DeFi moves centre stage in post-Covid ecosystem Six reasons why banks can’t ignore Decentralised Finance

DeFi moves centre stage in post-Covid ecosystem Six reasons why banks can’t ignore Decentralised Finance By Leon Gauhman, chief strategy officer Elsewhen

From the global race to launch CBDC, to bitcoin becoming legal tender in El Salvador and its ascent to become an institutional asset class, the outstanding trend of the last 18 months has been the emergence of cryptocurrency as a mainstream concept. But scrape away the crypto froth and there is actually a much more significant shift taking place – the rise of Decentralised Finance (DeFi).

It’s no exaggeration to suggest that this blockchain-enabled innovation has the potential to transform the global financial infrastructure by allowing consumers to buy/sell/lend or borrow using public decentralised blockchain instead of banks or other financial institutions. While incumbent banks may hesitate to embrace crypto, they can’t afford to ignore the profound implications of DeFi. Here are six reasons why:

1. DeFi is solving critical banking challenges. For years the traditional financial system has grappled with problems such as how to cater for the 1.7 billion people globally who remain underbanked or how to provide faster, easier to access and more flexible ways to trade assets, borrow money or earn interest on loans. The following DeFi protocols shows how DeFi is helping to address these challenges: Goldfinch Finance has the potential to transform access to capital by allowing anyone to become a lender. Uniswap, a decentralised cryptocurrency exchange which facilitates buy and sell crypto assets without the use of brokers, claims to have enabled 57m all time trades totalling $298bn (at the time of writing). Meanwhile AAve, an open source non custodial lending protocol, allows people to lend and borrow cryptocurrencies without going through a centralised intermediary.

2. DeFi is happening right now: Banks that have consigned DeFi to the pending pile are already falling behind. The key measure that is used to assess the buoyancy of DeFi is the ‘total valued locked’ (TVL) in its ecosystem. In July 2021, that figure was around $59bn, an increase of over 1500% on what it was a year ago. While DeFi’s extraordinary rise is partly linked to investor enthusiasm for cryptocurrencies, there’s no question that a deeper dynamic is also at play. Can banks really afford to miss out on such a rapidly growing alternative ecosystem?

3. DeFi’s roadblocks can be overcome: Critics of DeFi cite its lack of privacy, the risk of hacking, high transaction fees, and challenges around interoperability and scalability as reasons why it poses no threat to traditional finance. Part of the problem is that DeFi is heavily reliant on Ethereum blockchain – which has suffered some performance issues around efficiency, scalability and high gas fees. However, Ethereum is now upgrading to a next-gen 2.0 version . What’s more, it is also facing competition from a plethora of alternatives such as Tezos, Stellar and Hyperledger Fabric. As for privacy and interoperability, there are signs that these issues are also being addressed – with entrepreneurial firms like Relite in the vanguard of DeFi’s pathfinders. The bottom line is that it is complacent to assume that the collective energy of the DeFi community won’t find ways to unleash DeFi’s true potential.

4. DeFi is part of a wider digital-first trend: Having already embraced fintech banks such as Monzo and Revolut, BNPL solutions like Klarna, cryptocurrencies including Bitcoin and stock market robo-advisors, digital savvy consumers are primed to embrace the value in digital non-tangible assets. With platforms like Coinbase making it easier than ever for consumers to enjoy the benefits of DeFi, there’s growing pressure for traditional banks to follow suit – sharpish.

5. DeFi can be a democratic force: The recent Gamestop showdown between Wall Street hedge funds and retail investors had an intriguing spin-off when trading platform Robinhood decided to limit trades amid the dealing frenzy. Whatever the rights and wrongs of this decision, it’s not something that could happen in a DeFi-driven world. With decentralised finance, there are no restrictions on what investors can do. This inevitably means greater risk, but it’s also a means by which financial activists can sidestep what they see as a rigged market. DeFi entrepreneurs like DAOVentures are working on solutions that could simplify DeFi investment, meaning that the sector is opening up to a much wider user base, often with little or no experience. Traditional banks need to make sure they don’t lag behind such advances.

6. DeFi can add stability to the traditional finance ecosystem: This may seem counterintuitive, given the perceived wisdom that crypto/DeFi is the financial services equivalent of the dark web. Yet traditional finance has shown its vulnerability time and again – not least during the 2008 crash which sent the global financial system into meltdown. Famed investor Warren Buffett said one of the key learnings from 2008 was that “we’re all dominoes. And we’re very close together.” But what if DeFi could space the dominoes out?

Hester Peirce of the US Securities and Exchange Commission (SEC) recently noted that DeFi could help financial markets become more robust by “moving away from centralised potential points of failure to a distributed approach that means that no one point is particularly important”. ING’s white paper concluded that, despite the clear differences between centralised and decentralised financial services, “we envision that these two services combined will bring benefits to both centralised institutions, to DeFi, and more importantly, customers.”

Final Thought: From online user experience to the speed at which they authorise loans, incumbent banks have lagged fintech challengers in most respects. So perhaps DeFi is a way for the empire to strike back, by enabling legacy financial services firms to reach out to customers that have traditionally been locked out of banking. Underbanked individuals, nascent SMEs and customers in less financially stable markets could all, potentially, become new lines of business. This could reinvigorate the image of established banks while also triggering opportunities for economic growth and prosperity.