Article by Bankless Africa Cover Art by AB_colours

While blockchain technology and cryptoassets have created a whole class of investment vehicles for individuals who already have access to financial services, unbanked people can benefit the most from decentralized finance (DeFi). For individuals without a bank account, these technologies enable them to gain access to basic financial infrastructure, such as faster and cheaper remittance payments, loans, and retail investment opportunities.

In 2021, The Fintech Times found that 57% of the African adult population remains unbanked. But it’s not for lack of technology, as sub-Saharan Africa has long been a fast-growing mobile phone market. By some measures, 75% of the population now has access to a mobile phone. Combined with the growing deployment of public WiFi, it has become far easier to get an Internet-connected mobile device than to open a bank account.

Despite having a mobile phone and internet access, there has not been a correspondingly large uptake in DeFi usage. Here we examine the lagging adoption of DeFi across the African continent and highlight some of the ways Africans can benefit from DeFi protocols.

DeFi mimics traditional financial services, such as lending, borrowing, and a savings account, but cuts out centralized third parties through the use of blockchain technology. Instead of entrusting a centralized custodian with their money, DeFi users transfer their funds to a smart contract which, depending on the DeFi protocol used, can serve many functions of traditional finance. Several key categories of DeFi applications include stablecoins, exchanges, credit, derivatives, insurance, and asset management.

One of the earliest and most common DeFi use cases is lending. Borrowers stake one type of cryptoasset as collateral to the lending smart contract and receive a loan in another cryptocurrency, typically a stablecoin. Upon repayment of the loan plus interest, the borrowers can withdraw their collateral again.

Another common use case is the generation of passive income. For example, crypto tokens held on a decentralized exchange (DEX) are in constant need of liquidity. Users who provide this liquidity can be rewarded with a share of the trading fees the DEX collects, or more of the tokens for which they have provided liquidity (known as liquidity mining). Most recently, automated yield farming strategies have emerged that combine several of these yield-generating opportunities in order to maximize the passive income that may be earned.

DeFi is often contrasted with CeFi (centralized finance) crypto service providers, such as Binance or Coinbase. Like any traditional exchange platform, centralized crypto exchanges hold all user funds together to pool liquidity, utilize a market-making algorithm to connect supply with demand, and manage an order book to internally record and validate every transaction. In contrast to permissionless DEXs, CeFi operators determine which cryptocurrencies to list for exchange.

According to the World Bank’s Global Findex database, as of 2017, 1.7 billion people did not have access to a bank account and many more are underbanked. By far the most common reason cited was lack of enough money to use one; other reasons include lack of necessary documentation, inconvenient locations of financial institutions, and the expenses associated with holding an account. Women and young people are disproportionately excluded from the financial system, but there are signs that mobile technology may help to close this gap.

DeFi can enable access to a rich financial infrastructure, especially for those who do not have formal identification or who live in places without robust institutions or stable economies. In order to fulfill this vision for economic inclusion and prosperity and go beyond the crypto talking point of “banking the unbanked”, DeFi will need to prioritize four goals:

• Cater to everyday use cases

• Offer easy to use products

• Enable risk transfer use cases

• Account for mobile devices and internet accessibility

While cryptoassets are gaining a foothold in Africa at roughly the same pace as in other continents, adoption of DeFi applications has generally been slower. The Chainalysis 2021 Geography of Cryptocurrency Report shows Togo had the highest rate of DeFi adoption among all African nations. In a worldwide comparison, Togo is ranked at number 20, followed by South Africa (26), Nigeria (34), Ghana (37), Côte d’Ivoire (43), and Zambia (52).

Adapted from the Chainalysis 2021 Geography of Cryptocurrency Report (p.14)

In the following sections, we analyze possible causes of the slow adoption of DeFi in Africa and what can be done to increase DeFi adoption rates.

