Central banks around the world are looking to develop their own digital currencies, which use technology to represent a country’s official currency in digital form.
Last year, the Bahamas launched one. In the past two months, Norway, Japan, Indonesia, Sweden and South Korea have announced digital currency trials. In Africa, Ghana, Morocco, Egypt, Kenya, and South Africa are exploring the technology’s feasibility.
Dr. Co-Pierre Georg, associate professor at the University of Cape Town (UCT), South Africa, is an expert on central bank digital currencies. He says Africa should take the lead in disrupting the global financial services system through the instrument, as the continent has a significant remittance market and is primed for more fintech investment. UCT recently joined the University Blockchain Research Initiative, a blockchain accelerator program, to solve key fintech challenges and explore real-world solutions for blockchain and cryptocurrency.
Digitizing currencies is not an easy proposition, and it raises questions around accessibility, privacy and what architecture to use. Quartz spoke about these and more with Dr. Georg, who is also a research economist with Deutsche Bundesbank, Germany’s central bank. The conversation was edited and condensed for clarity.
Quartz: How could central bank digital currencies (CBDCs) be feasible in Africa?
Dr. Co-Pierre Georg: The question really touches on “How should central banks approach CBDC?” I think the best way to look at them is as a piece of public infrastructure, [with] some principles that you should follow. It should be universally accessible, should be open to everyone, should be transparent efficient trustworthy. And in that regard, Africa doesn’t differ from Europe, the US, or from China.
We need to decide how we are going to build this public infrastructure. The additional challenge that Africa has is that it’s a lot of countries. If every country is building their own CBDC, then you have some co-monetary areas like we have here in southern Africa. You need to make sure that, on top of all the principles that hold for public infrastructure, they are also interoperable. I think that’s quite key: to create a system that doesn’t add artificial barriers to economic activity between the different countries A lot of central banks are evaluating this now and they are making decisions on how to build the CBDC platform.
The big challenges of CBDC and one of the big open questions that also might also need the studying is: “How do you provide universal access to digital payments?” How do you include people who don’t have smartphones, or who don’t have phones into a modern digital payment system? And that’s one of the questions that we’re working on.
What kinds of problems would CBDCs solve?
Think of somebody living in an informal settlement. They struggle with access to finance because they don’t have collateral. They also probably don’t have a bank account. But even if they do have a bank account, they don’t have collateral, because title deeds in these situations are uncertain, they are not always formally recognized.
So these guys struggle to access a lot of financial services. One of the consequences of that, is that you have a lot of your wealth in a lump sum risk. If you think about your portfolio as a household, for most households the majority of your wealth will be in your home. And this holds for lower income records as well—the majority of their wealth will be in their property, but it exposes them to a huge lump sum risk. One of the things you can do is you can tokenize ownership of property and you can create easy means of diversification. So that instead of me owning my house and only my house, I own part of my house, but I also own a part of houses that are in very different areas. I can diversify my portfolio.
Asset tokenization is a very powerful driving force for a lot of business models these days. It holds for physical property or agricultural commodities, where you can use asset tokenization to overcome asymmetric information. But again, in particular, it holds in the digital economy.
When you think about digital objects and how they are being traded, these are low-value transactions, usually because digital objects can be copied and therefore if you have a lot of them and they are cheap and easy. So you do need very low-value transactions in order to facilitate digital marketplaces and marketplaces in the digital economy.
These are classic use cases for asset tokenization, where creating a token that represents that asset actually facilitates new uses. If you do that, you do need a payment system that is in sync with this. You can’t just put a tokenized asset onto a normal payment system, because then the payment system might be too slow to facilitate the use case that you want. Or too expensive. Because of correspondent banking, we have very expensive, very slow international transactions, especially in Africa. The cost of cross-border remittances is still very high and it’s not just Western Union’s fault—there are many reasons for it. And that means that the existing payment systems are not built for these kind of low-value transactions that in particular the digital economy needs. For me this is the clearest use case to say we do need a CBDC.
There are two other reasons. One of them is that a CBDC provides entrepreneurs with a unified market access. So if you build a CBDC, you create a standard on which start-ups can build innovations. They can build their apps, they can create solutions that are tailored to the African market. Instead of just importing the next American or UK or German app into your country, you enable your entrepreneurs to build for a much larger marketplace than if they were to use private crypto assets – so if they were to use their own marketplace.
