Crypto-based lending, mostly in the form of micro-loans, is an emerging offshoot of cryptocurrency promising options to Africans excluded from traditional finance and to those attracted by lucrative terms and faster turnarounds. How is crypto lending playing out in 2022? Who is using it and how are traditional banks and regulators responding to a sector not immune from fraud and scandal?
By Shane Starling
On the surface the rise of crypto lending is a case of new technologies and methodologies powering up financial inclusion – of nimble start-ups filling a need unmet by legacy players lumbering under the weight of their own processes and structures.
“The African markets have really been at the forefront of using simple, existing technology to solve complex financial inclusion challenges,” said Nathan Lynch, financial crime specialist for Thomson Reuters in the Asia-Pacific and Emerging Markets and author of The Lucky Laundry.
“We’ve seen with their innovative use of SMS and M-Pesa, for instance, that they can adopt really robust financial technology to solve the challenges of providing payment services.”
Crypto lending is another iteration of this phenomenon.
New liquidity pools attract smaller lenders and borrowers
The pool of available funds for crypto loans has rapidly expanded in an increasingly high inflation macroeconomic climate coupled with COVID-driven downward price pressure on many African currencies that has seen more parties investing in cryptocurrencies as a store of value.
“What we’ve seen is people looking at crypto as a way of basically storing their money,” said Topsy Kola-Oyeneyin, Partner in Nairobi and co-leader of McKinsey’s Payments Practice across EEMA . “It could be stored as a crypto stable coin, ready to be converted to the local currency as needed. So a kind of devaluation hedge.”
“People have realised if you have this crypto stored, you can participate in crypto lending via a decentralized finance (defi) liquidity pool and earn some interest on it. So all of a sudden your crypto actually becomes more valuable.”
“Then there are those that want to access loans – the borrowers – they can now use their crypto assets as collateral for loans much faster than might be possible through traditional lending.
“It’s very exciting but there is still a gulf between the crypto opportunity and those who can access it. A good number of the underbanked really don’t understand how to participate in the crypto market. That’s a challenge.”
In Nigeria, as in many African countries, such a gulf is widened by strict regulatory restrictions or outright crypto bans. The US Library for Congress found 23 of the 51 nations worldwide that have banned or restricted crypto access were African in a November 2021 report.
These range from blanket crypto bans in Tunisia, Egypt, Morocco and Algeria to restrictions are in place in 19 other countries including Lesotho, Niger, Togo, Burundi, Mali, Senegal and Cameroon.
Kola-Oyeneyin noted crypto participation rates remain low in Nigeria, where about half the country’s adults are unbanked and the Central Bank in February 2021 outlawed Nigerian banks from interacting with crypto markets and operators in advance of it becoming the first African nation to launch its own digital currency – the eNaira – in October just gone.
“The drive for financial inclusion” was one of the principle reasons cited by the Central Bank of Nigeria for launching the eNaira. Some speculate central bank digital currencies (CBDCs) like the eNaira will eventually offer their own suite of centralised lending options.
Collateral and risk
South African-based Wiehann Olivier, audit partner and digital asset lead at Mazars, said defi crypto lending had a lot to offer but the requirement for collateral challenged how far financial inclusion could go.
“Defi can offer massive interest rewards to lenders,” he said. “And it can bring in a new band of borrowers, but almost all crypto loans require collateral in the form of a crypto asset and this is where the risk can arise, with the inherent volatility in the crypto space.”
“As soon as the funds you borrow drop below a certain level – usually it’s 80%, 60% or 50% of the initial loan value – the smart contract will auto-transfer the collateralised digital asset to the lender.”
Such loans also typically earn the lender 10-12% in interest.
“So the smart contract itself is written to completely protect those putting funds into the platform as opposed to those borrowing against it.”
For this reason, unless the loan is issued in a crypto stable coin, knowledge of the crypto market can be the difference between a loan default and a fast repayment.
“A lot of it depends on crypto price momentum…a lot of it is just being used for leverage trading,” Olivier observed.
In this sense crypto lending remains a long way from achieving its financial inclusion potential.
