Blockchain Revolution

CHAPTER 7

SOLVING THE PROSPERITY PARADOX: ECONOMIC INCLUSION AND ENTREPRENEURSHIP

A PIG IS NOT A PIGGY BANK

he Pacific coast of Nicaragua is one of the most beautiful landscapes in the Americas, where verdant green forest meets endless blue waters. Its rolling hills

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and stunning beaches make it a top destination for backpackers, sunbathers, and ecotourists alike. Nicaragua is also one of the poorest and least developed countries in the region. Sixty percent of the population lives below the poverty line. Those not employed in its tourism industry survive on near-subsistence-level agriculture and fishing. Nicaragua has the second-lowest nominal gross domestic product in the Americas, with 10 percent of its entire GDP from remittances—money earned overseas and repatriated by the Nicaraguan diaspora. Nineteen percent of Nicaraguans have a formal bank account, but only 14 percent are able to borrow and only 8 percent have formal savings.¹ Yet 93 percent have a mobile phone subscription, usually in the form of prepaid access.²

That is the reality that Joyce Kim faced when she took her team down to Nicaragua. Kim is the executive director of the Stellar Development Foundation, a not-for-profit blockchain technology organization (not to be confused with Stellar, the large architecture and construction firm). A Nicaraguan microfinance operation wanted to learn more about Stellar’s financial platform. The woefully underdeveloped banking industry in Nicaragua keeps most people in an inescapable cycle of poverty and exacerbates the plight of would-be entrepreneurs. They struggle to start new businesses, register titles to their land and other assets, and resolve outstanding claims from the Sandinista government’s mass land expropriation in the 1980s.³ Stellar’s platform would enable Nicaraguans to transfer, save, invest, borrow, and lend money.

Kim was both impressed and surprised by the local focus on microcredit. She understood that access to credit was paramount to economic inclusion but believed that savings, the ability to store value reliably and securely, was a prerequisite for

almost all other financial services. When Kim asked about savings, she was told, “Oh, savings is not a problem around here. People have pigs.”⁴

Livestock makes up the vast majority of farmers’ net worth in many agrarian

economies because financial services are not widely available and individuals have a tenuous right to their land. In Nicaragua that means people own pigs, and lots of them. Kim was surprised at first, but quickly saw the age-old logic to it. “You walk out of a meeting, and you look around and you see pigs are everywhere.”⁵ Livestock has long been an accepted, relatively useful form of savings. For those excluded from the digital economy, animals are about as liquid an asset as you can own, even more so if they produce milk, and they pay dividends in piglets, eggs, lambs, calves, and sometimes cheese.

Prosperity is a relative concept. In Kenya, Masai tribesmen who own four to five

hundred head of goats are considered prosperous, but their lives can be rough, brutish, and short. Livestock-based wealth is “highly localized, so that you can’t actually transact with anybody unless they’re right there in front of you,” Kim said. “You run the huge risks with your animals running away or getting sick or some blight coming that could actually wipe out all of your savings.”⁶

Credit was an even tougher nut to crack than savings. Kim got to know a local

Nicaraguan fisherman, a member of a cooperative, who explained that no one fisherman ever has access to enough credit to outfit an entire rig. According to Kim, “they form fishermen crews where one person will get a loan for the net, somebody else will get a loan for the bait, somebody else gets a loan for the boat, somebody else a loan for the motor, and then they come together and they form a crew.” No one person is able to float his or her own venture (no pun intended) because access to credit is so tight. The model works, but it involves as many middlemen as there are fishermen.

The lifelong financial struggle of the Nicaraguan fishermen and farmers is the story of most unbanked people, around two billion adults in the world today.⁷ What they lack—a store of value that won’t get mad cow disease or die of old age, or a payment mechanism that extends beyond the village—we take for granted.

Financial inclusion is a prerequisite for economic inclusion. Its repercussions extend beyond finance. Kim said, “I don’t consider financial access and financial inclusion to be the end goal. It’s a path we all have to walk to get better education, better health care, equal women’s rights, and economic development.”⁸ In short, financial inclusion is a fundamental right.

