While COVID 19 disrupted the global economy, governments reacted quickly to the pandemic by imposing lockdowns and facilitating a new normal through social distancing protocols. Governments worldwide also rolled out fiscal stimuli to get economies back on track. However, most of the stimulus measures focused on the financial aspects of the economy’s supply side, not the demand side.
Stimulus was extended to all sectors, and special care was taken to support micro, small, and medium enterprises (MSME) because they are the growth engines for national economies. According to the World Trade Organization, 152 member nations introduced stimulus measures for MSMEs in the form of loan moratoriums, sovereign-backed loan guarantees, and wage payments. Nonetheless, support to MSMEs was disproportionately smaller than aid for large corporations; thus, the MSME industry felt it needed additional incentives.
Although economic activities have resumed amidst the ongoing pandemic, some non-essential establishments, such as department stores, salons, bakeries, and boutiques, have waited to reopen, suffering from reduced cash flows, working capital, and demand.
Introducing the following concepts helps address these issues:
- Community financing: Normal individuals lend small amounts to the local establishments they use frequently to provide liquidity and address cash flow issues.
- Upfront demand generation for MSMEs: Money borrowed from individuals is repaid in goods or services. This type of lending can inspire confidence for MSMEs by proving that a market in which they can do business exists.
We believe that a decentralized finance model with social capital and trust at its core addresses the challenges faced by MSMEs, lowers defaults on loans, and provides affordable interest rates.
Save MSMEs before they shut down
Twenty-eight million American SMEs account for nearly two-thirds of new private-sector jobs in recent decades. SMEs that export tend to grow faster, create more jobs, and pay higher wages than businesses that do not trade internationally.
To tackle the economic disruption of the COVID-19 outbreak, the CARES Act was established in the U.S., which contains emergency relief resources for American workers and small businesses. The Small Business Administration (SBA) is accepting new Economic Injury Disaster Loan (EIDL) applications from all eligible small businesses, private non-profits, and U.S. agricultural businesses.
Globally, MSMEs represent 95% of all companies and account for 60% of all jobs. A recent survey of the Korean Federation of MSMEs showed that 70% of 407 surveyed MSMEs would survive for no longer than six months if the COVID-19 situation doesn’t improve. In India, MSMEs contribute 29% of its GDP, and that contribution is expected to grow to 50% by 2024. The MSME sector in India is the second-largest employment provider after agriculture. According to a survey conducted by the All India Manufacturer’s Organization, 43% of MSMEs would close if they don’t receive financial support in the coming months.
Community financing is different from P2P lending and cooperative banking
Peer-to-peer (P2P) lending services leverage online platforms to match lenders with borrowers. Individual creditors lend to individuals they do not know and charge high interest rates. Community financing, however, establishes a mechanism to lend to a borrower in the creditor’s community and charges nominal interest rates.
Cooperative banks lend support to MSME industries but obtaining loans is manual and requires multiple bank visits. Many micro-enterprises do not have access to banking services or are overwhelmed by the banking process. Co-ops have not yet addressed the demand shock experienced by MSMEs during the pandemic.
With community financing’s simple, easy, accessible, and affordable platforms for raising money, MSMEs can address the issue of liquidity and demand shock.
How does community financing work?
Community financing solutions tend to leverage existing financial infrastructures, especially digital wallets. We propose blockchain technology, decentralized in nature, could create a financing mechanism using the following structure:
- Business owners in need of capital place requests from a mobile app with information about the type of service they provide, the amount of capital needed, the duration of the loan, and other know-your-customer-type credentials.
- Community members interested in lending transfer the amount to the borrower’s wallet using existing payment methods.
- Once the business owner’s digital wallet is credited with the requested capital, a smart contract is triggered that creates equivalent or greater tokens per the agreed-upon interest amount. These tokens are credited to the lenders’ wallets as an instrument of dividend redemption.
- Once the lender receives the tokens, they can utilize them for purchasing goods and services from the borrower for an agreed-upon period.
Operationalizing the solution
The solution we propose consists of a mobile or web application built for lenders in the community, borrowers who operate the MSMEs, and a nodal agency that manages the transactions.
- Nodal agency, which could be a local community organization, approves and on-boards lenders and borrowers
- Borrowers place a request via mobile or web app built with blockchain
- Nodal agency, holding the master view of all transactions within their neighborhood (ensuring confidential and anonymous data), verifies and validates the requests
- Lenders view the requests and validation details by the nodal agency
Blockchain technology, a decentralized platform, is the right fit. Blockchain connects multiple parties in a trustful environment and provides them a means to transact securely with data immutability, real-time auditing, and a single source of truth to tackle issues of fraud, defaults, and disputes.
Benefits of decentralized community financing
Decentralized community financing helps MSMEs meet their capital requirements with the community’s support and without going to a bank or non-banking financial company. Upfront demand generation assures MSMEs that lenders will frequent their businesses. Less bureaucracy means fewer loan defaults as MSMEs become establishments that individuals directly interact with on a day-to-day basis. Communities can be a part of the post-COVID rebuilding process when everyone, including financial institutions, faces increased stress. Ultimately, this system fosters social responsibility and provides a platform for more sustainable community development.