#47 The African Crypto Regulatory Hurdle

Understanding the factors that drive Crypto bans across the continent and how to deal with them

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Introduction

I have been a keen observer of the Crypto space particularly since I started dabbling in the Crypto space in more depth. The combination of less than developed financial systems and low levels of financial inclusion in Africa are problems which crypto intuitively solves. In the latter case of inclusion, I’ve stated multiple times that the main issue is not the ability to have a wallet or store of value, but rather the ability to participate in the global financial system through value movement either money or other representations of wealth.

A key area that I keep thinking about is the regulatory hurdles in Africa from a crypto perspective that hinder widespread usage of crypto to solve particular pain points. Of course, an analysis of this leads to some questions about whether even Crypto is the best way to solve some of the stated problems and whether other mechanisms exist that are win-win for everyone. 

Indeed, negative regulatory approaches are not an African issue, China and India have active bans against Crypto although India has recently proposed new taxation measures that tax crypto trades at 30% signaling a veiled acceptance of cryptocurrencies. The road ahead for crypto adoption faces significant barriers that are brought about by regulatory edicts. 

It’s important to have a holistic perspective on crypto starting with the stated benefits of cryptocurrencies and then understanding the basis behind the regulatory attitudes in the continent. With this understanding, crypto players can then start having targeted discussions with regulators that are likely to succeed and eventually the crypto promise can be upheld.

Crypto, Blockchain and web3

The entire industry encompassing cryptocurrencies, blockchain technology and the emergent web3 has become a topic of global interests. Just last month, a16z announced to its investors that it’s looking to raise a US$ 3.5 billion dollar fund that would invest in the crypto space including a US$ 1 billion fund to invest in seed stage startups targeting digital assets. Despite the apparent crypto winter where prices of Bitcoin, Ethereum and other cryptocurrencies have fallen, the interest in crypto continues unabated. 

The space can only be discussed in totality given that all pieces work together to form the big picture narrative.At the base are the underlying blockchain database structures that by being decentralised, form the basis of the token incentive structure that underpins almost all crypto projects. This older article gives a detailed breakdown of blockchains and decentralised databases. On top of these blockchains lie tokens that are the native currencies of that blockchain e.g. ETH or Sol for Ethereum and Solana respectively. Tokens are simply representations of value that can be traded. In some instances tokens are the functional equivalent of a US$ note or a share certificate depending on the context.

Thereafter, depending on the underlying blockchain, deeper functionality is built in representing a myriad of use cases such as digital assets like NFTs, smart contracts and maybe even the metaverse. My technical knowledge and skill in this space is limited so excuse the generalisations. Web3 nonetheless represents the promise of a new economy that avoids the gatekeepers of the existing internet (think Google, Facebook and Amazon) and decentralises ownership and decision making to the users. It’s still in the early days but the promise is big. Here’s a breakdown of why web3 matters.

Within the continent and emerging markets at large, crypto offers several promising yet untested at scale use cases;

Stablecoins

Stablecoins offer the promise of instant real time cross-border payments for businesses and individuals. This can power not only remittances but increased trade within the continent. Stablecoins are cryptocurrencies whose value is tied to a specific fiat currency, in most instances the US$. There are different stabilisation mechanisms such as holding fiat in reserve like USDC and Tether (USDT). Alternatively algorithmic stabilisation occurs where incentivisation mechanisms are designed so that the peg holds. MakerDAO is an example of an algorithmic stablecoin. Given that they’re on-chain, these stablecoins enable holders to transfer value globally and in real time. The use cases for B2B trade are quite useful particularly for transactions below US$ 100,000. Payment finality and confirmation is a major hindrance to trade payments in the continent. Other potential beneficiaries of stablecoins are African remote workers and African creators who can receive payment for their work without going through the hoops that the global AML/KYC system places on them.

NFTs and Ownership

Non-Fungible Tokens (NFTs) offer significant promise for digital asset ownership and tracking. According to the dictionary, a token is a thing that serves as a visible or tangible representation of a fact, quality or feeling. This is a useful description. A dollar note is a tangible representation of the fact that the US government stands behind the value represented by that dollar. Fungibility represents uniqueness and that it cannot be replaced or represented by another item. NFTs are thus representations of ownership that are unique and not replaceable. This definition shows why the whole concept of NFTs and the immutability of the blockchain is so promising for asset ownership and trade.

At the moment, NFTs are being used largely for digital art but they can easily encompass other areas where uniqueness and a representation of uniqueness is important. Examples include stock certificates, warehouse receipts, title deeds and other bearer instruments such as bonds. This article by Samakab Hashi of Lateral Capital gives a good primer of how NFT’s can drive growth in the continent. In a previous article, I detailed how DeFi can drive growth in African commodity trading and local value accretion. 

At the moment, a lot of the discussion around NFTs is driven by digital assets but in the long-term, moving physical assets on-chain can be a gamechanger.

