By: Matti O. Jeremiah
Africa’s financial system is plagued with numerous challenges, especially in the area of cross-border payments. Inefficiencies in the financial system lead to high transaction fees, long wait times for payment processing, and limited access to financial services, particularly for individuals and small businesses. However,the emergence of blockchain technology and decentralized finance (DeFi) could provide a solution to these problems.
The African financial system is characterized by limited infrastructure and access to financial services. A large proportion of the population remains unbanked, with limited access to traditional banking services such as loans, savings, and investment opportunities. Additionally, cross-border payments in Africa are costly, inefficient, and slow. For instance, sending money from one African country to another is, in some cases, almost impossible or could take days, with high transaction fees charged by intermediaries (banks) in the payment process.
Blockchain technology could solve some of these challenges by facilitating secure and fast cross-border payments. Blockchain technology provides a decentralized and transparent platform for financial transactions, eliminating intermediaries in the payment process and thus reducing transaction fees and increasing speed. Blockchain technology enables peer-to-peer (P2P) transactions, which could eliminate the need for traditional banking services, particularly for individuals and small businesses.
DeFi platforms are built on top of blockchain technology and use smart contracts to execute financial transactions without the need for intermediaries such as banks. These platforms provide users with access to a range of financial services, including loans, savings, and investment opportunities, using cryptocurrencies as collateral. One key advantage of DEFI platforms is their ability to provide capital through the use of liquidity pools.
Liquidity pools are pools of cryptocurrency or currency that users can deposit into to provide capital for financial services such as loans, payments, and trading (exchange of different currencies).
A smart contract is a self-executing digital contract that automatically enforces the parties’ obligations and regulations without the need for intermediaries such as banks or attorneys. It is a program that runs automatically when certain conditions are satisfied and is stored on a decentralized blockchain network. Smart contracts, because they cannot be manipulated once they are deployed, provide a secure and transparent mechanism to conduct transactions without the requirement for trust between the parties. They have a wide range of applications, including financial transactions, supply chain management, and digital identity verification. Smart contracts are used in the context of decentralized finance (DeFi) to automate lending and borrowing of capital, peer-to-peer payment, currency trading, and liquidity pool management.
Stablecoins are cryptocurrencies that are pegged to the value of a fiat currency, such as the US dollar, British pound, etc. They provide stability in the value of cryptocurrency, making them ideal for cross-border payments.
Cross-border payments in Africa are often slow or nonexistent in some cases, inefficient, and expensive due to the lack of a reliable and stable financial infrastructure. However, DeFi platforms offer a solution to this problem by providing fast and secure cross-border payments using liquidity pools, digital currency, and smart contracts.
Users (liquidity providers) can deposit funds into a liquidity pool, and other users can use the available funds to perform various financial functions. This system eliminates the need for traditional banks and intermediaries to perform core financial services, thereby reducing fees and increasing speed.
Additionally, stablecoins could be used to ensure that the value of the currency remains stable, reducing the risk of currency fluctuations and making cross-border payments more predictable and reliable.
On a lower level, here is an example of how this could work: A flow of funds from Ghana to Nigeria
The DeFi platform creates eNaira and eCedis digital wallets that are linked to the user’s bank account or virtual cards in Nigeria and Ghana, respectively. These wallets allow users to deposit and withdraw funds in Naira and Cedis, respectively and are also used to facilitate transactions on the DeFi platform. A platform like Celo, a mobile-first blockchain platform, can be used to create digital currency and wallets.
A liquidity pool for the Naira in Nigeria and a pool for the Cedis in Ghana are created. The pools are funded by liquidity providers, who deposit an equal amount of Naira and Cedis into the respective pools, which will be benchmarked against a base stable coin (USD = USDT, USDC, or BUSD). To be more specific, if a liquidity provider deposits $100 into the main pool, $50 will be distributed equally between the Naira and Cedis currency pools at the current exchange rate.
The DeFi platform creates an oracle and smart contracts that constantly monitor and adjust the exchange rate between the two currencies, ensure the pools have an equal value, execute transactions immediately, and calculate transaction fees.
When a user in Ghana wants to send money to Nigeria, they deposit Cedi into the pool in Ghana, plus a transaction fee, and the equivalent amount in Naira is deducted from the pool in Nigeria and transferred to the recipient’s wallet instantly.
The fees charged on transactions are shared among the liquidity providers based on the amount of liquidity they provide. This incentivizes liquidity providers to deposit funds into the pool and maintain liquidity, which helps to reduce slippage, increase transaction volume, and ensure that users can execute larger transactions.
For example, let’s say a user in Ghana wants to send Naira to Nigeria. They would deposit 1,000 cedis plus the stipulated transaction fee into the Cedi pool in Ghana, and the equivalent amount in Naira would be deducted from the naira pool in Nigeria, based on the exchange rate determined by the smart contract. If the exchange rate is 1 Cedi = 0.56 Naira, then the user would receive 560 Naira in Nigeria.
A smart contract ensures proper execution of the payment flow; the transaction is executed immediately, and the fees charged on the transaction are shared among the liquidity providers. This provides an efficient and cost-effective way for users in Ghana and Nigeria to send money across borders without the need for intermediaries.
Blockchain technology and DeFi have the potential to revolutionize Africa’s financial system by providing a decentralized and transparent platform for financial transactions. These technologies provide an alternative to traditional banking services, particularly for individuals and small businesses, thus increasing financial inclusion. Additionally, these technologies could facilitate fast and secure cross-border payments, thus reducing transaction fees and increasing speed.
However, the unstable government monetary policies and political systems in Africa could pose a challenge to the adoption of DeFi and digital currency. African countries have a history of unstable government monetary policies and systems, with many experiencing high inflation rates, trade imbalances, currency devaluations, and poor investment in technology infrastructure.
Furthermore, the lack of clear regulatory roadmaps for DeFi and digital currency in Africa poses a significant risk to their adoption. The absence of clear regulations could lead to fraudulent activities, a lack of investor protection, and uncertainty, hindering the growth of the DeFi ecosystem.
To overcome these challenges, it will be important for DeFi platforms and blockchain creators to work closely with regulators and financial institutions to ensure that these technologies are implemented in a way that benefits everyone. This will require a collaborative effort from all stakeholders to establish clear regulations, provide education and awareness around these technologies, and build trust in the system.
In conclusion, blockchain technology and DeFi have the potential to solve Africa’s financial system challenges, particularly in the area of cross-border payments. These technologies provide a decentralized and transparent platform for financial transactions, and increasing financial inclusion.