We have long understood our traditional financial system to be inadequate. There’s sufficient and, frankly, overwhelming evidence that it actively contributes to inequality through discriminatory, exclusive, and often predatory practices.
In 2018, 11.8% of Americans, or 38.1 million people, lived below the poverty line. The rate, while historically low for the U.S., is among the highest in the developed world. The failure of the U.S. government to provide sufficient support during the pandemic has further exaggerated the situation. A study by researchers at Columbia University shows that the number of people in poverty has grown by 8 million since May. Another study shows that poverty increased by 6 million people over the last several months. Meanwhile, 69% of Americans live paycheck to paycheck, with little or no financial stability.
Now, let’s have a look at the banking system through the lens of financial inclusion and its impact on the most vulnerable share of the population. According to the Report on the Economic Well-Being of U.S. Households in 2018, 22% of Americans were either unbanked or underbanked, with limited access to basic financial services. The cost of financial exclusion falls almost entirely on the minorities. Nearly 50% of black households are financially underserved, which, according to consulting firm McKinsey, can add up to roughly $40,000 in fees throughout a financial lifetime.
There are many reasons for that. One of them is that these customers are not profitable for the banks. They live in rural and exceedingly remote areas, have little financial assets, and will not pay enough to justify the cost of servicing them. Did you know that it costs anywhere between $250 and $400 for a bank to open and maintain a bank account for a person? This number is a bit smaller for local and community banks as they have lower overhead and other associated costs.
What this means is that millions of Americans are excluded from what most of us consider to be necessities, things like phone or internet subscriptions, any form of e-commerce, etc. Locked out of the financial system, these people have no way to store whatever savings they might have safely and conveniently. With no credit history, they lack access to institutional credit and must turn to predatory services.
For the unbanked and underbanked, everything we take for granted comes with a fee. Cashing a check, transferring money, or paying bills all have associated fees. In fact, an average of $108 per month of fees.
Everywhere you look, the traditional financial system is actively contributing to the growing inequality. Without access to financial services, many are not able to save, invest or insure themselves, often failing to convert the money they earn into sustainable wealth.
To address these structural flaws, a new financial system is being built on top of the blockchain technology. Introduced by Satoshi Nakamoto in his original Bitcoin whitepaper, blockchain is one of the innovations powering the first cryptocurrency. It allowed us to create trustless, decentralized systems that operate according to open and publicly available set of rules.
One such system is decentralized finance (DeFi). DeFi is the recreation of the traditional financial system on a blockchain. While replicating many of conventional financial products, DeFi is inherently democratic and open, with no discriminatory biases. In fact, anyone can participate in the DeFi ecosystem as there are typically no KYC requirements, identity, or credit score checks.
DeFi, however, still requires fiat to crypto on-ramps. Despite the increase in the use of digital payments, many Americans still prefer cash over plastic. In fact, 99% of Americans still report using cash, significantly above the 75% and 80% who have a credit or debit card, respectively.
This is where Bitcoin ATMs (BTMs) come in. As of November 1, there were 11,497 BTMs worldwide, allowing anyone to buy or sell Bitcoin and other digital currencies. Majority of those, nearly 83%, are in North America. Most BTMs are easy to access and offer underbanked communities an easy option to save, invest and pay bills. Ben Weiss, COO of CoinFlip, stated that his BTMs are mostly located in convenience stores and gas stations, removing some of the geographic barriers associated with accessing traditional financial services.
From the investment perspective, Bitcoin offers many benefits. In today’s world of unprecedented money printing and fiscal stimulus, it’s one of the very few assets that is genuinely scarce and fundamentally deflationary. While Bitcoin’s supply is currently growing at 2.5% a year, the issuance of new coins will stop once the programmed amount of 21 million is reached. Research, from the blockchain analytics firm Messari, shows that Bitcoin offers superior risk-adjusted returns and has a low correlation to traditional markets. Historical investment performance, as evident in the chart below, speaks for itself.
There’s an increasing recognition among many investors that Bitcoin is a safe haven asset, a so-called digital gold narrative. This narrative is being adopted by professional investors like Paul Tudor Jones, Bill Miller and Stan Druckenmiller. On the corporate treasury side, many companies are allocating capital to Bitcoin, including MicroStrategy’s $425 million investment and Square’s $50 million allocation. In fact, cash is no longer safe. This year, cash underperformed most traditional assets, despite the worst economic crisis since the Great Depression. At the same time, the purchasing power of the U.S. dollar has consistently declined over the decades, dropping by 1% so far in 2020.
For many unbanked and underbanked communities, BTMs present perhaps the only opportunity to gain exposure to the growing crypto ecosystem. While most BTMs are user-friendly and convenient, there could be significant differences between BTM operators.
In the US, BTMs are regulated as money services businesses (MSB) and must register with the Financial Crimes Enforcement Network (FinCen). With this, come compliance and regulatory obligations. Using a non-compliant BTM provider could have legal and tax repercussions. In Germany, for example, the Federal Financial Supervisory Authority known as BaFin has recently seized 17 BTMs that were unlicensed and operated illegally. BaFin also announced that any business or person providing services, like internet or real estate space, to unlicensed BTM operators would be complicit in the illegal activity.
Fees and commissions are another crucial difference between good and bad BTM operators. Some BTMs have astronomical commissions and spreads. If not careful, customers can end up paying 5% to 20% above the market price. Of course, BTM operators face substantial costs associated with their business from rent and compliance to banking and cash logistics. This does not mean, however, that they need to resort to predatory practices to operate a profitable business. Despite this, providers like Coinsource and Coinflip have introduced competiative fees at 11% and 8% respectively.
To protect consumers and reduce the risk of fraud, we need a fair and comprehensive regulatory framework for BMT operators. CoinFlip, for example, has taken an active approach by advocating for regulatory reform in the U.S. to build a sustainable and innovative blockchain industry.
Now, however, the regulatory framework in the U.S. is significantly behind many European and Asian countries. Companies have either left or are considering moving their businesses overseas, to countries like Switzerland, Singapore, Japan and the U.K. According to the Executive Chairman of Ripple Inc, Chris Larsen, “blockchain, and digital currencies are not welcome in the U.S.”
When it comes to BTMs, operators need a money transmitter license for each state they do business in. Some states, for instance, don’t require a permit for so-called two-party transactions or transactions that don’t involve an exchange. Others have prohibitive requirements like costly licenses and large surety bonds. Lack of clear-cut federal regulation is hindering the innovation in the space.
There are some signs that Washington is waking up to the need for regulatory clarity on digital assets. The “Digital Currency Exchanges Act 2020”, if passed, would bring digital currencies under one federal law, removing the need for state-by-state licensing. Another bill, the “Securities Clarity Act” aims to introduce a clear distinction between a digital token and a security. This would “provide a path to regulatory certainty for digital assets and other emerging technologies under securities law.”
If properly regulated, the blockchain industry can deliver jobs, tax revenue and most importantly, an inclusive financial system to unbanked and underbanked communities. If not, innovative companies will increasingly move elsewhere, leaving millions of Americans behind. Time is of the essence.