De-Fi Lending

One of the issues within the continent is a broken financial system in most countries. The two core factors in my view are;

1. Active financial repression;

2. Uncompetitive banking markets;

In the case of financial repression, a number of central banks create conditions that force local savings with low returns so that they can dictate how money moves within the economy and what projects get funded. An interesting yet not obvious example is Kenya where a mixture of interest rate caps and a high appetite for domestic borrowing has kept interest rates for savers within a very narrow band for over five years. Kenya is an interesting example yet not glaring given that it runs an open capital account thus savers are open to moving their money out. In smaller countries, financial repression is executed through capital controls that lock money in whilst offering low real returns due to inflation to savers.

Uncompetitive banking markets that are typically oligopolistic; benefit from high interest rate spreads often in the double digits thus penalising both borrowers and savers. De-Fi lending where African savers and borrowers can access global capital pools using cryptocurrencies offers great promise. Savers can benefit from stable assets particularly in the case of stablecoins whilst benefiting from low interest rates when borrowing.

Enter Regulators

Clearly, with the above use cases being so useful, why aren’t regulators keen to play ball with crypto? There are a myriad of reasons why but in my view the largest are AML/KYC and monetary stability. The two must be analysed in concert. 

Source: worldmapblank.com

To analyse the motivations behind each regulator, one has to have an all of government view and knowledge of the local socio-political dynamics in each country. Most people within the tech space unfortunately don’t discuss these “all of government issues” which are very valid. 

We tend to bash gatekeepers but some gatekeepers are necessary such as the ones who actually protect you from foreign attacks e.g. the military. We can’t throw the baby with the bath water in our quest for unbridled decentralisation and autonomy.

Macro, Terror and Politics

When analysing the continent on the map above, it’s useful to categorise countries based on factors such as inherent macro stability, political maturity and terror threats.

Looking at the map above, we can start with my home country of Kenya and wander across the continent discussing the different motivations that each government has. Kenya for instance shares a border with Somalia to the east. Additionally due to historical decisions or factors, Kenya has been a target for global terrorism due to close links with the West particularly around security and intelligence. Kenya is thus a target for global terrorists as has been witnessed with attacks such as Westgate, The Garissa Massacre and the recent Dusit attacks. Anti-terrorism financing and traceability of money movement is thus central to national security and interests. The anonymity that crypto offers thus cannot be accepted and this is almost non-negotiable once you put yourself in the government’s shoes. Of course, there are ways around this. Stablecoins that are owned and managed by regulated and approved entities can offer benefits whilst avoiding the anonymity of crypto. This could be a potential entry point to the market. 

In neighbouring Uganda, the reasons could be both political and terror related. The country has been led by a single party since independence with a history of political repression. In such countries, anonymity is viewed as a risk because political opponents can finance their activities through crypto. In fact, I’ve heard of a case where an investor in one of the countries in the Great Lakes had a deal canceled by the intelligence authorities at the 11th hour because the said transaction would have benefited a member of the opposition. Imagine if the recent acquisition of Activision by Microsoft was blocked because Ivanka Trump was a shareholder in Activision? Well, This is Africa.

Crossing over to West Africa, Nigeria actually ticks all three boxes. Nigeria has inherent macro instability due to over reliance on oil. Additionally, it’s not a mature polity (neither are many African countries) and it faces significant terror threats. Even if the anonymity of Crypto could be solved in a viable manner acceptable by the government, macro risks would dictate that this would work against the interest of the central government. Ghana faces macro risks as well due to commodities such as gold, cocoa and recently oil. In fact, Ghana has had experiences of high inflation in the last decade largely driven by currency fluctuations. In Nigeria, Crypto has been marketed as a panacea to all the problems in the country unfortunately. However, Crypto won’t solve good governance, sound economic policy and adherence to the rule of law. This also applies across the continent.

In South Africa, there’s a stable polity and no sustained experience with terrorism. Nonetheless it’s a managed capital account with restricted currency outflows. In my view, South Africa is well placed to be a test bed for crypto and web3 in Africa due to its deep integration into the global economy, advanced commodity supply chains, world class banking system and deep financial market infrastructure.

In Francophone West Africa, consideration has to be given to where decisions on currency are made. In most other countries such as Malawi, Zambia, Botswana, Zimbabwe, Rwanda, Tanzania, Mozambique and others; a mix of immature polities, anti-terror financing and macro instability drive regulator attitudes towards crypto. Zambia for instance is heavily commodity dependent and thus crypto would be a non-starter. Having said this, there’s talk of Zambia being the Delaware of Africa given the president’s proactive stance towards supporting technology in Africa.

What does this thing do?

