Blockchain and its use in microfinance

Microfinance is quickly becoming one of the biggest fintech sectors in the world. Its goal to include as many people as possible in the digital economy of the 21st century is quickly being achieved as more and more people are being lifted out of poverty and forming their own small enterprises.

However, despite the already achieved success, there are some major issues that are keeping microfinance back. Most of the problems stem from technical difficulties and the limitations they impose on daily or even monthly users. It mostly revolves around transaction issues, not enough digital inclusion and, most of all, decreasing accessibility for the poor.

What is blockchain doing about this

The blockchain is predominantly digital, in fact, there is no “real world” application to any of the technology. Sure the server hardware is tangible, but that is not the main value of the system. Most of its value comes from the cryptocurrencies that are fueling the industry and the benefits they provide to their communities.

With the inclusion of the Blockchain, microfinance platforms are starting to pay a lot more attention to the main point in their agenda. Digitalize finance to a point where there is no other alternative, include as many people as possible, popularize fintech and overall deliver value to the world.

One of the best examples of this inclusion in South Africa, where many microfinance platforms are being formed as we speak. Due to the low income and even lower GDP per capita in the country, the population is unable to afford fully fledged loans from local banks, plus they are now afraid due to the African Bank disaster in 2014. Therefore they usually resort to the financial markets as a means of gathering enough funds for their future projects or just to sustain themselves.

This was becoming a real issue as Forex traders started to multiply in the country. The money lost with the regulated Forex brokers in South Africa was basically money wasted on other opportunities for economic development in the country.

The creation of the microfinance platforms was a direct counter to these Forex brokerages. A means to provide a source of funds for the population, which contained much less risk and involvement.

However, the microfinance platforms also came across some serious issues further in their management. Most applicants were not eligible even with the most forgiving criteria, but if they rejected them all, then they wouldn’t be creating any value. But once they did, most of these borrowers started defaulting on their loans or didn’t receive them in time.

How does the blockchain solve this?

Main issues with microfinance

Although microfinance is a directly fintech related industry, it relies very little on the participation of the users, which takes away the whole value of including more and more people into the digital economy.

People just receive the loan, cash it out in fiat and that’s it, the digital inclusion ends there.

Furthermore, most lenders on these platforms find themselves powerless in regards to who they can loan. Most platforms just gather a large pool of funds and just lend it out accordingly, while paying minimal interest rates to the lenders.

The blockchain aims to solve this through the transparency of its smart contracts. For example, what blockchain-based lending platforms can do is include a P2P connection between the lender and the borrower. Most participants will be able to indicate their criteria and their possibilities. This not only gives the lenders the opportunity to avoid risk but also provides the chance for the population to build their credit score.

The introduction of competition

The microfinance platform’s competition revolves around the companies themselves and not the people investing in them. Therefore, corporate deals on minimal interest rates offered is usually the case for the industry. This not only prevents growth but also hinders it from achieving its primary goal, “lifting the people out of poverty and including them in the digital economy”.

The introduction of fund control for the lenders will bring in a lot more competition. For example, a lender will not be able to afford high-interest rates due to his competitors offering industry standards.

And since the microfinance platform’s competition is quite linear (mostly about interest rates), we may see loans with just single digits as interest rates. Which is perfect for providing the population to borrow money, invest it in their enterprise or somewhere else, and later afford to pay it back.

What does the blockchain offer?

Overall it is hard to emphasize the value that the blockchain can bring to the industry. But it can be displayed in a simple list as follows:

  • Market competition (lower interest rates)
  • Fund control (better security)
  • Fast transactions (lower fees)
  • Better transparency (smart contracts & source codes)

Overall, these 4 points are the major advancements the microfinance industry can benefit from if it massively adopts the blockchain system.

Author: Yash Hirani

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