How Bitcoin Could Cut the Cost of Remittances and Aid

By Mary Beliveau

Those wishing to send aid, remittances, and investment overseas face exchange rate manipulation and inflated fees when using traditional money transfer services. One emerging alternative to using these services is to transfer Bitcoin internationally. Bitcoin is alluring because financial institutions do not manage its online trade. The transfer of Bitcoin is therefore much less costly than transferring traditional currencies because it bypasses bank fees and regulation.

Several organizations are already beginning to trade and transfer Bitcoin across international borders, and profitable businesses have developed plans to facilitate these trades. Although hesitant investors remain wary of Bitcoin, optimists see the potential to make a big splash in the way $167 billion of foreign aid and $436 billion of global remittances are transferred to the developing world.

Bank-less money transfers are swiftly becoming the norm in the developing world, where less than fifty percent of adults own a bank account. Hassle-free mobile money services such as Kenya’s M-Pesa, Vodacom Tanzania and MTN Uganda are used in lieu of credit and debit cards in these areas. However, the benefits of convenience and low cost mobile transfers are largely limited to domestic transactions.

Enter services like BitPesa; a Kenya-based start-up that raised $1.1 million in venture capital earlier this year. BitPesa slashes fees by sending Bitcoin, rather than traditional currency, across borders. BitPesa does not manipulate exchange rates and charges a mere 3 percent transaction fee to send money from the US to Kenya. The market reaction to this service has been overwhelmingly positive; the company reports thirty percent or more growth per month since its 2013 Kenya launch, and has already expanded to Tanzania.

In addition to the remittance market, several popular non-profit organizations now accept donations in Bitcoin. Give Directly, a charity that gives qualifying individuals living in developing countries a no-strings-attached $1,000, accepts Bitcoin on their website. Other organizations such as Save the Children and the American Red Cross accept Bitcoin donations through BitPay. This service converts Bitcoin to currency at the time of the transaction and does not charge a fee for non-profit donations.

But why is Bitcoin transfer uniquely inexpensive? The answer lies in the low-cost, inherently decentralized Bitcoin system. In October 2008, Satoshi Nakamoto (a pseudonym for unknown author(s)) published the paper “Bitcoin: A Peer-to-Peer Electronic Cash System“, describing both the theory and computer science behind this cryptographic payment system. The paper states that in the absence of trust between two parties (i.e. during an online payment), a third party institution is required to authenticate transactions. Banks primarily fulfill this role online today, but charge high fees for their service. Nakamoto argued that authentication can, and should, be decentralized. In the Bitcoin system, each transaction is verified by a community of computers who are rewarded with Bitcoin for sequencing and verifying transaction chains.

Users on both ends of the transaction can bypass the financial sector because these computers, referred to as nodes, guarantee that Bitcoin is not double-spent and that the sender has the amount of Bitcoin he or she is trying to send. Nodes are not regulated by governments as are financial institutions, but rather rewarded with Bitcoin for verifying transactions, and are thus economically incentivized to cooperate. Bitcoin usage costs remain low because the system is decentralized, competitive, and inherently authenticating.

This concept has the ability to alter the way international aid organizations, individual donors, and remitters send money overseas. Imagine a villager in Kenya needs to receive a $500 payment for an international shipment, financing from a foreign donor or investor, or remittance to fund her child’s education. She is one of the over 2 billion people in the developing world without a bank account. In order to receive her $500, she must use services that charge fees and artificially deflate the Kenya shilling-to-dollar exchange rate. As Figure 1 indicates, these fees and manipulations can result in the villager losing up to $26.

The analysis in this table is based on a similar analysis of remittance transactions completed by the World Bank. All fees and exchange rates were determined based on data gathered from the websites of money transfer services and differ from data gathered by the World Bank. These rates do not reflect an extensive study, but rather the lowest rates listed on websites at various times during the writing of this article.

*Exchange Rate Margin is the cost resulting from the fact that the firm applies a rate that is different from the interbank one. The margin is the percentage difference between the interbank exchange rate and the exchange rate actually applied to the transaction (Defined by the World Bank)

**The Total Cost of sending a remittance transfer includes: the fee charged to the sender plus the exchange rate margin (Defined by the World Bank)

Bitcoin offers an interesting solution to the problem of expensive money transfer. To send money using Bitcoin, the sender utilizes an online Bitcoin “wallet” to purchase and trade the virtual currency. The sender buys Bitcoin with USD through CoinBase, Itbit, or other exchange services, and immediately sends the coin to another user’s wallet – in this case in Kenya. Once the villager in Kenya receives the Bitcoin, she transfers her Bitcoin to shillings.

Of course, Bitcoin transfer is not devoid of fees – most platforms charge between .05-1 percent to transfer Bitcoin to local currency, and local currency to Bitcoin. However, as depicted in the chart above, these fees are comparatively much more affordable than traditional methods of international money transfer.

One potential hazard of this process is the volatility of Bitcoin. Like every currency, Bitcoin’s value fluctuates throughout the trading day, which can lead to losses or gains during the time it takes to transfer Bitcoin across borders. This is the reason for the growing popularity of platforms such as BitPesa, which charge slightly higher fees than Bitcoin wallets but mitigate risk by locking in purchase exchange rate.

The future of Bitcoin is still very unclear. Several barriers to wide-scale adoption exist today, including the lack of trust in an unregulated system and exchange rate volatility. There are also concerns about limitations in the underlying technology, debate over which has led to a split in the Bitcoin community that could create even greater uncertainty about its future as a currency (though these issues have less of an impact on its utility for simply transferring money across borders).

Whatever happens to Bitcoin, electronic money based on the same basic philosophy is probably here to stay. The use of Bitcoin has opened the door to ways to limit inefficiency in the international money transfer market. According to the World Bank, $1.4 billion was remitted to Kenya in 2014. Assuming that the three most prevalent money transfer services were used equally, another $57.7 million was spent on remittance transactions but never reached Kenya. Bitcoin offers a way to put more money in the hands of people who need it worldwide by significantly reducing this sum.

Mary Beliveau is a temporary Program Assistant for Africa at CIPE.