Unlike cryptocurrency payments, which can be sent to a wallet even when the recipient is offline, usage of DeFi protocols requires a more readily available Internet connection. In 2020, one out of two urbanized Africans reported using the Internet compared to only 15% in rural areas. The rapid growth of Internet usage in impoverished communities became possible with the advent of mobile devices, such as smartphones and tablets, which provide affordable access without the need for fixed hardware and a stable power supply.

However, MetaMask, which is by far the most commonly used wallet to access DeFi services, was not available on these mobile devices before September, 2020. Since many DeFi applications have only limited options to connect a wallet and MetaMask was the preferred wallet in most cases, this meant that many DeFi services were not accessible without a computer. 

Finally, there is an increased security risk when storing cryptoassets in a mobile wallet, since these devices are more prone to loss or theft, and are more than desktop computers. Hardware wallets, which provide the highest level of security, are often not a viable option either, due to the relatively high upfront costs. 

Although decentralized finance is among the most sophisticated use cases of blockchain technology, it has not yet reached the awareness of mainstream crypto users. Extensive knowledge of the whole crypto ecosystem is needed to properly assess the risks and benefits of the various DeFi protocols.

Ideally, DeFi investors should have an idea of how their investment is utilized on any DeFi protocol they use. This is even a problem in the developed world, as “DeFi degens” often invest their crypto based purely on the yield stated on the DeFi app without doing adequate research. Doing proper DeFi research takes both time and an extensive knowledge base of the whole crypto economy.

Until recently, most DeFi platforms were concentrated on Ethereum. Due to its notoriously high transaction (gas) costs, the leading smart contract platform has not become the blockchain of choice for crypto payments in Africa.

This has meant that DeFi on Ethereum was not viable for sums below one thousand USD, since the transaction fees for depositing and withdrawing funds would offset all the benefits received from using DeFi applications. This only changed after the events of “DeFi summer” in 2020 when DeFi protocols began to spread to alternative blockchains, either by expanding to an Ethereum alternative, or by being forked by an independent project.

Even with low-fee alternatives available, the utility of DeFi is relatively low for impoverished communities that cannot afford risky investments. Oftentimes, investments into basic household amenities provide a higher economic benefit than growing one’s wealth through speculation or passive income, which leads to a strong tendency towards risk averse behavior.

DeFi lending typically involves using a volatile cryptocurrency as collateral while borrowing in a stablecoin. On the opposite end, supplying a stablecoin to a DeFi protocol in exchange for an APY creates a smart contract risk that low-income individuals might not be willing to take.

Decentralized risk markets, which can be used to hedge against certain risks, could turn this situation around. However, DeFi penetration into risk markets, such as decentralized insurance protocols, is still in the early days of development and it will likely take some time for them to roll out suitable mainstream use cases.

DeFi education campaigns targeting African users should take into account the prevailing socio-economic characteristics of the local population. Specifically, consumer needs should be carefully assessed to find out which DeFi applications can provide the most benefit to the users.

For example, DeFi users in low-income agricultural economies have different needs than in high-income African countries with a growing middle class who can afford risky investments. Furthermore, the knowledge level of the population should be taken into account. This includes general education, financial literacy, and crypto literacy.

DeFi education should be done from the ground up — starting with the secure management of self-custodial wallets, general blockchain knowledge, and the most basic building blocks of of DeFi, such as lending and DEXs — before moving on to more sophisticated use cases like liquidity mining and yield farming.

Finally DeFi education in Africa should have a strong focus on risk management. Novel DeFi applications in the field of insurance or hedging tools that might be more suitable to African consumer needs should be identified.

More research is needed in how DeFi can be used to hedge against risks. An important part of this is insurance protocols such as NexusMutual or Solace that can be used to secure a position on a specific DeFi platform.

In the next step, DeFi tools that can mitigate business or production risk might hit mainstream adoption in the near future. For example, this could take the form of a prediction market that uses adverse weather outcomes, pandemics, or natural disasters as outcome factors.

Synthetic assets could also become a tool for risk transformation. It’s feasible that a synthetic asset that tracks the wholesale price of a specific resource could be used by the enterprises that process this resource to hedge against rising resource prices. For example, an agricultural business that has the business risk of rising fertilizer prices might want to purchase synthetic assets that track the price of fertilizers to decrease this risk.

