#37 - The eNaira Project

Trying to contextualise the eNaira and understand its potential implications

Hi all - This is the 37th edition of Frontier Fintech. A big thanks to my regular readers and subscribers. To those who are yet to subscribe, hit the subscribe button below and share with your colleagues and friends. 🚀

Introduction

Nigeria’s Apex Bank recently pulled out of the public launch of the eNaira that was meant to coincide with the Nigerian Independence Day. The next launch date is yet to be announced but may likely happen in Q1 of 2022. Banks on the other hand have been working closely with the CBN to ensure that they are ready for the launch given that they are the main partners in the eNaira project. The eNaira is Nigeria’s Central Bank Digital Currency and will likely be the first in Africa. Other countries such as Bahamas and China have already launched their CBDCs whilst globally, different Central Banks are at various stages of their CBDC journeys from white papers to early testing.

Jamaica, Bahamas, Eastern Caribbean and Uruguay have all launched or completed their pilot programs. Here’s a global tracker of where different countries are in their CBDC journeys. 

Whenever you survey the coverage of the CBDC by Nigerian as well as international press, there’s an element of the classical line from Superman; “Look! Up in the Sky! It’s a bird! It’s a plane! It’s Superman!”. The coverage has been all over the place. Some coverage has been around the fact that the eNaira is a cryptocurrency or stablecoin. Other coverage has been around the idea that the eNaira will solve the existing currency devaluation issues that the country is facing by somehow powering remittances and of course, there’s been coverage around the impact of the banking sector and how the eNaira will disintermediate the financial system and thus drive fairer outcomes. With all this confusion, I thought it necessary to dive deep into the eNaira and build my own conclusions as to what the eNaira actually is, why it was necessitated and the likely impact on the Nigerian financial system. This is particularly relevant given the amount of money that’s been invested in the Nigerian fintech ecosystem.

First, it’s important to understand what the CBN has been up to for the last 10 years or so and maybe this will shed light on the rationale for the eNaira.

CBN and Financial Inclusion

Starting from around 2010, the Central Bank of Nigeria has paid close attention to driving financial inclusion in the country. At the time, the overall statistics around financial inclusion were not standing up well when compared to peers such as South Africa and Kenya. If the CBN drove financial inclusion, there would be improvements in key areas such as the depth of local savings, the ability to transact and participate in the economy and overall economic improvement measured both by GDP and the reduction in poverty levels.

As of 2010, only 36.3% of Adult Nigerians were formally included with over 46% of Nigerians being excluded. As regards exclusion, similar exclusion rates from South Africa and Kenya were 24% and 33% respectively. Kenya had a higher rate of informal exclusion which probably included Mobile Money providers. Through a set of targeted interventions, the CBN wanted to improve formal inclusion to 70% by 2020. These targeted interventions included;

1. Introducing tiered KYC to enable easier onboarding into the financial system for people who didn’t meet the existing formal identification requirements;

2. Developing a regulatory framework for Agency Banking;

3. Continued pursuance of mobile based payments system and cash-lite policies;

4. A host of other policies surrounding MSME credit schemes, consumer protection, financial literacy and agricultural finance policies particularly for small farmers;

As of 2020, the targets are yet to be met despite significant progress and innovation within the financial system. Formal financial inclusion according to Enhancing Financial Innovation and Access (EFinA) stood at 51%, quite far from the 70% target. At the same time, significant progress has been made in the Nigerian financial system such as;

1. Introduction of the Bank Verification Number (BVN) by the Nigerian Interbank Settlement System (NIBSS);

2. Introduction of Instant Payment System also by NIBSS;

3. Introduction of the Shared Agent Network Expansion Facility (SANEF);

Despite all these impressive measures, the targets are yet to be hit. This probably is based on a structural issue that should be solved by a change in the definition of formal inclusion, an acceptance of informal financial services into mainstream thinking or a deeper understanding of the structural issues around Nigeria’s economy. For instance, given the troubles in the North and the low income in some areas, is 70% inclusion even possible? In Kenya for instance, formal inclusion grew from 26% in 2006 to over 83% in 2019 largely driven by M-Pesa. 

