Why microlending needs blockchains
Blockchain and crypto technology had a terrible 2022. With each month we seemed to have another major firm collapsing or another billion-dollar scam unraveling. And yet the underlying tech itself is getting stronger and opening new, real-world, use cases.
Here’s a quick primer on the basics of blockchains for anyone interested in bringing credit to emerging economies.
1. Forget “cryptocurrency”
The original technical breakthrough was a short whitepaper with a pseudonymous byline attributing the work to Satoshi released in 2008 in the wake of the global financial crisis. The paper outlines a system that relies on independent computer nodes using cryptography to create a digital ledger, meaning it could allow users to keep track of digital assets without a central authority. The system leverages a math-based lottery system to incentivize computer node operators, hence the astronomic energy costs and slow transaction speed.
Yet Bitcoin is merely the proof-of-concept — today there are multiple networks of computer nodes operating dozens of blockchain-distributed ledgers, each with their own twists and utilities. The foundational technology is the concept of a single ledger distributed across a vast computer network that is open and simultaneously secure. “Cryptocurrency” is a terrible moniker since the tech is neither cryptographic nor a currency.
2. It uses energy, but not as much as you think
You’ve seen the headlines that claim global blockchain networks devour as much electricity as a small Nordic nation–less reported is the shift in the way these networks operate to a more cost and energy-efficient model.
Bitcoin originally relied on a computational-cost model to disincentivize bad actors in the network. That is, one would need vast amounts of computing power to corrupt the shared and distributed ledger. This is key — if a blockchain can’t guarantee the integrity of the central ledger, it’s useless. But newer chains use a “staking” method, in which computer node operators essentially lay down assets to prove they are good actors. Anyone trying to cheat the system and gets caught by others in the network loses their “staked” assets. The largest blockchain by value, Ethereum, switched from the old math-lottery system to the new “staked” system in late 2022, resulting in a 99.5% energy usage reduction.
3. It’s not (all) about speculative assets
Having a single ledger lets you create virtual assets — some of which end up as highly speculative or worse, as part of scams.
When you step back though, the potential of a single ledger that is open and secure comes into view. Say we distribute tokens for pro-social behavior, or reward positive externalities. We could create on-chain reputation systems that are tamper-proof and link those reputations to real-world benefits.
4. It could upend finance
Letting you conduct transactions on a public, distributed, and largely frictionless system means emerging markets could leapfrog all sorts of financial systems. Everything from payment rails to online banking to financial products could use blockchains instead of heavily guarded centralized systems. This would mean sending money would be as simple and cost-effective as sending an email. And it could mean taking a complex financial product, an S&P 500 index fund for example, fractionalizing it, and letting lower-income savers invest.
5. Authoritarian regimes are not fans
An open and secure distributed ledger directly threatens centralized control. It would allow NGOs to bypass state capital controls, it would let users stay anonymous and avoid government surveillance, and it would virtually eliminate financial borders.
6. It could transform microlending
Just as in the early days of the internet, practical applications seem a long way off. It’s easy to get lost in the stories of scams and buffoonery that pervades crypto. Yet blockchains’ practical applications, while in their infancy, are taking off. One such practical use is how Jia uses public ledgers to reward microloan recipients for repaying their debt and issuing them a form of equity. By giving clients a stake in the entire ecosystem’s success, they’re moving from a 20th-century static model to a 21st-century dynamic one, where the line between customer and partner is fuzzy.
Disclaimer: While Zed Tarar is a member of the U.S. diplomatic service, the views expressed here are his own and do not necessarily reflect those of the Department of State or the U.S. government.
