Now, his attitude toward crypto is changing, but not for the reasons you’d think.
"With the increasingly onerous banking requirements in Mexico, I am very tempted to use crypto, especially to buy things online," Sosa said.
Sosa is not alone. In a trend that is largely unnoticed outside of the country, Mexico is embracing cryptocurrency at a breakneck speed.
In the eight months between September 2019 and May 2020, the trading volume of Mexico’s leading crypto exchange, Bitso, grew by 342%, according to the exchange. Earlier this year, Bitso announced it had surpassed 1 million users on its platform, of which 92% are Mexican.
Sosa is drawn to crypto in part for its potential to transfer money more easily. In Mexico, that is becoming increasingly hard to do. In its effort to crack down on criminal activity, Mexico may have made simple transactions difficult for ordinary citizens as well.
The country has long struggled with tax evasion and money laundering. But two years ago, Mexico decided to put substantial prevention methods in place. In August 2019, right before Bitso’s trade volume began its dramatic climb, the government began implementing new fintech laws that sought to govern financial service providers in the banking and private capital sectors, from entrepreneurs to crowdfunding institutions.
According to the new laws, tech firms that hold deposits for users had to register as a financial institution within the country. But compliance was expensive, with applications running over $35,000 and the law requiring businesses – even startups – to have a minimum annual profit of $100,000. National media reported at the time that of the 500 listed startups in the country, 201 had to be approved by regulators to continue operations. Once the new laws rolled in, only 85 ended up applying for accreditation. Bitso was among the firms approved to continue operations in Mexico.
In order to comply with the new banking laws in Mexico, PayPal announced it will no longer be holding deposits on customer accounts. Now, it only processes payments as an intermediary, which means Sosa can no longer maintain a balance on his account. When Sosa’s mother, based in New York, wants to send him money, she can use PayPal or Western Union if she pays a transaction fee. Instead, she sends funds from her Apple Pay account to Sosa’s, where the funds remain inaccessible until he travels to the U.S.
Crypto trading platforms can facilitate faster money transfers at a lower cost than banks. According to Cadenas, who is also pursuing a PhD in financial engineering, the combination of Mexico’s stringent new banking laws, expensive financial services and large unbanked population is driving public interest in cryptocurrencies.
Like other countries, crypto is used primarily for speculation and trading in Mexico, Cadenas said. But the multibillion-dollar flow of remittances into the country, particularly from the U.S., and the difficulties involved in money transfers, have created a unique business opportunity for crypto platforms that promise to make transactions easier and cheaper.
“Internally, we can say that the use of cryptocurrencies is becoming more attractive compared to what other financial institutions offer,” Cadenas said.
Record-Breaking Remittance Flows
In 2014, Bitso launched Mexico’s first bitcoin exchange.
According to Bitso co-founder and CEO Daniel Vogel, in 2016 Bitso grew thanks to young adult gamers in Mexico paying for video games with bitcoin on the digital media platform Steam. But all that went away the following year, when bitcoin’s value soared from $900 to $20,000 in a matter of months. By the end of the year, bitcoin transaction fees also spiked, accounting for up to 40% of a single transaction. The young gamers simply couldn’t afford it anymore.
“Transaction fees went through the roof, from costing a fraction of a penny to $20 or $30 on their Steam accounts, and that use case just disappeared,” Vogel said.
“But this is Mexico. You don't have as much disposable income as places like the U.S. or Europe or Asia. And so even though trading revenue did go up, we didn’t grow as much as some of the international players,” Vogel said.
But there was a massive untapped market just begging for new players: remittances. Bitso had already partnered with payment platform Ripple to enable the quick transfer between dollars and pesos via liquid XRP, and the firm began processing remittance transactions.
“We transacted, I think on a weekly basis, almost 10% of the remittances from the U.S. to Mexico and on a monthly basis over 7% of remittances. And that was super exciting,” Vogel said.
Almost all of those transactions were electronic transfers, through bank accounts, Western Union, PayPal’s Xoom and crypto trading platforms like Bitso. But there are charges involved. Last year, Mexico President Andrés Manuel López Obrador blasted Western Union and Xoom for charging high fees on remittance transfers. For instance, Xoom charges up to 4% in transaction fees, and earns profits on the exchange rate each time money is sent to Mexico.
Comparatively, depending on which exchange you use, the transfer cost of that money via cryptocurrency can be as low as 0.1%, Cadenas said. According to Bitso’s website, a number of withdrawal methods, including bank transfers, are free for users receiving funds through the exchange.
According to Cadenas, Bitso processed 3.5% of incoming remittances in January this year, which increased to 5.3% in a matter of weeks.
But there’s another problem: A 2018 global database on financial inclusion published by the World Bank revealed 63.1% of Mexican adults (ages 15 and above) didn’t have a bank account.
According to Jonathan Terluk, senior economic and public policy analyst at EMPRA, an emerging markets consulting firm that focuses on Mexico, the country’s large unbanked population and cash-driven informal sector is made up of workers or businesses that are not registered with the government.
Between 55% and 60% of the total employed population in the country belong to this informal sector and are paid in cash, he added.
