African Free Trade Can Succeed With Bitcoin
The African Continental Free Trade Agreement (AfCFTA) is the dawn of a fresh start for the continent, and if implemented successfully, it will unleash a new era of prosperity on the back of increased intra-African trade. At present intra-African trade is very low, making up only 14.4% of the continent’s total exports. The United Nations Conference on Trade and Development (UNCTAD) predicts that the AfCFTA could potentially increase intra-African trade by 33% thus reducing the continent’s trade deficit by at least 51%. The elimination of tariffs, key infrastructure development and the harmonization of customs procedures are also core tenets of the agreement that are critical to its success.
As the continent grapples with the negative economic effects of the pandemic, it became very clear that developing decentralized regional value chains is necessary. This pact aims to create a new borderless market that connects 1.3 billion people across 55 different nations with a combined gross domestic product (GDP) of $3.4 trillion, thus becoming the largest free trade area in the world according to the World Bank. This will potentially lift at least 30 million people out of poverty and add at least $450 billion in potential income to the region. This article will explore how the AfCFTA could benefit from Bitcoin adoption.
Cross-border payments within Africa are very slow and costly. This is partly due to the fact that 80% of African cross-border transactions originating from African banks are routed offshore for clearing and settlement through correspondent banking relationships. With over 42 different currencies on the continent, currency conversion costs amount to $5 billion annually. Additionally, the majority of these currencies don’t have any value outside of their home country and, coupled with disparate regional exchange rate regimes and payment systems, transacting with African currencies becomes impractical. Without a uniform or robust payments network, the AfCFTA is unlikely to succeed, and this is where Bitcoin is a viable solution.
Although mobile money usage has increased with the rise of services like M-Pesa, most mobile money wallets are closed systems that aren’t interoperable and only work within certain jurisdictions. Bitcoin wallets, on the other hand, are interoperable and are not limited by geography or regional monetary systems. Merchants are able to transact with each other via their bitcoin wallets at a much faster and cheaper rate than traditional fiat payments. Layer 2 solutions like the Lightning Network have resulted in the reduction of transaction costs for bitcoin-denominated transactions, thus making micropayments possible and reducing the costs of remittances. This would greatly benefit informal traders who are currently unbanked.
The Pan-African Payment Settlement System (PAPSS), a centralized payment and settlement infrastructure for intra-African trade was developed to allow for quicker processing of cross-border transactions and all the bottlenecks cited above. An initiative of the African Export–Import Bank (Afreximbank) in conjunction with the AfCFTA secretariat, PAPSS aims to connect African markets with each other by enabling instant cross-border payments in respective local African currencies for cross-border transactions. In other words, according to a description of how PAPSS works, when an individual or company initiates a cross-border African transaction, compliance checks between countries involved are done within the system instantly. Money from a sender’s bank would go straight to the beneficiary’s bank within minutes and not days.
While this is a welcome development and would remove some of the friction associated with cross-border payments, it has a few major disadvantages. First, every payment company, bank, fintech company, etc. that wants to become a participant of PAPSS has to be individually connected to its central database. This is not only inefficient, but it also creates a single point of failure due to its centralization.
Second, PAPSS in its current form does not incentivize financial inclusion on the part of traditional financial institutions in any way. This results in financially excluded informal sector traders being unable to reap the full benefits of the AfCFTA. Furthermore, the trade flows of informal cross-border traders will continue to be inaccurately recorded as they carry on trading with cash. Lastly, African currencies are generally weaker due in part to political instability and low economic productivity; this is something that PAPSS cannot hedge against that bitcoin can.
In September 2021, when El Salvador officially made bitcoin legal tender, President Nayib Bukele, made it clear that the goal was to offer digital banking services to all the unbanked, who make up around 70% of the population. In the first 21 days, Chivo, the government-backed bitcoin wallet, had 2.1 million Salvadorans using it, that’s more users than the customers of any Salvadoran bank. The president’s target was met within 45 days with over 4 million new users being onboarded, out of a total population of 6.5 million people.
Like El Salvador, Africa also has a huge financial exclusion problem with around 65% of adults being unbanked. The majority of these people are employed in the informal sector and the informal sector in Africa accounts for over 85% of all employment. The sector also contributes at least 55% of the continent’s $1.95 trillion GDP, according to studies done by the UN and the African Development Bank. Traditional financial services providers have ignored this sector for decades, as their prohibitive cost structure makes it unprofitable for them to service it.
