Decentralised finance (DeFi) promises to revolutionise financial services and deliver financial inclusion for all. But how does DeFi work, and what could this system mean for Africa’s traders and SMEs? Tedd George, founder and chief narrative officer at Kleos Advisory, reports.


Decentralised finance (DeFi) has become the latest buzzword in global finance. The sector has grown dramatically over the past five years, accelerated by the impact of the pandemic and the growth of digital banking services. According to Forbes, adoption rates, or the total locked value in DeFi protocols – the programmes that power DeFi – were at nearly US$43bn in April 2022. But what exactly is DeFi, and how is it different from traditional finance?

Put simply, DeFi is an ecosystem that uses cryptocurrency and distributed ledger technology (DLT) to manage financial transactions. DLT, blockchain and crypto have been around for more than a decade, attracting their share of hype and speculation. This is evidenced by the fortunes of the most popular cryptocurrency, bitcoin, which as of press time has lost over 60% of its value since peaking in November 2021. A large part of the weakness of cryptocurrencies stems from the fact that few of them are being used for their stated purpose, which is to make payments and replace existing financial services. Instead, many cryptocurrencies have become speculative assets in their own right, with investors seeking to make quick returns rather than build an alternative financial system.

But with DeFi, blockchain may have found its killer application. This is because unlike traditional lending and saving, which involve centralised financial institutions, central banks and regulators, DeFi is decentralised. There is no central authority setting the rules (or arbitrarily changing them) and there is no ‘middle man’, such as a bank or intermediator, taking a cut of the transaction. Instead, DeFi allows lenders and borrowers to deal directly with each other, transferring value using cryptocurrencies and managing all data processes on the blockchain. As result, DeFi represents

a completely new financial rail outside the banking system which can provide the same mixture of financial services as a bank, from loans, savings and mortgages to complex contractual agreements and asset trading.

DeFi can bring several advantages to businesses and traders, especially in emerging markets.

First and foremost, DeFi removes the barriers to lending. For example, an African SME processing cocoa for export currently has to jump through multiple know-your-customer (KYC), due diligence and compliance hoops to get a credit approved by a bank. Even if it is successful, this process can take months to complete, with the funds coming at a high cost. But with DeFi, all processes are automated. Once a borrower has been onboarded, a loan can be granted in a few minutes and the funds made available immediately. This means that anyone – not just a bank – can be a liquidity provider to an SME using DeFi, and borrowers need only go through the KYC process once – without having to restart it every time they approach a new lender.

Second, DeFi is much cheaper than traditional lending and can provide higher returns for investors. Most lending in Africa, especially in high-risk sectors like agriculture trade and retail, comes with high interest rates, often to the point at which it is no longer affordable for the borrower. But with DeFi, both lender and borrower can take advantage of the lack of a middle man (and their need for a margin) to secure lower interest rates and higher rates of return. In addition, this could be done with no charge to transfer funds and no currency exchange fees, further reducing the cost.

And third, DeFi uses smart contracts. These are agreements written in computer code that are programmed to complete transactions automatically once certain conditions are met. For example, once a shipment of goods has been received by an importer with the correct documentation, a payment is automatically made to the exporter’s bank at the price stipulated in the smart contract. This could be a fixed price or an agreed market rate. As the CEO and founder of blockchain-powered KYC solutions provider Tradle, Gene Vayngrib, puts it: “The smart contract is the judge and jury. There is no margin call, it just executes on its own. That’s the beauty of it.” By embedding complex contractual terms into the crypto code, the efficiency, transparency and speed of transactions can be greatly enhanced, benefitting both the lender and the borrower.

The application of DeFi to African markets might seem counterintuitive, given that crypto is typically associated with multinational investors rather than African SMEs. But as with all digital financial services, it is not necessary for users to know anything about the underlying technology or system – in this case, DeFi – or even that they are using crypto. DeFi can be transacted using a decentralised app (or ‘dapp’) or on a mobile phone’s chat function, leveraging the widespread popularity of chat apps like WhatsApp, Telegram and Messenger. This opens up financial services to anyone who owns a mobile phone, which in practice means every African adult.


DeFi could transform African trade

Given DeFI’s inbuilt advantages, the system has the potential to transform African trade and address the well-documented trade finance gap. Despite concerted efforts by multilateral agencies, banks and African governments, this gap has changed little over the past decade and was estimated by the African Development Bank (AfDB) to be worth US$81bn in 2019. There are multiple causes for Africa’s trade finance gap, but DeFi could prove effective in removing the most persistent barriers for SMEs to access trade finance.

The first barrier is the reluctance of traditional banks to finance low-ticket deals. For most banks with appetite for African trade finance, any deal worth less than US$5mn is not worth the time and resources needed to assess the risk and structure the lending. At a single stroke this excludes most SMEs, many of which are creditworthy. According to a 2020 report by the AfDB and the African Export-Import Bank, in the period 2011-19, SME trade finance rejections averaged between 23% in East Africa and 47% in Central Africa. But if traders use DeFi, they can access loans from the micro level (for example, US$10,000 to invest in new trucks or machinery) to the medium-size (for example, US$100,000-500,000 to expand the business), filling a gap that banks cannot.