This chapter looks at opportunities for mobile and financial service providers and

other businesses to use blockchains to unleash the economic potential at the bottom of the pyramid. We’re talking billions of new customers, entrepreneurs, and owners of

assets, on the ground and ready to be deployed. Remember, blockchain transactions can be tiny, fractions of pennies, and cost very little to complete. Anyone with the smallest of assets—say, a talent for embroidery or music, spare water pails, a chicken that lays eggs, a mobile phone that records data, audio, and images—could exchange value. The new platform also eliminates the point-of-access barrier. If you can access the Internet on a mobile device, then you can access assets with no forms to fill out and very little literacy. These are seemingly small but incredibly important breakthroughs. If we do this right, blockchain technology could unleash the biggest untapped pool of human capital in history, bringing billions of engaged, prospering entrepreneurs into the global economy.

THE NEW PROSPERITY PARADOX

For the first time in modern history, the global economy is growing but few are benefiting. On one hand, the digital age is bringing limitless possibilities for innovation and economic progress. Corporate profits are ballooning. On the other hand, prosperity has stalled. Throughout modern history, individuals and families at the 51st percentile were on the rise. Despite depressions and upheavals, prosperity for these individuals, and for society as a whole, steadily increased. This is no longer the case. Standards of living are even declining in the developed world. Median wages are stagnating in OECD countries. And, according to the International Labour Organization, youth unemployment in most of the world is stuck at about 20 percent. “Young people [are] nearly three times as likely as adults to be unemployed,” the ILO reported.⁹ In many developing nations, the numbers are significantly higher. Such unemployment is corrosive to all societies, no matter what their level of development. Most citizens want to contribute to their community. Anyone who has been jobless knows how it erodes self-esteem and well-being. Those with power and wealth are getting ahead, and those without are falling behind.

This new prosperity paradox, not to be confused with the intergenerational “Paradox of Prosperity” coined by economists such as Gilbert Morris, has befuddled every policy maker in the Western world. One of the best-selling business books of 2014, Capital in the Twenty-First Century by Thomas Piketty, became the #1 best seller on the New York Times hardcover nonfiction list in 2014. A tour de force of academic scholarship, Capital explains why inequality is accelerating and will likely continue to do so as long as the return on capital exceeds long-term economic growth. The rich have gotten richer because their money made them more money than their work did. Hence, the proliferation of new millionaires and billionaires. But his solution for how to stem growing social inequality, by imposing a wealth tax on the

ones who own most of the world’s wealth, was somewhat less inspiring, if only because we’ve heard it before.¹⁰ Indeed, for as long as capitalism has been the primary mode of production, the debate about how to share the fruits more equally has not moved much beyond the redistribution of wealth, usually through taxation of the rich and the provision of public services to the poor. Advocates of our current economic model point to the hundreds of millions of people in the developing world (mostly in Asia) who have been lifted out of abject poverty, but often overlook the asymmetric benefits conferred to the very wealthy and the widening chasm between the superrich and the rest of the population in those same countries. Today, the global 1 percent owns half the world’s wealth while 3.5 billion people earn fewer than two dollars a day.

Defenders of the status quo are quick to point out that most of the world’s superrich got rich by creating companies, not through inheritance. However, behind the successes of a few are some very troubling statistics. The rate of new business formation is down. In the United States, the share of total firms that are younger than one year old fell by nearly half between 1978 and 2011, from 15 percent to 8 percent.¹¹ The millennial generation, oft characterized as entrepreneurial risk takers, is doing little to buck the trend and may be contributing to it. A recent analysis of Federal Reserve data found that only 3.6 percent of American households headed by someone under thirty held a stake in a private company, down from 10.6 percent in 1989.¹²

In the developing world, the digital revolution has done little to clear the entrepreneurial path of red tape and corruption. Where it costs only 3.4 percent of per- capita income to start a business in OECD countries, it costs 31.4 percent in Latin America and a shocking 56.2 percent in sub-Saharan Africa. In Brazil, an entrepreneur has to wait almost 103 days to incorporate his company versus 4 days in the United States and half a day in New Zealand.¹³ Exasperated by government bloat and inefficiency, many would-be developing-world entrepreneurs instead choose to operate in the so-called informal economy. “There are a bunch of things taken for granted in the West. Property records are fine-tuned, for example. In the Global South, entrepreneurs would rather the government not know they exist. We need to make identity a profitable proposition,” said Hernando de Soto. For now, staying in the shadows frees these entrepreneurs from meddlesome and corrupt officials, but it also profoundly limits their ability to grow their business, limits rights, and makes “dead capital” of money that could otherwise be deployed more efficiently.¹⁴ Moreover, even for those who operate their businesses in the open, laws of many countries do not provide for limited liability. If your business fails, you’re personally on the hook

for all liabilities. If you bounce a business check in many Arab countries, you go straight to jail—“do not pass go” or any other institutions of due process on the way.¹⁵

