Closing the Cash Gap With Cryptocurrency

(Bloomberg Businessweek) -- At the Sifa Children’s Center, shacks made of corrugated metal serve as classrooms for some 300 pupils, circling an expanse of dusty, hard-packed earth that’s both playground and meeting space. Beyond the school stretches Gatina, one of the poorest neighborhoods in Kenya’s capital of Nairobi. Headmaster Francis Wanjala is standing in an unused classroom studying his phone; he’s just learned how to trade a blockchain-based digital token.

Four years ago, Wanjala joined a local experiment in economic development, agreeing to accept and use a so-called community currency, paper vouchers that complement the official Kenyan shilling as a means of exchange within Gatina. At the start, the headmaster, and every teacher, got an allotment of “Gatina-pesa” worth about 400 shillings ($3.93)—enough to pay for a simple family meal. They could then spend them at local businesses that had also signed on to use the vouchers. The school uses Gatina-pesa to buy vegetables, sugar, and other ingredients for lunches.

At the same time, about 20 percent of parents now pay the fees for their children’s education in community currency. Fewer kids are dropping out, according to Wanjala. “We as a school noticed that there were a lot of challenges when it comes to paying school fees, because most of the parents run small businesses,” he says. “Whenever we have a parents’ meeting, we tell them about the community currency.”

Closing the Cash Gap With Cryptocurrency

Now, Gatina-pesa is going crypto, shifting from multicolored paper notes to a digital token based on blockchain, the recordkeeping technology that makes Bitcoin possible. The pilot program is funded by Bancor, a project based in Switzerland that operates a decentralized cryptocurrency trading platform. Bancor raised $153 million last year selling its own digital token, making it one of the splashiest of 2017’s so-called initial coin offerings, attracting instant skepticism from the many critics of crypto euphoria. Some of that doubt seemed justified in July, when thieves stole some $23.5 million from the fledgling Bancor Network (no customer wallets were breached, according to Bancor, and $10 million was recovered). But the network has processed more than $1.5 billion in cryptocurrency trades so far. Bancor’s name is a clue to its grander economic ambitions—it’s a reference to a currency conceptualized by John Maynard Keynes in the 1940s to remake the system of international trade. In Kenya, the startup is working to prove not only that crypto is useful for something besides speculation or illicit trade but also that it can be the basis for financial inclusion and economic stimulus for the poorest.

Closing the Cash Gap With Cryptocurrency

Despite the dominance of national currencies controlled by central banks, most of us also use alternative currencies without even realizing it. Think frequent-flier miles. One of the longest-running examples is WIR Francs, which hotels, retailers, and other companies in Switzerland have used for business-to-business transactions since the 1930s, helping insulate them from currency shortages and volatility. In general, though, governments and traditional financial institutions have tended to view such experiments with suspicion. The Austrian town of Wörgl created its own vouchers in 1932, using them to pay hundreds of unemployed residents to complete projects, such as road paving, for which the town didn’t have enough official currency. The workers in turn could spend their earnings at local businesses. But the Austrian government soon stepped in and made it illegal.

Will Ruddick ran into similar resistance after he started the community-currency project that includes Gatina-pesa about eight years ago. A physicist-turned-development economist who’s originally from California, he saw an opportunity to spur economic activity in impoverished Kenyan neighborhoods that were largely cut off from the formal financial system. In 2013 he launched the Bangla-pesa in the sprawling Mombasa slum known as Bangladesh. The government responded by throwing him in jail on charges of forgery. Ruddick was able to make bail after two nights, and the charges were later dropped.

Gatina, Bangladesh, and four other communities now have their own pesa, or sarafu (the words for money and currency, respectively, in Swahili), and more than 1,200 businesses and schools use them. Ruddick says the program has brought concrete benefits to these communities, including more students staying in school because their parents can pay the fees, better food security because families can buy from the local market with the vouchers, and an increase in local trade, according to user surveys.

Closing the Cash Gap With Cryptocurrency

The basic idea is that in communities where cash incomes are low and often sporadic, the vouchers can be used as credits to keep the local commerce in basic goods and services flowing. “We are not trying to create a new currency,” says Ruddick. “We are just filling a gap.” Crucially, the system is supported by agreement within the local community, rather than facilitated by charging interest, as in formal banking.

Elizabeth Olum, a slender woman of 30 who runs a grocery wholesale business, has used Gatina-pesa since 2014. “The community currency has been of great value to me, because I am part of a network, one family,” she says. “I have acquired many customers, because if someone has Sarafu and doesn’t have enough shillings, they can pay part of their purchase in Sarafu.”

Closing the Cash Gap With Cryptocurrency

Until now, these benefits have been limited by geography. Olum couldn’t buy vegetables with her Gatina-pesa in markets in the Lindi and Kangemi neighborhoods, which have their own vouchers. As the number of people and communities participating grew, Ruddick began looking for a way to scale up, adding liquidity and expanding the market and economic impact. This year he began working with Bancor as its director of community currencies. “I came to Bancor originally hoping that they could provide a solution for this situation we’re in: We’re starting to get more and more of these currencies in Kenya. How do you link them together?” he says.

