As we said earlier the M-PESA is similar to a legal and modern version of the cross-border Hawala system with a black market honor system replaced with market competition. Recall that using Hawala's, the transfer between the sender and the recipient could be instant. Sender gifts the dollar to its agent, calls the recipient with a secret code and the recipient withdraw the Euros from his agent. This phone call therefore represents the transfer of e-money, that is virtual balances that could be conveyed via phone calls or text messages. The settlement between the two agents uses physical cash. So let's call that the physical money. So, just like the Hawala, less have a system of agents located across the country. They could be the post office, small shops on the street or the newsstand that you saw earlier. And importantly like the Hawala where the Hawala orders maintain a stash of different currencies, we'll let each of the end Pesa agents hold a stash of both e-money and physical money. And we're going to specify that the e-money can be exchanged one to one with physical money. Both the agents and the customers can buy e-money with physical money at a one-to-one ratio and both can redeem the e-money back into the fiscal cash at a one-to-one ratio. This dual market system enabled instant money transfers over simple text messages like this. Let's take a deeper look at the business model. We have two customers, sender and receiver, as usual located in two different towns, and they have their own standard non smartphones. Suppose there are two agents, one in each of these towns. And again, they could be post offices or small stores. Now, the physical money is going to be maintained in one big bank account that's operated by M-PESA. Each agent could deposit physical money into M-PESA's bank account and obtain the equivalent amount of e-money. You can keep the record of all that even on a piece of paper, vice versa, the agent could sell the money back to M-PESA and get the physical cash back. Note that you don't need a computer to do this, the agent could simply go to the nearest bank branch and do the deposit and withdraw there. And more importantly, M-PESA makes the process even easier by employing a large team of the so-called master agents whose job is to drive around these towns and villages in cash vans visiting the agents to buy and sell either physical or e-money to them. The roaming master agents are essentially market makers. Providing liquidity to the physical agents, saving them trip to the banks. Now, the sending customer comes in and gives physical cash to the agent. The agent then does a simple accounting task. It increases his cash holdings by the amount given and correspondingly reduces the e-money inventory by the equivalent amount. It then transfers the e-money to the sender with a simple text message with an embedded security code just like the Hawala system. The sender now has some e-money available, could simply send a text message with the amount and the code to the receiver. The receiver takes the code and goes to the agent in his town. He transferred the e-money to the agent, getting physical cash in return. The transaction could complete in a couple of seconds and each agent would receive a percentage of the transfer to compensate their services. Notice how the competitive markets for physical and e-money are nicely separated. The ecosystem up here on top is completely e-money which could be transferred instantly with text messages. Down here at the bottom is the market for physical money, whose settlement is facilitated by the market making master agents. The really clever part of this, there's no single entity acting as the central intermediary here. It's a relatively decentralized system that runs completely on a competitive basis. Anybody can sign up and become an agent after some simple background checks. Afterwards, they are completely autonomous. There's no central control and they freely compete with each other for business. And their core business is very simple. Either buying e-money for M-PESA with physical money or selling e-money to M-PESA and get physical money. In other words, their primary business is inventory management. They want to maintain a optimal level of inventory in both e-money and physical money to serve the most number of customers and maximize their own profits.