Nigeria seems to have taken the stance of “Anything but Mobile Money” and the eNaira could be an off-shoot of this. The eNaira could be the CBN’s latest move in slaying the exclusion beast and there are significant implications based on how it’s designed and how it’s driven. 

One interesting story I’ve heard about the eNaira is the role of Ade Shonubi, currently a director at the CBN and one of the masterminds of the eNaira project. A technobanker like no other, Ade Shonubi cut his teeth managing IT and Operations across some of the largest banks in Nigeria. Thereafter he played a key role as the Managing Director of NIBBS from 2012 to 2018. In 2018, he was nominated to be a Deputy Governor of the CBN overseeing operations at the CBN. He has been the driving force behind a lot of the innovations such as the BVN and Instant Payments. Some say it’s because of a personal grudge against Interswitch which has had a stranglehold over payments in Nigeria through its transaction processing business and the Verve Card. Whether this is just hearsay or not, one thing I believe in is the power of people and ideas in driving transformational outcomes. Behind every great outcome is someone with the conviction to push through his ideas. 

What is a CBDC?

For a thorough primer on Central Bank Digital Currencies, read this older post of mine which does a decent job at breaking down what CBDC’s are. Driving the whole CBDC discussion is the issue around cash as a public good which enables every citizen in the country to participate in the economy. 

However, new modes of transacting are emerging such as stablecoins, private digital wallets and other fintech applications. These payment methods are novel and convenient, nonetheless they are potentially exclusive given that they are largely offered and managed by private entities. CBCD’s are meant to bridge this by offering digital legal tender to every citizen thus enabling citizens to transact in the modern era. It should mostly be seen as an appendage to existing payment systems rather than something that should override everything else. Additionally and importantly, CBDCs are digital cash and thus from a Central Bank perspective are considered base money or M0 and will be included in the Central Bank balance sheet in a similar category to cash.

Further, in terms of taxonomy, the money flower below enables one to contextualise what a CBDC is;

Source: Bank for International Settlements

CBDCs are meant to be widely accessible (retail based), digital and central bank issued currencies. Additionally they can either be token based or account based. In terms of design, the following are the core considerations;

1. Account or Token based - CBDCs can either be issued as accounts or wallets or they can be tokens issued by the Central Bank. These tokens can be attached to any wallet of your choice. There are serious considerations around both these design choices. If it’s token based, then the Central Bank will have to develop private key infrastructure and significant KYC capabilities. If it’s account based, there are considerations around their impact on the banking system. The eNaira seems to be account based where every Nigerian citizen, business and institution will have a wallet at the CBN;

2. Direct/Indirect distribution - If they are wallet based which they are; the Central Bank will have to figure out a distribution strategy. You can either distribute directly where wallets are held at the Central Bank or you could distribute indirectly where banks and other intermediaries are allowed to offer CBDC wallets. In Nigeria, the eNaira will be distributed directly by the CBN with banks playing the role of on-ramps and off-ramps into the eNaira system;

3. Interest bearing  - Central Banks could issue interest on CBDC holdings or they could be non-interest bearing. There are significant implications of paying interest to CBDC holdings in terms of monetary policy. In the case of the eNaira as well as the eCNY, both are considered M0 and thus won’t be interest bearing.

The diagram below shows how CBDC’s can coexist with other elements of the payments system.

On the left, the Central Bank will have a CBDC system that works through banks and other intermediaries to offer either tokens or accounts (wallets) to the general public of digital currency. This will live together with existing systems of traditional banking based on cash and account based payments or digital wallets which are backed by trust accounts held in the banking system.

Additionally, CBDCs are not necessarily cryptocurrencies. They are not decentralised ledgers that run on multiple nodes. If anything, they are centralised at the Central Bank. Therefore I don’t understand discussions around CBDCs and blockchains. Having said this, CBDCs can be built around smart contracts thus enabling programmability. However, my view is that programmability is best suited to token based CBDCs and not account based CBDCs.