The second barrier DeFi can help lower is the high cost and complexity of trading across borders in multiple currencies and jurisdictions. Take for example a trader from Democratic Republic of the Congo (DRC) buying sugar and maize in Zambia for sale in DRC. Currently, the trader must first change local currency into US dollar cash (often at a high cost), then hide the money in their truck, drive into Zambia and buy the goods in cash, before returning to DRC to sell them. Not only is this process costly and time-consuming, but throughout the journey the trader is at risk of having the money stolen or being shaken down by corrupt border officials. In contrast, by using DeFi the trader can cross the border without any cash and do all their transactions with Zambian sellers via mobile phone, with no currency restriction.

All of these factors make DeFi a powerful tool in the roll-out of the Africa Continental Free Trade Area (AfCFTA), which aims to create a single market for goods and services across the continent. One of the obstacles to achieving this vision is the number of different currencies used in Africa. This has resulted in most cross-border trade being transacted in US dollar and euro, greatly increasing the costs and compliance hurdles for traders. DeFI could remove these hurdles, enabling African SMEs to transact with each other using their own currencies, which can be converted into crypto and instantly transferred. By linking together African traders, DeFi could help build cross-border value chains for food processing and consumer goods, reducing post-agricultural losses for crops like tomatoes, which are typically 50% in Nigeria, and decreasing dependence on costly imports of processed foods.

In the long run, DeFi could also help resolve one of the greatest challenges in African finance – how to get funds to ‘the last mile’, the communities and SMEs operating in remote, peripheral and rural areas. In recent years, last-mile financial services have primarily been provided by mobile banking, either through banking apps or mobile wallets. Although mobile banking has greatly increased financial inclusion, these services have come at a high cost for low-income households. For example, Kenya’s ubiquitous M-Pesa payment platform charges customers for every payment worth more than KSh100 (US$0.84) and for cross-border mobile-to-mobile transfers. In contrast, a DeFi payment between two users could be free, regardless of the size of the payment or where either party is located.

For remittances into, out of and across Africa, transaction and exchange rate fees can be exorbitant, but with DeFi cross-border payments can be made instantly, for free and with no exchange rate risk. This opens up possibilities for African micro-service providers to sell their services across borders. For example, using nothing more than WhatsApp/Messenger and DeFi, a teacher in Rwanda could help an illiterate taxi driver in Uganda fill in an online application for a new permit, and then be instantly paid US$1 for their work. Using current remittance platforms, it would cost many times more than US$1 to send this amount of money from one country to the other, making such cross-border micro-jobs unviable.


African regulators are waking up to DeFi

The rapid growth of DeFi has not gone unnoticed by Africa’s regulators, who are waking up to its potential. Regulators were initially sceptical about blockchain and cryptocurrency, citing well-founded concerns over the stability of crypto, its widespread use by criminal networks, and concerns that crypto was being harnessed to subvert currency controls. For example, during Nigeria’s periodic foreign exchange liquidity shortages, when exporting US dollar is tightly controlled, some Nigerians have turned to bitcoin as a means of paying tuition fees for their children studying in Europe and North America. Given regulatory concerns that crypto could negatively impact financial stability, around half of all African countries have an implicit or absolute ban on the use of bitcoin and other crypto, and it is not possible to have an account in crypto with a regulated African bank.

Nonetheless, over the past two years, African regulators have taken renewed interest in blockchain, looking beyond bitcoin and considering the technology’s broader applications in the financial sector, notably DeFi. Seven African countries – Ghana, Kenya, Rwanda, Mauritius, Mozambique, Nigeria and Sierra Leone – are reported to have set up regulatory sandboxes where blockchain companies have been invited to develop DeFi solutions, under the supervision and protection of the nations’ central banks.

African central banks are also considering the creation of central bank digital currencies (CBDCs). These are the same as fiat money but are issued directly by the central bank and only exist in digital form. By using the integrity of the blockchain and the credibility of the central bank, CBDCs could enable African traders to transact international business more easily, as CBDCs are exchangeable with any digital token or asset. They can also be used by central banks to target liquidity towards sectors of the economy where banks may fear to tread, for example in agriculture, sanitation and local infrastructure.

The African pioneer in this field is Nigeria, which launched the eNaira in October 2021. That the first African CBDC came out of Nigeria is not surprising, given that 42% of the country’s population own or use cryptocurrencies, the highest figure in the world, according to Statista. The key objectives of the eNaira are to boost financial inclusion (enabling those without bank accounts to transact digitally with the national currency), lower the cost of remittances and encourage the formalisation of the informal sector.

Ultimately, DeFi innovators and regulators will need to work hand-in-hand to scale this technology across Africa and get the maximum benefit from it. For African traders and SMEs, DeFi could create cheap and instantly available pools of liquidity, as well as offer rapid settlement of transactions and greater security. And for the last mile, DeFi could provide blockchain-based financial services which are cheap, or even free, instant and easy to access through any mobile phone.

The positive impacts that DeFi can have on boosting financial inclusion, supporting SMEs and growing Africa’s economies align the technology closely with the global sustainability agenda and the UN Sustainable Development Goals. This makes the sector an attractive investment for investors, asset managers and pension funds looking to make their portfolios more sustainable and directly address social impacts.