Okay, then, the world has always had haves and have-nots. Today fewer people

starve to death, or die from malaria or through violent conflict. Fewer people live in extreme poverty today than in 1990.¹⁶ Certain emerging economies have benefited from outsourcing of manufacturing and liberalization of economic policies—China being a prime example of both—and the mean income of citizens in most developed countries increased. On balance, people are better off than they used to be, right? So what if the rich just happen to own significantly more? Shouldn’t they keep what they’ve earned through their efforts? What’s the problem?

Piketty pointed at capitalism. But capitalism, as a system for organizing the economy, is not the problem. In fact, capitalism is a great way to create wealth and prosperity for those who know how to use it. The problem is that most people never get a shot at seeing the benefits of the system because the Rube Goldberg machine of modern finance prevents many from accessing it.

Financial and economic exclusion is the problem. Fifteen percent of the population in OECD countries has no relationship with a financial institution, with countries like Mexico having 73 percent of the population unbanked. In the United States, 15 percent over fifteen years of age, or 37 million Americans, are unbanked.¹⁷

Financial inequality is an economic condition that can quickly morph into a social crisis.¹⁸ In 2014, the World Economic Forum, a multistakeholder organization whose members include the largest companies and most powerful governments in the world, argued that growing inequality posed the single biggest risk globally, beating out global warming, war, disease, and other calamities.¹⁹ Blockchain could be the solution. By lowering barriers to financial inclusion and enabling new models of entrepreneurship, the tonic of the market could be brought to bear on the dreams and ideas of billions of the unbanked.

Prosperity Purgatory: An Exercise in Futility

For centuries, banks have relied on network effects. Each successive customer, branch, product, dollar in, and dollar out increases the value of the bank’s network. However, building these networks has come at a cost. Specifically, the cost of acquiring a profit-turning customer has only increased. If a prospect’s money won’t earn its keep, the bank won’t be interested in keeping it. Thus, banks have little economic incentive to win customers in the bottom half of the pyramid. According to Tyler Winklevoss, banks don’t serve most of the world and have no existing plans to serve them. However, new technology could remove that step. He said, “A lot of

African countries leapfrogged the infrastructure of landline telecoms with cellular. They skipped that step. Blockchain will have the greatest impact in areas where the payment networks don’t exist or are very poor.”²⁰ Blockchain will push many nascent initiatives, such as mobile-money service providers like M-Pesa in Kenya, owned by Safaricom, and microcredit outfits globally, into high gear by making them open, global, and lightning fast.

A bank is the most common financial institution, and so we will use it as an example here. How do you open a bank account? If you live in the developing world today, you will likely have to visit the branch in person. In Nicaragua, there are only 7 bank branches per 100,000 people compared with 34 per 100,000 in the United States. Nicaragua looks well banked compared with many countries in Africa, where there can be fewer than 2 branches per 100,000 people.²¹ So you will probably have to travel a good distance to find a bank. You will also need to bring a government-issued identity card, but that will be just as difficult to come by if you don’t already have one.

In the developed world—say, the United States—you need to meet certain requirements. While these requirements vary from bank to bank and state to state, you typically need to deposit and maintain a $100 to $500 minimum balance. You also need to prove your identity. Banks that do business in the States must comply with stringent “know your customer,” “anti–money laundering,” and “anti–terrorism financing” regulations.²² And so they must do more comprehensive background checks on applicants before granting them an account. Ultimately, the bank is less interested in evaluating your character than it is in complying with regulatory agencies. That means a laundry list of requirements. First, you need a Social Security card. Don’t have one? That’s usually enough to get rejected. How about a photo ID like a driver’s license or passport? Don’t have one? You’re not opening a bank account. Let’s say you have both a Social Security card and photo ID. The bank, just to be safe, asks for a recent utility bill as proof of permanent residence or some proof of a previous bank account. If you happen to be new to town, or staying with family, or from an entirely unbanked region of the world, you’d likely fail some of these tests. The bank doesn’t want you as a customer unless it can confirm your identity based on various papered credentials. It’s not interested in knowing you as a well-rounded person. It’s interested in knowing you as a set of checked boxes. Previous attempts to streamline this process for immigrants and the poor, such as the New York scheme to allow people to use their city ID cards, have failed.²³