The eNaira

Source: CBN eNaira Presentation

The diagram above from a presentation by the CBN on the eNaira gives the overall characteristics of the eNaira project. By its definition as a legal tender that has parity of value to the Naira and is non-interest bearing, one can see its role as base money (M0). Additionally, it’s clear that it’s an account based wallet and thus not a token with settlement finality. Onboarding will be based on the BVN as well as the National Identity Number which is being rolled out across the country.

Source: CBN eNaira Presentation

At an overall level, there will be a Digital Currency Management System built by Bitt Inc, a Caribbean based Fintech company that builds blockchain based payment systems for both Central Banks as well as banks.  The DCMS will have modules to cater for the whole spectrum of participants such as banks, government agencies, merchants and retail consumers.

The flow of transactions is best captured by the slide below from the presentation.

Source: CBN eNaira Presentation

In terms of distribution, banks will start by sending a list of all their BVN’s (account holders) to the Central Bank. Thereafter the Central Bank will issue authorisation codes for each BVN and share this with the banks. Banks will then send these authorisation codes to their customers and invite them to open their eNaira wallets. Customers will then download the Speed Wallet from Google Play Store or IoS. They will proceed to enter the authorisation code received from banks, enter their personal details and then have their eNaira wallets approved and ready to transact. Transactional limits will be pre-set based on their KYC levels.

Thereafter, banks will request a specific volume of eNaira from the Central Bank. Once this is approved, the institution's account at the Central Bank will be debited and their eNaira account will be credited. The second tier of distribution will kick in; If a customer requests eNaira, the bank will debit their bank account and credit their eNaira wallet. In principle, this is very similar to the two tier distribution model for mobile money. You can read about that here in this older post.

In MoMo electronic currency is issued by a bank and regulated by the Central Bank. Participants open wallets through the Telco such as individual wallets, agent wallets or biller wallets. The role of the bank is to ensure that the electronic float in the entire system corresponds to the trust account balance. The eNaira currency management system thus works in a similar fashion to MoMo but in this case it’s a public system owned and managed by a Central Bank.

Things to Think Through!

There are a number of implications if the eNaira succeeds that will need serious consideration.

Impact on Banks

eNaira is base money and is based on an account held at the Central Bank. The process of moving money from your account to the wallet is functionally equivalent to withdrawing money from your account and keeping cash. One of the disadvantages of cash relates to remote payments. If you have electronic cash, then remote payments are enabled thus obviating bank account based payments. There are significant implications. Banks make their money by converting M0 into higher forms of cash such as M2 and M3 via maturity transformation. A banks payment business is built around transactional enablement with the benefit being low cost liabilities and fee income. Low cost liabilities power maturity transformation and fee income is risk free income.

If banks were able to issue eNaira wallets, then functionally this problem wouldn’t occur given that the balances held in bank issued eNaira wallets are equivalent to cash and would be useful for liquidity management. 

Banks have to maintain the infrastructure behind onboarding into the eNaira i.e. the burden of KYC is managed by banks whereas the downside of losing your liquidity accrues solely to banks. I think a discussion is required here by the banking lobby as to how the Central Bank will manage this. One potential approach is to severely limit the balance each eNaira wallet can hold thus practically throttling deposit loss. This is a structural issue that the CBN needs to think about given that banks will be responsible for the initial launch and can thus kill this process given what’s at stake for their businesses but also for society at large. Maturity transformation is one of the secret sauces of the industrial revolution. If you disable it, then you kill economic growth. The current eNaira design will convert banks into peripheral players in the financial system.

Impact on the Payments System;

A lot of people have dismissed the eNaira system from the get go. Indeed there are significant structural issues such as the one mentioned above. However there are potential benefits. First, the CBN needs to ensure that the eNaira system is stable, reliable and scalable. It needs to have 99.9999% availability particularly when it comes to payment finality. The CBN is backing this project and the eNaira is a claim on the government and not a private entity; it can thus notionally engender more trust by citizens than any other payment system. This is not something to be scoffed at. If well executed, you can in principle drive financial inclusion and payments innovation.

