By Lou Grilli, Sr. Innovation Strategist for Primax
DeFi is a powerful concept that could be a major disruptor in the financial services industry. In much the same way Uber and Lyft made us think differently about taxis or Airbnb and VRBO changed how we book vacations, DeFi has the potential to change how we view lending, borrowing, savings and trading.
What is DeFi?
DeFi, short for Decentralized Financial Services, is a broad term for financial services conducted on public blockchain, primarily Ethereum. It does not have a central authority or the involvement of a bank or other traditional financial organization, hence the term “decentralized.” DeFi services are accessible to anyone with an internet connection, anywhere in the world, at any time. Looking at four typical banking services, lending, borrowing, savings and trading, it becomes more apparent how powerful and disruptive DeFi might become.
Lending
Anyone holding cryptocurrency can be a lender by locking up their holdings, also referred to as “staking,” as collateral. The underlying currency continues to appreciate (or sometimes depreciate), but by locking up the currency, the lender also gets a return on their staked assets, typically around 6-8%. Since DeFi is unregulated, there are many areas of risk, including the borrower defaulting or the staked collateral depreciating below the loaned amount.
Borrowing
Borrowing in the DeFi space looks very different than borrowing from a bank. The borrower can apply for a loan without filling out an application any time, day or night, from anywhere in the world. The terms of the loan are documented as a “smart contract,” which is essentially lines of code comprising a program on a blockchain. The smart contract is executed automatically, without a central figure. When the lending terms are met, the borrower receives the proceeds of the loan paid out in a stablecoin. The borrower accepts the stablecoin and then can turn around and use the funds as needed. The borrower does not have to have a credit score or pass a creditworthiness test. The lenders do not even know who the borrowers are and vice versa.
Saving
Savers looking to earn rates better than the typical half a percent offered by most financial institutions today find DeFi a much better alternative to regulated financial institutions. Although there are higher returns on DeFi savings, it is also accompanied by higher risk; accounts at DeFi exchanges are not insured.
Trading
When it comes to money movement, DeFi is promising. Using DeFi services, anyone can issue nearly instant payments to someone else, anywhere in the world, without the need for a bank account – and this can be done at a lower cost than traditional money movement tactics.
Why is DeFi Important?
DeFi takes the original premise of Bitcoin — digital money — and expands on it, creating an entirely digital alternative to banks without all the associated costs for branches, salaries, compliance and more. With so many possible benefits, there are also several areas of risk associated with DeFi. Eventually, federal regulations may result in DeFi being required to conform to banking regulations, resulting in diminished benefits.
There are many unknowns regarding how quickly, if at all, DeFi will disrupt banking, especially in the global lending market. Banks should monitor the progress of DeFi in the industry, including leading industry providers of DeFi, and consider how the potential disruption will impact their business processes. DeFi has the potential to further shift consumer demands by creating more flexible, convenient financial services open to anyone with just an internet connection. Banks can meet that need by looking to make their own services, including lending and borrowing, available on demand with improved response times but with the added safety and compliance that customers deserve.
Lou Grilli is a Senior Innovation Strategist tasked with building and shaping a superior payment and banking experience capability. Lou is currently focused on real-time payments and cryptocurrency. He participates on the U.S. Faster Payments Council and is named on a patent for the use of blockchain for loyalty programs. Lou holds an MBA from Duke and a master’s degree in Computer Engineering from the University of South Florida.