The Prosperity Passport: An Exercise in Utility

Fortunately for the unbanked, blockchain technology is engendering a new form of financial identity—one not dependent upon one’s relation to a bank but rooted in one’s own reputation. In this new paradigm, being “banked” in the traditional sense is no longer a prerequisite. Instead of passing the traditional ID tests, individuals can create a persistent digital ID and verifiable reputation and deploy it, in whole or in part, in different relationships and transactions. The blockchain endows this digital ID with trust and access to financial services. This capability is unprecedented at a massive scale. Joseph Lubin of ConsenSys said, “We all have reputation. It just isn’t easy to use as social and economic systems are currently constructed. Most of it is ethereal and ephemeral. In the best case, it is fragmented and you have to present shallow documentation of it anew for every venture that requires it. In the worst case, billions of people don’t have a way of presenting reputation to anybody but their immediate social circle.”²⁴ It might as well be a pig or a cow. However, with the basic building blocks, people can construct digital identities that are not fragmented or ethereal but universal and standardized, with robust attestations of aspects of themselves and their interactions. They can share these digital IDs granularly—that is, share only very specific information about their identity—to facilitate more interactions that will likely lead to their own personal economic growth and prosperity. David Birch, a cryptographer and blockchain theorist, summed it up: “Identity is the new money.”²⁵

Consider the possibilities: the underbanked of the world can enfranchise themselves as they interact with microlending outfits. Potential vendors or lenders can track their usage and repayment of tiny loans, previously unfeasible, on the blockchain rather than rely on some credit score. “Once a previously unbanked person pays back a microloan, they are on their way to securing more and larger loans to build their businesses,”²⁶ said Lubin. This behavior, when repeated, adds to the reputation score of the borrower. Combined with a global, frictionless payment platform, individuals and small business owners can do the previously impossible: pay a remote vendor for merchandise or services, thereby advancing their prospects in the global economy. Joyce Kim mused, “What if we could create a credit score for women based on their household history?”²⁷ Economic and financial fault lines often run alongside gender lines, making this technology a boon for the world’s disenfranchised women. Referring to the global poor, de Soto said, “It’s not that they don’t want to come into the global economy. It’s that the standards and information to bring them into the system are not in place. Blockchain is terrific because it gives us a common platform to bring people together.”²⁸

What could this persistent reputation mean for global entrepreneurship? If you have a reliable, unique, and robust identity, and you’re deemed trustworthy,

counterparties will feel more comfortable providing you with access to value. This is not redistribution of wealth but a wider distribution of opportunity. Haluk Kulin, CEO of Personal BlackBox, said, “The biggest redistribution that is about to happen is not a redistribution of wealth but a redistribution of value. Wealth is how much money you have. Value is where you participate.”²⁹ Blockchain can enable every person to have a unique and verifiable reputation-based identity that allows them to participate equally in the economy. The implications of this equality are profound. Lubin imagines a future where the “unbanked and underbanked will become increasingly enfranchised as microlending services will enable investors across the globe to construct diverse portfolios of many microloans of which the usage and repayment can be tracked in full detail on the blockchain, using Balanc3’s [a ConsenSys portfolio company] triple- entry accounting system, for instance.”³⁰ In this new future, when people repay microloans, they are on their way to securing more and larger loans to build their businesses.

ROAD MAP TO PROSPERITY

Financial identity is the genesis for a wide array of financial and economic opportunity previously unattainable for more than two billion of the world’s population. Blockchain technology enables people from all walks of life to map out their own prosperity. Imagine that, a wealth of one’s own—for large numbers, ultimately billions of people.

Tools of Abundance: The most basic requirements to participate in an economy are tools like a mobile phone and some kind of Internet access, the portal through which people interact with different value systems. Dr. Balaji Srinivasan, managing partner at Andreessen Horowitz and a lecturer at Stanford University, said, “If you can access the Internet on a mobile phone, suddenly you’re able to access all these other things. You can access a bank or at least the mechanisms for it.”³¹ Blockchain technology creates a whole new set of business models previously unimaginable that empower individuals as economic agents.