Different countries have approached their payments journey in different ways, there has to be a balance on pros and cons whilst having a foundational true north underpinned by your structural realities. In essence, as Elon Musk says, you have to “teach to the problem and not the tool”. Thus Central Banks need to move away from tool based thinking and move towards problem based thinking with a CBDC just being a part of the toolkit. 

India has approached payments innovation through the India Stack and UPI, Brazil similarly has launched Pix. The UK and Europe are approaching payments innovation through Open Banking built along real time payments such as SEPA and Faster Payments. China has a private sector led payments system and has thus built an eCNY to offer an alternative to private payment platforms. Kenya is built around Mobile Money and specifically M-Pesa. There is merit to the eNaira in the sense that an open banking based system may not work given issues around financial inclusion. An Indian one may not take off due to the underlying absence of the rich identity stack. A Kenyan model may work very well, but given that payments are a public good, public policy should lean towards a more open system. Thus an electronic Naira based on a universally accessible wallet makes sense. The devil is in the executional details.

Programmability and Accessibility;

The eNaira will only be as useful as its programmability and accessibility. To understand this, you should appreciate the following;

1. It’s not necessarily a payments innovation given that its functions can be achieved with existing technology - It’s a financial inclusion innovation;

2. Given it’s distributed structure, there are likely to be massive balances held across citizen eNaira wallets largely for transactional purposes;

3. APIs are driving an unbundling of universal banking with a separation occurring where payments, lending and credit analysis are unbundled;

With that in mind, to drive full value, the CBN has to enable fintechs and other players to innovate on top of the eNaira system through open APIs. For instance, merchant eNaira receipts can be evaluated in real time to enable SME credit scoring and thus more contextual lending decisions. Players can emerge in this space with organisational structures and practices custom built for eNaira based merchant lending. This amongst others will be the key long-term innovations that will drive further financial inclusion.It can be a very strong incentive for onboarding into the eNaira. Additionally, the CBN should think of a hardware wallet for off-line access.

eNaira is not a Panacea

The eNaira will not solve any structural issue such as inflation or exchange rate dynamics. African governments have a history of playing tricks around structural issues. In the last 15 years, both Zambia and Ghana have rebased their currencies whilst not solving for the structural issues underpinning currency weakness. The eNaira will not solve for devaluation and will neither solve for increased remittances given that the latter is held back by a dual exchange rate system. 

Don’t sleep on the eNaira

There was a moment captured on Kenyan TV some years back, where the then Permanent Secretary in the Ministry of Health was recorded threatening a journalist. In an expose that was recorded, the PS warned the poor journalist in Swahili by asking her “Wewe unajua serikali kweli” which can be roughly translated as “Do you really know what the government is capable of”. He was basically telling the journalist that the government has powers that most citizens don’t even know about and if she continues meddling, she will soon discover them. It’s a phrase that has stuck with me because he was right, most people don’t understand the power of the government. 

Emmanuel Augustus was a professional boxer who came to fame in the mid 90s and retired in 2011. He was known as the drunken master with a unique style where his movement resembled that of a drunken man. Nonetheless, this was calculated to confuse his opponent and he often landed heavy hits. African governments have a drunken master characteristic to them, they look heavy and clunky and from the outside, they seem like they’re stumbling along. Despite this, you should never underestimate them. It’s a lesson that is well known by traditional entities such as banks and older institutions but is less appreciated by Fintechs and startups. 

The Nigerian government, if committed to the eNaira project, has a number of heavy weapons in its arsenal that can drive universal usage of the eNaira. These range from paying public sector salaries into eNaira wallets, paying contractors through their eNaira wallets and a whole host of other directives. Fintechs and other observers should have a healthy respect of the eNaira project.

It will be interesting to see how this plays out, if well executed whilst catering to some of the concerns, then it can be a great innovation that all African countries should watch.

As always thanks for reading and drop the comments below and let’s drive this conversation.

If you want a more detailed conversation on the above, kindly get in touch on samora.kariuki@frontierfintech.io or samora.kariuki@gmail.com