Kenya has proven fertile ground for successful new-money technology, leapfrogging more developed economies with the mobile money system M-Pesa. Anyone with a phone can use M-Pesa to pay for most anything in Kenya, solving one of the major barriers to productive participation in the formal financial system: that millions of adults in Kenya don’t have a bank account. Last year, about three-quarters of them had a mobile money account.

In emerging markets such as Kenya, the relatively shallow reach of traditional financial systems and institutions means there’s less resistance to new financial technology, including blockchain, according to Marina Niforos, an economist and author of a series of studies on blockchain for the International Finance Corp., an arm of the World Bank Group.

Closing the Cash Gap With Cryptocurrency

The new digital version of Kenyan community currencies brings an M-Pesa-like convenience to the complexities of blockchain. Bancor developed the wallet app to be simple, so it takes only one or two clicks to do most things. The innovation, invisible to end users, is the Sarafu network token, a digital reserve currency. Now if Olum wants to venture into the Lindi neighborhood to buy vegetables, she can pay in Gatina tokens, which automatically convert to Lindi tokens. To Wanjala, though, it looks very familiar: “It works like M-Pesa.” Wanjala happens to have an Android smartphone, but most Kenyans have older-model flip phones. So Ruddick and the Bancor team have developed a way to use the digital tokens by dialing a code on any phone and following a simple text menu.

Closing the Cash Gap With Cryptocurrency

From a technical perspective, the most important hurdle is making a blockchain system that’s workable for small, daily transactions, such as the sale of tomatoes in a market in Gatina. That would be challenging with the original cryptocurrency, Bitcoin, which depends on a decentralized global network of computers engaged in a race to win their owners more Bitcoin. Vast electricity-sucking server farms in China and Canada have been harnessed for that task.

The new digital community currencies work on a different open-source system that Bancor helped to develop called the POA Network. Transactions on it are verified by a group of licensed notary publics in the U.S. who earn a small, fixed commission for managing the network. The community-currency trades are recorded on their own subnetwork, then bundled together and submitted to the main POA Network to reduce transaction fees (now about $0.0000019635, according to Ruddick).

Closing the Cash Gap With Cryptocurrency

Bancor has put more than $5 million into research and development for the technology supporting the Kenya project, including things like the wallet app, according to Galia Benartzi, a co-founder of Bancor. Like many in the crypto world, she speaks of remaking the global financial system. “The real opportunity here with blockchain and crypto is that we can build railways for a financial system which doesn’t rely on so much profiteering to operate it, which means that value can be redistributed, reinjected to communities and people,” she says.

Niforos, who’s also the founder of business advisory firm Logos Global Advisors in Paris, cautions that there are big risks to any blockchain project at this stage. “I’m not trying to be negative, because this is the kind of experiment that I’d like to see happening more,” she says. “What happens if this protocol is unstable or it keeps having security breaches? That doesn’t nullify the great processes going on on the ground. But what if they can’t guarantee the technical platform or the governance of the platform? Who’s responsible? These risks need to be actively managed from the start.” Such questions could be asked of many crypto ventures. But because Bancor users in Kenya are especially vulnerable economically, the stakes of getting it right are high.

Ruddick says a team of experts from the nonprofit Grassroots Economics and local leaders work to ensure transactions are functioning as they should. For now, communities can decide if they want to keep some of the paper vouchers alongside the digital tokens. And although the community currencies can trade with one another on the Sarafu network, they aren’t yet tradable for other cryptocurrencies, or for shillings or dollars, so the prospect of hacks or instability remains low. But it’s there, even in a relatively closed system. What if one community attracts the bulk of trade for all of the now-linked neighborhoods, sinking the value of the others’ currencies?

Ruddick and the Bancor team are working through all these issues, including a way to buffer the value of one community currency if it’s sinking relative to another, and a mechanism to build collateral that’s tied to the currencies, which could then be sold for regular, official currency. In case the blockchain the system is using becomes expensive or obsolete, Bancor is developing bridging technology to allow tokens such as the community currencies to migrate to other blockchains.

Ruddick says going digital will make some things simpler—no more printing costs—and also make it easier to launch more community currencies. The idea is that anyone with goods and services to trade can issue a token or cryptocurrency in what amounts to personal credit creation. In the Sarafu network, donors will eventually be able to buy Sarafu tokens, injecting money into the project, and then see exactly where that money goes and measure the impact by looking at the data recorded on the blockchain. The first trade on the Sarafu network was for a tomato.

Closing the Cash Gap With Cryptocurrency

“This is the first time I can really say that something as cheap as a 5¢ tomato was actually traded in a way that’s usable for a woman living in poverty,” he says. This time, the Kenyan government has been a lot more encouraging. It recently invited him to present the project to a government task force on blockchain.

Wanjala has already adapted to the digital version of the currency. “I prefer using the app,” he says. “When people look at the paper money, sometimes they don’t take it seriously.”

©2018 Bloomberg L.P.