Martha Reyes-Hulme, head of research at London-based digital assets exchange Bequant, said smaller merchant-focused crypto loans could use, for example, “receivables that they could potentially then collateralize.”
“You can build a track record and everything’s open and transparent on the blockchain. If you’re not in the banking sector, you’re never going to build up that credit history. It’s all about getting into the system.”
Types of crypto lending
Open software community SourceForge lists 191 firms engaged in crypto-based lending from colossal multinational trading platforms that offer lending protocols like Binance and Crypto.com to decentralised finance (defi) specialists like AAVE and NFTfi that African citizens and enterprises can access.
NFTfi matches lenders with borrowers who put up NFTs (non-fungible tokens) as collateral for loans issued in two cryptocurrencies: Wrapped Ethereum (WETH) which is pegged to the price of Ethereum; and DAI, a top-20 crypto stable coin pegged to the US dollar.
“The NFT is held in escrow when the loan amount is transferred to the borrower,” said its London-based chief marketing officer, Ani Alexander. “When the borrower pays the loan back, the NFT will be released from escrow and transferred back to the borrower. If the borrower defaults and does not pay the loan back, the NFT will then be transferred to the lender. There is no input from a central authority at all.”
“The space is currently not regulated at all.”
Smaller African-focused operations like KamPay and Koinwa that are witnessing rapid growth in crypto trading and facilitating crypto lending don’t even make the SourceForge list.
No collateral loans target farmers
Dominica-listed KamPay is an example of how differently a crypto operation can function compared to traditional finance.
KamPay is building a digital ecosystem that includes cryptocurrency trading including its eponymous tradeable cryptocurrency and crypto-based services that at least 10 African governments like Chad and Guinea have employed or will be using to streamline public access to national lotteries.
The firm is funnelling such revenue into a crypto-based micro loans with one scheme targeting sub-Saharan smallholder farmers. The loans come in the form of vouchers redeemable at stores of its partner Africa Grain and Seed (AGS), a farming collective operating in South Africa, Zimbabwe, Zambia, Malawi and DRC.
“The farmer doesn’t get actual money,” said KamPay chief technology officer, Yigal Weinberger. “We store things on a blockchain but they get a voucher they can only redeem for agricultural products at AGS outlets – usually seeds. When the products are grown and sold the loan is repaid via the Kampay wallet, which can then be converted to fiat. We don’t take collateral but AGS helps us select who we give loans to.”
Another reason slated by the Central Bank of Nigeria for launching the eNaira was to up the fight against fraud – an issue never far from any crypto-based activity.
“The Know-Your-Customer (KYC) on these transactions is often severely lacking. Even in cases where Anti-Money-Laundering (AML) regulations are in force, the sophistication simply isn’t there for many crypto start-ups and disruptors,” said Lynch of Thomson Reuters.
“The inherent nature of these digital marketplaces means that people are rarely doing face-to-face transactions, which gives rise to a whole host of digital identification, fraud, and customer onboarding risks.”
“Investors who enter the crypto lending space really need to be concerned about ‘return of money’, not just the return on their money.”
Eyes on South Africa’s next crypto moves
South Africa is a gigantic and dynamic crypto market that has experienced such vulnerabilities and is in the process of doing something about it.
“There remains a lot of crypto scepticism with the amount of scamming and fraud we had in South Africa over the past few years,” said Mazars’ Olivier, noting scandals like that of Mirror Trading International (MTI) where thousands of people were defrauded of Bitcoin before the firm was liquidated in December 2020.
“These kinds of scandals make people very weary to get into the space. But South Africa remains unregulated although the South Africa Reserve Bank (SARB) says regulations are expected this year. I’m not sure what it will look like but I welcome it.”
The Bank told us the new rules would “strike an appropriate balance between promoting responsible innovation and mitigating against potential risks…”
SARB said that while digital technology can improve access to banking and the financial system, access to finance is best served by “financial products or services that are offered within the formal financial system, within a regulated framework.”
Lynch said the SARB’s stance would be “watched closely across the continent.”
“Scams and frauds, alongside the sheer popularity of crypto, is driving this push for better regulation in South Africa and elsewhere. It’s early days but the trajectory is set. These markets are not going away.”