Despite the obvious threats brought about by monetary considerations, terror and politics, crypto still has a long way to go to convince regulators. One key area is around decentralisation and the benefits that this brings about. Do people really want to be their own bank or insurer? A key question is whether the benefits that crypto brings about such as inclusion, immutability, non-fungibility and token economics can be brought about through other technologies. An interesting experiment to this end is what China is doing with CBDCs. It’s interesting to note that Russia has also started to embark on a CBDC. 

This article gives a useful breakdown of web3, detailing the authors skepticism on web3 and decentralisation in general. The passage below states that web3 is generally a gold rush and this could be the underlying reason why regulators are yet to accept it. 

But you can’t stop a gold rush

When you think about it, OpenSea would actually be much “better” in the immediate sense if all the web3 parts were gone. It would be faster, cheaper for everyone, and easier to use. For example, to accept a bid on my NFT, I would have had to pay over $80-$150+ just in ethereum transaction fees. That puts an artificial floor on all bids, since otherwise you’d lose money by accepting a bid for less than the gas fees. Payment fees by credit card, which typically feel extortionary, look cheap compared to that. OpenSea could even publish a simple transparency log if people wanted a public record of transactions, offers, bids, etc to verify their accounting.

However, if they had built a platform to buy and sell images that wasn’t nominally based on crypto, I don’t think it would have taken off. Not because it isn’t distributed, because as we’ve seen so much of what’s required to make it work is already not distributed. I don’t think it would have taken off because this is a gold rush. People have made money through cryptocurrency speculation, those people are interested in spending that cryptocurrency in ways that support their investment while offering additional returns, and so that defines the setting for the market of transfer of wealth.

The people at the end of the line who are flipping NFTs do not fundamentally care about distributed trust models or payment mechanics, but they care about where the money is. So the money draws people into OpenSea, they improve the experience by building a platform that iterates on the underlying web3 protocols in web2 space, they eventually offer the ability to “mint” NFTs through OpenSea itself instead of through your own smart contract, and eventually this all opens the door for Coinbase to offer access to the validated NFT market with their own platform via your debit card. That opens the door to Coinbase managing the tokens themselves through dark pools that Coinbase holds, which helpfully eliminates the transaction fees and makes it possible to avoid having to interact with smart contracts at all. Eventually, all the web3 parts are gone, and you have a website for buying and selling JPEGS with your debit card. The project can’t start as a web2 platform because of the market dynamics, but the same market dynamics and the fundamental forces of centralization will likely drive it to end up there.

At the end of the stack, NFT artists are excited about this kind of progression because it means more speculation/investment in their art, but it also seems like if the point of web3 is to avoid the trappings of web2, we should be concerned that this is already the natural tendency for these new protocols that are supposed to offer a different future.

I think these market forces will likely continue, and in my mind the question of how long it continues is a question of whether the vast amounts of accumulated cryptocurrency are ultimately inside an engine or a leaky bucket. If the money flowing through NFTs ends up channeled back into crypto space, it could continue to accelerate forever (regardless of whether or not it’s just web2x2). If it churns out, then this will be a blip. Personally, I think enough money has been made at this point that there are enough faucets to keep it going, and this won’t just be a blip. If that’s the case, it seems worth thinking about how to avoid web3 being web2x2 (web2 but with even less privacy) with some urgency.

When such dynamics are at play, then it’s difficult to make a use case to a government regulator for web3 and crypto. Consider for instance that it can take up to 10% of the value you’re transacting to on-ramp and off-ramp into Crypto in Africa through platforms such as Binance. The only economic agents who would be comfortable with such transaction rates are the ones who are either speculating or gambling.

Wrapping it Up

Crytocurrencies and blockchain technology as pertains to tokenised incentives have great promise in the continent. Nonetheless, it will take a lot for regulators to come on board. One major job to be done for entrepreneurs in the space is to define a starting point that can be the springboard to larger crypto adoption and that is a useful proof of concept that a government can learn from. In my view this would mean finding a space that;

1. Aligns with a central government objective such as financial inclusion, growing agricultural value chains or widening the tax bracket;

2. Does not have entrenched commercial interests e.g. land transactions, defence contracting etc;

3. Proves core crypto outputs such as verifiable asset ownership, value transfer and immutability;

4. Gives government agencies visibility into the activity on the platform for potential tax and security reasons;

5. The core outcomes can give comfort to regulators to widen the scope of the proof of concept;

For Crypto to be widely accepted, it has to not only solve specific user problems but cater to core societal issues unfortunately encapsulated in government policy. Ultimately, as Africans we can’t imagine an existence outside of our governments. I imagine an African youth spending time on the metaverse whilst being robbed in real life. Going forward, maybe what is needed are Crypto research centres that engage actively with both government, large corporates, entrepreneurs and global investors. I know a number of people working actively to launch these. 

The years ahead are interesting for Crypto entrepreneurs in Africa. To make them more interesting, entrepreneurs need to add government engagement to their existing armoury.

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