clampdown on crypto currency owners and traders in some countries pushed many under and away from advertising and transacting publicly. Bitcoin accepting points of sale closed shop and transactions became discrete.
Potential for new monetary policy in EA?
In 2017 the East African Community members were against digital currencies even as their appeal grew across the world. Kenya, Tanzania and Uganda governments said trading in cryptocurrencies like Bitcoin was illegal, for reasons ranging from whether they are commodities or money to being pyramid schemes that could plunge investors into losses. The Kenyan and Ugandan governments issued warnings.
The Bank of Tanzania said dealing in cryptocurrencies was tricky because they are not regulated and it was not clear who controls the market. However, the Tanzanian government appears to have softened its stance when in 2023 announced a phased approach towards adoption of a Central Bank Digital Currency (CBDC).
A CBDC is a digital or virtual form of a country fiat currency (such as USD, EUR and TZS) issued and regulated by a central bank. Their value is based on the government’s ability to maintain its value by controlling supply and demand, are used as a medium of exchange in transactions, and are considered legal tender within their respective countries.
Therefore, when issued, CBDC becomes a legal tender, analogous to physical notes and coins. Based on the literature, CBDC is thought to offer a range of benefits to the economy and its adoption has been slowly garnering interest in many countries around the world.
What are monetary policy and socio-economic risks of crypto currencies?
- Lack of transparency and proper regulation and a high-risk potential for disruption of the financial system.
The International Monetary Fund (IMF) warns that crypto currencies expose users to cyber-risks such as hacking and loss of their assets. Governments are exposed to lack of transparency around issuance and distribution of crypto assets and this can be disruptive to managing monetary policy.
- Susceptible to fraud, and tax evasion as captured in the Nextflix true story documentary-Bitconed.
Cryptocurrencies can be conduits for fraud, tax evasion and illicit financial conduct. Because of their volatility their value is difficult to predict and store. In 2022 it was estimated that at least 12 million people in East Africa lost billions of dollars in the cryptocurrency market crush and a contagious series of ‘Bitcoin get rich’ schemes whose value disappeared overnight. The susceptibility to fraud and sudden fall from temporary economic opulence that may arise from crypto currencies has been well captured by Netflix in a true story documentary-Bitcoined.
- Potentially used for money laundering and terrorism financing:
Crypto currencies can be vehicles for money laundering and criminal financing. A report by American cryptocurrency market research firm, Chaina analysis says laundering of stolen funds through cryptocurrencies and scamming of users were the highest crimes in 2021 and 2022, accounting for over half of the illicit transactions. Moreover, a Reuters investigation report claimed that the world’s largest crypto exchange by volume was used by drug lords, hackers and fraudsters to move illicit cash. According to Reuters, cryptocurrency-based crimes hit a record high in 2021, with illicit transactions rising 79.4 percent to $14 billion, from $7.8 billion in 2020.
Other crypto crimes that increased included financing of terrorism, ransomware, money laundering of child abuse material funds, cybercriminal administration and fraud shops. The US cryptocurrency exchange, Binance, was flagged out as one of the platforms used by criminals to lauder at least Sh274.4 billion ($2.35 billion) across the world in five years. Binance has since denied the claims but the negative image of cryptocurrencies and some associated crypto exchange companies as conduits for crime still hangs on.
- Crypto contributes to climate change environmental damage:
Cryptocurrency activities have been associated with contributing to emissions affecting climate change and have come under criticism from climate change and environmental activists. As indicated cryptocurrency transactions and mining occurs across multiple computer systems running on blockchain technology constantly over time, using energy and emitting heat.
The environmental effects of bitcoin are significant. Bitcoin mining, the process by which bitcoins are created and transactions are finalized, is energy-consuming and results in carbon emissions as about half of the electricity used is generated through fossil fuels.
According to environmental reports by the University of New Mexico, an average of every $1 of bitcoin mined between 2015 and 2021 resulted in $0.35 of climate change damages. Further studies show that the cryptocurrency industry, swiftly outpaced many of the traditional top-emitting sectors and significantly contributing to climate change.
The Cambridge Bitcoin Electricity Consumption Index, which tracks the real time impact of Bitcoin, in their short history shows that, Bitcoin mining alone had emitted nearly 200 million tons of carbon dioxide equivalent (CO2e). From an environmental perspective therefore scaling up wider use of blockchain technology and crypto is a danger to the environment and climate change, the report concluded.
Despite the risks and potential down side, a United Nations University (UNU) report suggests that the negative view could change as blockchain technology and cryptocurrencies percolate across from developed economies into Africa. The monetary policy and regulative landscape is evolving and governments must be aware and leverage the benefits of technology[1].
According to a commentary by the Brookings institute, indeed, many cryptocurrency fortunes have already evaporated with the recent plunge in prices. But whatever their ultimate fate, the ingenious technological innovations underpinning them will transform the nature of money and finance.
Are East African governments running late? In the next issue we discuss how EAC can address the downside of the crypto economy, leveraging its monetary policy to harness its dividends.
[1] https://unu.edu/press-release/un-study-reveals-hidden-environmental-impacts-bitcoin-carbon-not-only-harmful-product