Cash is the only means of transacting in the informal sector. In a local context, this is fine; however, it’s a huge drawback for taking advantage of the cross-border trading opportunities that are opened up by the AfCFTA. Bitcoin adoption would instantly grant informal businesses access to an open, permissionless and geographically agnostic monetary network that they can start using immediately. Bitcoin is fully decentralized and is not controlled by any corporation or government making it the ideal universal currency for settlement of cross-border transactions and contract negotiation. Furthermore, a universal pricing standard across the continent would emerge when goods and services are priced in bitcoin. This will ultimately lead to efficiency in production and competitive pricing for similar goods or services.
Another benefit of Bitcoin is that it has immediate and final settlement, therefore, the need to route transactions via offshore banks for clearing and settlement is eliminated along with the associated costs. Not only will this reduce unnecessary delays, but the risk of exchange rate fluctuations due to exchange rate misalignments is also mitigated. Businesses operating in countries experiencing currency crises or hyperinflation are able to use bitcoin as a hedge, thus insulating themselves from these upheavals that negatively affect small businesses the most.
Armed with an international currency and the ability to seamlessly transact across borders, more informal sector businesses will be better positioned to export their goods, grow their businesses, and thus increase the rate of intra-African trade in line with the goals of the AfCFTA. Just like in El Salvador, financial inclusion will be rapidly accelerated as a result of the low barriers to entry of this strategy.
Africa faces significant difficulties in securing finance for infrastructure development mainly due to political risk, underdeveloped local currency capital markets and weak tax bases. To add insult to injury, infrastructure investment was reduced significantly by African governments and their development partners in the 1980s and 1990s, as a result of structural adjustment programs that most African countries implemented under the “Washington Consensus.” Africa’s current infrastructure investment needs are between $130 billion to $170 billion a year, with a financing gap of $68 billion to $108 billion according to the African Development Bank. The AfCFTA’s main objective of boosting intra-African trade can only be achieved with adequate quality infrastructure, as goods and services do not move on their own.
Energy infrastructure is the biggest major financing need in Africa, with approximately 600 million people in sub-Saharan Africa lacking access to electricity. This not only drives up the cost of doing business, but it also hinders the delivery of quality healthcare and educational services. In order to close this financing gap, alternative sources of finance are required. One potential solution is to take a leaf out of El Salvador’s book and issue “bitcoin bonds.” The bond structure could allow 40% of the funds to be used for purchasing bitcoin and the remaining 60% could be directed toward building renewable energy infrastructure like hydroelectric power plants or solar farms, and also for purchasing bitcoin mining equipment.
Once the plant is fully operational, some of the power generated could be used to mine bitcoin, which will be used to repay investors as well as to build transmission infrastructure connecting households and businesses. With a 6% coupon rate, a lot of fixed income investors would be incentivized to purchase the bond as it gives them exposure to bitcoin’s performance through a financial instrument that does not violate their investment policy guidelines. This could potentially unlock a large pool of capital from institutional investors like pension funds, sovereign wealth funds and insurance companies that have over $100 trillion worth of assets under management globally.
Finally, Bitcoin adoption presents African central banks with a unique opportunity of accumulating and holding bitcoin as part of their reserves. As de-dollarization gradually occurs globally and a multipolar future becomes imminent, Bitcoin adoption reduces exposure to and reliance on currencies like the dollar and the euro for trade. A recent report by Fidelity Digital Assets states the following, “If Bitcoin adoption increases, the countries that secure some Bitcoin today will be better off competitively than their peers. Therefore, even if other countries do not believe in the investment thesis or adoption of Bitcoin, they will be forced to acquire some as a form of insurance. In other words, a small cost can be paid today as a hedge compared to a potentially much larger cost years in the future.” Therefore, African central banks would gain a significant first mover advantage in this regard ahead of most central banks in the world.
In conclusion, meeting the objectives of the AfCFTA is going to require a lot of creativity, tenacity and willingness to experiment with new ideas and approaches. While this article was only able to highlight a few areas that Bitcoin adoption would optimize, there are numerous other opportunities that can be unlocked by this.
This is a guest post by Kudzai Kutukwa. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.