Synthetic assets can be issued in a simple way in the same fashion as any decentralized stablecoin, using a wide variety of tangible or intangible underlying bases. For instance, it is conceivable to have a synthetic asset token that tracks a basket of consumer goods, the inflation rate, or the central bank’s base rate. One success in the area of synthetic assets is Synthetix (fiat currencies, cryptoassets).

As of now, risk markets are a mostly untapped field in DeFi that will need several more years of research to become available on a large scale. Furthermore, there is a liquidity issue for exotic risk transformation protocols, since they need a counterparty to take over the risk.

It is estimated that only 3% of the 48 million smallholder farmers in sub-Saharan Africa have crop insurance. Following a successful pilot project in Sri Lanka, the decentralized insurance protocol, Etherisc, launched a larger-scale initiative to bring crop insurance to farmers in Kenya in November 2020. For this purpose, Etherisc partnered with the crop insurance provider ACRE Africa and Chainlink, which supplied weather oracles for the regions where the insurance policy was offered.

In cases where the Chainlink oracles reported an adverse weather event, the affected farmers received an automated blockchain-assisted compensation at the end of the season. This significantly helped speed up the compensation process, compared to traditional insurance programs where farmers typically were only compensated after the new season had started. In August 2021, the program was complemented by a mid-season payout option which allowed farmers to replant their crops and save the ongoing season.

Etherisc’s technology was integrated with the ACRE BIMA PIMA solution, which handed out scratch card codes alongside seed bags purchased from partnering suppliers. Upon SMS/USSD activation, the farmers automatically received basic crop insurance, which they were able to top up with their private funds. With the activation, the farmer’s phone location was triangulated and stored on the xDai chain, alongside other relevant data, such as the phone number and type of crop seeded.

What came of this was an automatic creation of an insurance policy, without further input needed. If an adverse weather event was detected throughout pre-defined windows of the planting cycle (germination, vegetation, flowering, etc.), the farmers were notified via SMS that the policy was triggered and were able to receive their compensation using the mobile payment gateway M-Peso.

During the first season of the program, Etherisc and ACRE have provided such insurance policies to over 17,000 farmers in 17 Kenyan regions. As of December 07, 2021, there were 511 mid-season payouts for a total of 75,295 KES ($670 USD) and 4,021 end-season payouts for 309,939 KES ($2,766 USD).

As the next step, Etherisc aims to expand the program to provide 250,000 farmers across East Africa with crop insurance for premium installments as little as 0.50 USD. For this purpose, they have joined forces with the Lemonade Foundation to form the Lemonade Crypto Climate Coalition DAO.

In the long-run, it is estimated that blockchain-based crop insurance can mobilize up to 10 billion USD in annual premiums once fully scaled. According to the Global Innovation Lab for Climate Finance, this insurance model can reduce the costs required to issue a policy by up to 41%, enabling a premium reduction of up to 30% and reduced claim cycles from three months to one week.

As an international media node of BanklessDAO, the BanklessAfrica team seeks to drive the adoption of trustless, decentralized money systems and blockchain technology with the aim to promote capacity building, economic empowerment and financial sovereignty in Africa.

Author Bio 

This is a collaborative effort between BanklessAfrica, BanklessDAO Research Guild, and BanklessDAO Writers Guild.

BanklessAfrica is an International Media Node that seeks to educate, onboard and inform everyday Africans about bitcoin, DeFi, DAOs and Web3.

BanklessPublishing is the publishing arm of BanklessDAO. Top shelf educational Web3 content.

BanklessDAO is an education and media engine dedicated to helping individuals achieve financial independence.

This post does not contain financial advice, only educational information. By reading this article, you agree and affirm the above, as well as that you are not being solicited to make a financial decision, and that you in no way are receiving any fiduciary projection, promise, or tacit inference of your ability to achieve financial gains.

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