Africa should step up crypto regulation to mitigate risk and costs

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Continued acceptance and use need an improved crypto regulation environment, without which significant risks and costs might arise.

  • A significant part of the populations of Nigeria (6.3%), South Africa (7.1%), and Kenya (8.5%) now use cryptocurrencies.
  • Stablecoins are another crucial component of the cryptocurrency ecosystem.
  • The current fragmented approach to crypto regulation throughout the globe is not optimal.

During the coronavirus disease (COVID-19) pandemic, the worldwide usage of cryptocurrency expanded tremendously. These privatized digital currencies have grown in popularity throughout Africa, posing significant costs and risks regarding state monetary sovereignty, policy space, and macroeconomic stability.

Read: Will crypto eventually replace fiat currency?

A significant part of the populations of Nigeria (6.3%), South Africa (7.1%), and Kenya (8.5%) now use cryptocurrencies. The Central African Republic adopted bitcoin as a legal tender in June. Continued acceptance and use need an improved crypto regulation environment, without which significant risks and costs might arise.

Crypto’s rapid evolution

A sophisticated and quickly developing cryptocurrency ecosystem has emerged since 2009, when the first decentralized crypto got launched. There are now over 19,000 cryptocurrencies, up from 1,500 in 2018.

Countless service providers, the most significant of which are decentralized financial platforms, crypto exchanges, and digital wallet apps, keep this system running. Based on distributed ledger technology, the former offers cryptocurrency loans, trading, and investing without the need for conventional financial intermediaries.

Crypto exchanges allow users to convert cryptocurrencies to sovereign currencies, and digital wallets store private digital currencies on their behalf.

Stablecoins are another crucial component of the cryptocurrency ecosystem. By holding financial assets as collateral, this new kind of cryptocurrency tries to maintain a steady price compared to a sovereign currency or a basket of currencies.

On the other hand, increased profitability may provide an incentive for stablecoin developers to keep risky assets. A drop in the value of such assets, or under-collateralization of stablecoins, would leave issuers unable to pay holders.

In contrast to a reduction in the value of cryptocurrencies, which would result in financial losses for holders, a more significant issue would be a drop in the price of stablecoin collaterals, which would need a public rescue, with taxpayers eventually footing the bill.

Several stablecoins are no longer tied to the US dollar as of May 2022. This has caused concern among cryptocurrency holders, resulting in market volatility and a massive sell-off.

Cryptocurrencies have the potential to be used as financial assets. Proponents claim cryptocurrencies, or private digital currencies, can free people from banking corporations and state control while encouraging financial inclusion. This potential mainly predicates the use of the underlying technology, distributed ledger technology, of which blockchain is a part.

This technology enables the utilization of linked computer networks to validate peer-to-peer private transactions. Network nodes or digital miners confirm the records and get rewarded with cryptocurrencies to ensure the integrity of the ledger without a central authority.

The allure of crypto in Africa

Between September 2019 and June 2021, the crypto ecosystem grew by 2,300%, mainly in emerging economies. According to some projections, 15 of the top 20 nations in cryptocurrency ownership in 2021 were developing markets and emerging economies, with four African countries (Kenya, Nigeria, and South Africa) taking centre stage.

Africa is now the world’s third fastest-growing cryptocurrency sector, drawing significant investment. Between July 2020 and June 2021, crypto use in Africa increased by more than 1,200%.

The rising adoption of cryptocurrencies in Africa is due to various factors. To begin, the usage of cryptocurrencies provides an appealing conduit for sending remittances in terms of price and speed.

As part of financial investments and speculation, Cryptocurrencies are primarily held by middle-income individuals in developing countries. Cryptocurrencies have emerged as protection for household savings, particularly in countries facing currency depreciation and rising inflation (caused or exacerbated by the COVID-19 crisis and Russian-Ukraine tensions).

Cryptocurrencies have also found suitability among a big part of the formerly financially marginalized and low-income populations. Most African banks were inaccessible to this market sector. Even when they were, exorbitant transaction charges deterred low-income account customers.

Cryptocurrency allows everyone with a mobile device and internet connection to participate in operations comparable to those done via financial institutions and intermediaries. This includes making payments, sending remittances, and investing.

The costs and the risks in the crypto space

The urgent need for regulations to protect crypto investors from fraud and scams.
The urgent need for regulations to protect crypto investors from fraud and scams. [Photo/ NEWS10 ABC]
Like other speculative transactions, bitcoin trading and holding results are very individual. Overall, the hazards and costs they entail in Africa, and other developing nations outweigh them. As a result, crypto users have various reasons to be wary.

The adoption of cryptocurrencies may increase the danger of financial instability. Monetary authorities may have to intervene if prices fall to restore financial stability. Notably, adopting cryptocurrencies in African nations opens up a new conduit for illegal financial transfers.

Second, the usage of cryptocurrencies weakens the efficacy of capital restrictions, which are essential for reducing the accumulation of macroeconomic and financial vulnerabilities and increasing policy flexibility.

Finally, if uncontrolled, cryptocurrencies may become a standard mode of payment and even informally supplant local currencies (a process known as cryptoization), jeopardizing nations’ monetary sovereignty.

The usage of stablecoins presents the most significant risk in African nations when reserve currency demand is unfulfilled. For example, in May 2022, the turbulence spurred a rush to better quality stablecoins that report audited holdings of their backings.

In April, the Central African Republic adopted bitcoin as a legal tender. Consequently, the CAR emerged as the first African country to do so and the second in the world after El Salvador. The International Monetary Fund, on the other hand, has raised concerns about the implications of utilizing cryptocurrencies as legal tender.

Read: Africa: stablecoins offer an efficient solution for cross-border

Laying the ground for crypto regulation

Global policymakers have started to control cryptocurrencies. In 2019, Facebook’s statement about the potential introduction of a transnational stablecoin prompted comments from authorities in industrialized nations.

The platform’s size, with over 2.5 billion active users, and ambition to become a worldwide payment provider aroused worries about the necessity for a possible public bailout in the event of a disaster. Furthermore, the entry of a notable technology corporation into the payment services industry raised concerns about data privacy and consumer protection.

The regulatory reaction caused Facebook to scale down its intentions from a worldwide stablecoin to a more modest application, namely the supply of a digital wallet with restricted regional availability. The news also acted as a wake-up call for central banks, particularly in Africa, with some examining the supply of public alternatives to private digital currencies.

Most African monetary authorities place a strong priority on central bank digital currencies (CBDCs). A few underdeveloped nations already have CBDCs, like Nigeria are working on pilot programs or investigating the design of such currencies.

What the future of crypto regulation in Africa looks like

Despite the market’s current collapse, cryptocurrency symbolizes the future of money and financial transactions. And there are signs that cryptocurrencies are here to stay, as seen by nations’ growing acceptance of them. At one extreme, the governments of El Salvador and the Central African Republic have made bitcoin legal tender. The widespread criticism of the execution and the effect on their economies have not affected their decisions.

Others, such as Nigeria, have recognized the necessity for central bank digital currencies as a governmental representation of digital currencies. Many other nations are currently investigating this possibility.

However, it is crucial to highlight that the acceptance of central bank digital currencies in underdeveloped nations that have implemented them has been relatively low. Countries are also investigating central bank digital currencies’ economic effect and whether adoption is the best way.

But, since transactions are worldwide, crypto must have international coordination and holistic regulation. This way, crypto will live up to its potential on the African continent and beyond. Although significant progress exists in this area, the current fragmented approach to crypto regulation throughout the globe is not optimal.

Read: The case for and against CBDCs


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