From an industrial policy perspective, it’s a very important argument to make, to say, “we want to facilitate this market.” It’s one of the main reasons why China is doing their CBDC.
The third reason why I think countries are interested in CBDC is a defensive one. If you don’t provide public access in this public market, you will have companies like Facebook creating private markets. They would control who validates transactions, which would give them a lot of power to exclude small startups from the system, or create barriers to entry to protect the initial members of the association. This was very concerning for central banks, because it means they would have lost part of the control over the money supply and the circulation of money. We need to provide a public infrastructure to prevent the privatization of that infrastructure.
What kinds of problems would CBDCs present?
You need to make sure that if it’s legal tender like cash, it is universally accessible to everybody, [from] remote areas where it’s intermittent connectivity [to] crowded urban areas. That is one challenge.
One of the reasons why cash is so good is because it gives you immediate settlement finality, as well as full privacy of transactions. If you work with cash in the informal sector, you don’t fear that the government suddenly can come and present you with a big tax bill. Many businesses in the informal sector actually really like cash for the privacy it provides and central banks don’t want to be involved—they don’t want to know all these low-value transactions, it’s not their business to know. What they do want to know is the know-your-customer, anti-money laundering for very high value transaction. So this lever between privacy and auditability, I think that’s the second really essential challenge that CBDCs need to solve.
How do you see CBDCs fitting in the context of the global rise of cryptocurrencies?
We’ve seen with the rise of private crypto assets that there is a lot of innovation happening in that space. In South Africa there’s a nice example of Sun Exchange, a company that uses a blockchain to facilitate investment in solar.
One of the big problems in these investment projects is that the investor doesn’t know whether the project is successful and that the money wasn’t used for something else, so there’s asymmetric information. By putting all these all the electricity outputs together and making it verifiable, you can actually help the investor to have trust in the project. You create a history of payments from that particular solar panel that then can be used to de-risk this asset. And all of a sudden, what used to be an un-investable project becomes investable. This takes out the risk of the project and it facilitates investment, and as a consequence they are building large solar facilities across South Africa. I think that’s a fantastic use case.
One of my students worked with small-scale farmers to use blockchain to verify when something was harvested. The farmer would block an entry for the harvest, then when the harvest would be delivered to a local market, someone else would log another entry to say, “We’ve received it Thursday morning.” What my students built was a platform where you can scan a QR code and get the story of your food. It brings you closer to your food. If you do that again, you overcome this asymmetric information in agricultural production, and open up [once-risky assets] for investors to invest. This is truly powerful.
All of this is, at the moment, with private crypto assets. A CBDC would bring this into a much more formal realm. There’s lots of onboarding issues, there’s lots of uncertainty still with private crypto assets. if you do this with a public infrastructure, you will unleash this kind of innovation on a much larger scale.
What role would CBDCs play in Africa’s remittance market?
The reason why we have such big remittance markets in South Africa or in Africa in general is two-fold. One, you have a lot of pan-African migration. And two, the existing correspondent banking system has failed these guys. They work in another country, they don’t always have all the paperwork necessary to get a formal bank account because there’s a big barrier to entry. And if you don’t have a bank account, you are reliant on a few providers like Western Union, who just have very high transaction fees. So either you’re sending cash across borders, which is very dangerous, or, you find alternatives.
If you have a CBDC, you take out all the frictions from having a Balkanized, fractured remittance system. If you have a South African CBDC and a Nigerian CBDC and you make them interoperable, you can have almost instantaneous, almost free transactions between them, if those two CBDCs are efficient. And you can be fully compliant with foreign-exchange controls. It removes the remittance payments from the correspondent banking system, which was not really not build for this.
How would CBDCs fit in the context of growing investment in Africa’s fintech industry?
Think about the Google or the Apple Play store. Why are they successful? Because they provide developers with access to the entire customer base. CBDC would be the same thing, except that it’s in public hands, controlled by the government, so its regulated, it’s safe, it’s secure, it’s efficient. And you provide this universal market access. I think it would be a great boost to investment in fintechs in Africa, because everybody knows, “This start-up, when they build something that is compliant with what the CBDC does, then they can tap directly into the CBDC system [and they] have access to a billion people as potential customers.” I think Africa is so big as a market, that this would really be an extremely attractive value proposition for investors.
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Correction: An earlier version of this article stated that Sun Exchange uses a blockchain to verify the electricity output of solar panels. It uses a blockchain to facilitate investment.