Lending In Digital Currency: A New Financial Frontier for Borrowers and Lenders

At the end of last year, KN Law LLP broke ground in the financial world by acting for a borrower in a debt finance transaction in Stable Coin. Stable Coin is a crypto asset that aims to maintain a stable relative value to a specified asset or pool of assets. It can be pegged to the US dollar or to the Kenya shilling, and may be issued by private issuers or by a sovereign. A case in point is the recently proposed Central Bank Digital Currency (CBDC).


In the transaction spearheaded by partner Doreen Onwong’a, the loan amounts were made available through a borrower’s pool, populated by USDC (United States Dollar Coin) and accessible through a bespoke non-fungible token.


Digital transactions in their various forms have been on the uptick since the debut of M-Pesa in 2007. The potential of FinTech (a portmanteau of the terms “finance” and “technology” and refers to any business that uses technology to enhance or automate financial services and processes), can therefore not be discounted. Traditionally, FinTech has caused a cascading effect on financial services, particularly in facilitating digital payments and lending. This has had broader impacts on society through enhancement of financial inclusion and poverty reduction. So what does this portend for ordinary borrowing transactions?


Credit Appraisal


Like in ordinary transactions, credit appraisal is carried out on the business. But instead of bank credit officers, operators of the borrowing platform use various methods of valuation, including carrying out the appraisal themselves. Alternatively, they collectively engage users of the platforms to perform individual audits and assessments, including physical verification of the business.




A contract between the parties is necessary to not only set out the agreed terms, e.g., the interest rate and repayment period, but also to provide for recourse in case of default.

This can be achieved through legal smart contracts. Smart contracts are legal contracts where some or all of the contractual obligations are performed automatically by a computer program, and is legally enforceable. Smart contracts take various forms:


  • A natural language contract with automated performance
  • A hybrid smart contract where some contractual obligations are defined in natural language and others in the code of a computer program
  • A contract recorded solely in code


Smart legal contracts are best suited for simple contracts or for executing performance automatically e.g., ensuring the payment of funds upon certain triggering events, or imposing financial penalties if certain objective conditions are not satisfied. The natural language part of the contract would then cover more complex matters such as risk allocation, covenants, including financial covenants, indemnities, governing law, and jurisdiction. These would typically mirror the terms in standard form borrowing contracts. The transactions may be secured by equivalent assets like digital currencies, or a conventional security package like an assignment of receivables or a charge over land, because the transactions fund real businesses.


Digital Currency in Kenya


According to the 2022 Central Bank of Kenya (CBK) Discussion Paper, M-Pesa accounted for 81.5% of number of transactions and 38.6% of value of transactions as of March 2021. P2P (Peer-to-Peer) trading volume in bitcoin in Kenya achieved highs of KES 150,000,000 during the second week of January 2021.


Taking this into account, CBK has also published a Discussion Paper on the proposed CBDC to complement paper currency. The paper arrives at the conclusion that digital currency, including crypto currency, can no longer be ignored. CBK’s primary objectives in considering the CBDC seems to:

  • Manage systemic risk caused by the prevalence of M-Pesa as a Payment Service Provider in the retail space and a few large banks that account for the lion’s share of customer deposits.
  • Manage the proliferation of private money which the CBK still considers risky, with the potential of exposing the general public to damaging consequences. Other reasons include reducing the cost of cross-border payments and enhancing interoperability.


The Future Is Bright


Crypto Lending


There are many benefits attached to using digital currencies and smart contracts in enhancing the ease of doing business. The COVID pandemic provided the ideal environment to accelerate the use of technology in streamlining and enhancing how we do business.


Non-fungible tokens (NFTs) can be used as debt security or as an instrument evidencing a security. This means that anyone who buys a security e.g., a debt instrument, receives an NFT when they supply capital. The NFT tracks the amount supplied and how much of it has been redeemed. The use of NFTs, as opposed to fungible tokens, ensures that no one redeems more than their proportional share of total repayments. This is especially useful to investment-based crowdfunding platforms that work as aggregators of capital in terms of administrating their day-to-day operations.


Transfer of Securities


Any process of transfer of securities can be achieved by simply transferring a non-fungible token. This completely eliminates registry and escrow fees.


The role of FinTech in the financial services industry cannot be overstated. The Capital Markets Authority (CMA) Regulatory Sandbox, the Draft Capital Markets (Investment Based Crowdfunding) Regulations published in 2021, and the recently published CBK Discussion Paper show that policy makers are now focusing on streamlining FinTech. CMA published the Draft Capital Markets (Investment Based Crowdfunding) Regulations of 2021 that allows companies to secure financing from investors using shares and debt securities such as bonds. In light of the Senate’s Start-up Bill in Parliament, doors to raising of capital through the granting of non-fungible tokens or coins that are secured against company assets are beginning to open.


The utility of crypto currency is in the ascendant, not only in ordinary borrowing and lending transactions, but also in the capital markets. The use of digital currency by platforms operated under the Draft CMA Regulations may just be what turns the tide. A detailed analysis of these draft regulations can be found.


However, challenges remain, such as the need for digital currencies to achieve legitimacy, uncertainties regarding changes in law, the use of digital currencies in crime, money laundering and terrorism, and tax-compliance. These are some of the obstacles that the CBDC seeks to neutralise. Regarding smart legal contracts, the fact that when automated they cannot be varied or provide room for discretion presents significant hindrances. For example, while a regular supplier may indulge a buyer with extra time, once the penalty is automated, a mandatory penalty is levied on the buyer’s account. And then there is also the risk of cyber security and the use of wrong data. But as contracts go, what is important is how the parties address and allocate these risks among themselves.





Read the original publication at KN Law LLP

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