Mexican citizens without bank accounts use digital payment systems provided by the likes of Oxxo, a chain of grocery stores akin to America’s 7-Eleven franchise, that accepts cash payments for everything from groceries to phone bills and electric bills. The system also processes payments for online purchases, and allows users to deposit money into debit cards or bank accounts. Since it has partnered with Xoom and Western Union, remittances can be sent to your nearest Oxxo for cash pickup.
“We've had to come up with all these workarounds, because people don't trust credit cards or banks that much and a lot of people just use cash,” Sosa said.
One reason for the general distrust in banks, Cadenas said, is that Mexico’s traditional financial services are expensive. The average annual interest rate for a credit card can be around 27.4% in Colombia, while the weighted annual interest rate of a classic credit card at Mexico’s Citibanamex is 56.3%. According to Cadenas, the annual interest on a personal line of credit is around 21% in Colombia, approximately 45.34% in Peru and 67.2% or higher in Mexico.
“To give an example, if today I request a [line of] credit of approximately $10,000, in five years, I will end up paying $30,000, it’s crazy,” Cadenas said, after calculating the amount on the government’s credit simulator.
By contrast, anyone can create an account and wallet on crypto exchanges to start trading. Setting up an account is usually free, and exchanges may charge a trading fee (Bitso charges between 0.05% and 0.5%).
Bitso’s transfer platform works like peer-to-peer lending app Venmo, where you can store, send and receive money free of charge. To serve the large population without bank accounts, crypto platforms usually offer multiple withdrawal methods that include transferring funds directly to your mobile phone, or a digital coupon to avoid bank deposit fees.
Another reason why crypto might be an appealing option to a population that feels exploited by traditional financial services is that even though crypto platforms are regulated in the country, there is no comprehensive framework on how it’s taxed.
In accordance with anti money-laundering requirements, crypto firms must report transactions (one-time or over a period of six months) exceeding roughly $2,500 to the financial authority as a “vulnerable transaction,” Diego Ramos Castillo, crypto litigator and founding partner of a commercial law firm in Mexico told CoinDesk. Beyond that, there are no specific rules for crypto: Mexico is still trying to figure out exactly how to tax it, and right now, there is room for a bit of interpretation.
For instance, according to Ramos, there are certain tax perks to storing your wealth in crypto: If you want to open and maintain an account that holds any type of foreign currency, you are required to declare any gains or losses you have made during a period of time, even if those are just price fluctuations of the currency you’re holding.
But you can hold your funds in stablecoins – cryptocurrencies backed by fiat assets in order to reduce volatility – more easily, Ramos said. Stablecoins are not considered a foreign currency so “you can have an account holding stablecoins, that would be the same as having a U.S. dollar account but you have the tax benefit of not having to report or declare the gains or losses until you sell the stablecoins,” Ramos said.
The fintech regulations enacted last year included a whole chapter on virtual assets.
As a consequence of the bill, exchanges were no longer allowed to hold or custody fiat currencies without a license. But applying for compliance was expensive and threatened to put crypto startups and entrepreneurs out of business.
A provision in the bill also required Mexico’s central bank to issue specific secondary rules on how virtual assets would be regulated. According to Ramos, the law banned financial institutions from issuing or transferring the “risk of cryptocurrency” to the customer in any way. But institutions were still allowed to use crypto for internal operations, Ramos said.
But the regulations issued by the central bank sounded worse than they actually were, Ramos said, because the government did not ban crypto or call it illegal, and that was good enough.
“The central bank recognized that crypto activities were permitted in Mexico. They were not illegal. What they were saying with this secondary provision was that financial institutions should take care and if possible avoid participating actively in the crypto industry,” Ramos said.
So operating a crypto business in Mexico is expensive, thanks to the new fintech licensing requirements, but well within the law.
It will take some time for crypto firms to become the leading processors of remittances, or the go-to digital payment system in Mexico. Across the country, cash is still the preferred method of payment and cryptocurrencies are not widely accepted. The industry has its own shortcomings, starting with the fact that not many people understand how crypto works, and it seems daunting compared to a short walk to the nearest Oxxo.
Sosa, for instance, will still need a bit more convincing before he actually opens a bitcoin wallet.
“For the average consumer, I still find it's just way too onerous. And, you know, I'm not gonna ask my mom to create a crypto wallet because that means that I'm going to spend six days walking her through it,” Sosa said.
Nevertheless, startups are continuing to enter the Mexican crypto space. For instance, while Bitso is looking to expand outward, having already established itself in not only Mexico but also in Argentina, startups like crypto exchange Mexo are uniquely targeting local users. Mexo co-founder and partner Bo Zhou told CoinDesk that everything about the platform, starting with its Spanish-language website, is designed to attract users in Mexico to conduct local transactions. AirTM, headquartered in Mexico, provides blockchain-powered dollar accounts to users worldwide. Last year, the startup distributed $300,000 in donations to Venezuelans in need.
It appears Mexico not only has a large population open to exploring alternatives to traditional financial services, but a number of factors have aligned almost perfectly to facilitate mass adoption. It can also play a role in advancing financial inclusion, Cadenas said.
“Cryptocurrencies in Mexico are a reality for those who not only seek to invest, but for individuals and companies that have the enthusiasm to improve their living conditions with more accessible financial products,” Cadenas said.