Banking in the age of DeFi
The last decade has been revolutionary for the world’s finance sector. We experienced a great surge in digital transactions, led by India and China with 80 million and 100 million individuals, respectively, making online payments using cards, mobile, or through the internet. 2010s marked the rise of the big 5 tech giants and along with their success a spurt in Venture Capital investments. Micro VCs sprung up in all corners of the world and evolved from being just a source of capital for young startups, helping them with hiring, financial management, business developments, etc. Just when the volume of VC investment was at its peak, we got hit by the global pandemic, unarguably the most unexpected and vicious calamity humankind has faced in this decade.
Even after all these world-changing events, the biggest and possibly the most impactful highlight of the financial world was DeFi (Decentralised Finance). Starting with the launch of BitCoin in 2009, we saw a small niche of investors supporting this seemingly rebellious idea of a decentralized store of value. It only took 4 years for BitCoin to reach a 1 Billion USD valuation. While investors were trying to wrap their heads around this new form of asset, Vitalik Buterin releases the Ethereum White Paper: “A Next-Generation Smart Contract and Decentralized Application Platform” in November 2013. It took till 2017 to gauge the developer’s interest in Ethereum, and then the real fun started. Projects like CryptoKitties and Maker DAO made big news, BitCoin grew 20x, from 1000USD to 20,000 USD in 1 year and Ethereum saw a steep increase in locked assets on its blockchain. Continuing the momentum, in 2018, revolutionary automated market-making protocols such as Uniswap and Sushiswap came out. Ever since we are experiencing a surge in innovative financial protocols and the smartest minds of finance flocking to the world of Decentralised Finance.
During this phase, the traditional banking sector has either been insolent or overly pessimistic about this growing economy. Even the VCs, the bold and disruptive forces of the tech world, failed to show confidence in DeFi’s early days. But with the overall crypto economy crossing 1 trillion dollars in evaluation in 2021, it was too big to miss. Young retail investors from all over the world started investing a significant chunk of saving in crypto assets. Financially struggling countries like El Salvador accepted BitCoin as a legal tender. NFT technology became the new buzzword of the valley as it crosses 1.5 billion USD in market size. 100s of billions of dollars were exchanged without any exposure to the traditional banks. Since then, the biggest banks and countries are trying to establish their presence in this evolving ecosystem. An ecosystem that is principally against centralized authorities and their black box decision-making.
It won’t be too ambitious to say that DeFi will be the biggest challenge for the BFSI industries in the coming decade. Will the Morgan Stanleys and Bank of Americas of the world be substituted by open protocols like Compound and Aave, Visa and Mastercard by Metamask, and Centralised exchanges like NYSE, LSE, etc by DyDx and Uniswap? Only time will tell. Needless to say, the journey towards a more decentralized future will be hard. Though the current community of crypto enthusiasts strongly believes that we no longer require the traditional financial institution, it's hard to imagine locking 100% of your life’s assets under the brittle security of zero-knowledge protocols. Solving the complexities of real-world asset ownership is what made the banks into an unfathomable force and DeFi doesn't offer much in this space. Moreover, crypto’s inherent properties allow tax evasion and money laundering, which is already a big concern for governments worldwide. The DeFi space is yet to prove its mantle by successfully working with regulators and lawmakers of the world while preserving its essence of decentralized decision-making.
Banks, on the other hand, need to be agile while adopting this change. They have to move quickly and build the services needed to boost the Web3 economy. If they have anything to learn from the past, it is the lightning speed at which the Web3 ecosystem has developed financial solutions and is continuing to do so. The open protocols promote knowledge exchange and provide financial support to those building in the same domain, which works as a great catalyst. Banks have to exploit the core inefficiencies of decentralized services and ease the connection between the two ecosystems. Loans, insurances, investment banking, and many other banking services are yet to integrate with digital assets and should be a great entry point for banks into this economy. Moreover, in the space of metaverse, P2E gaming, and NFT creators, millions of people earning in digital assets have to cross many hurdles before they can use that income for something as simple as groceries. While merchants and governments from around the world are still skeptical of trustless digital assets, banks have a fair amount of time to play catchup. But one thing they shouldn’t forget is that the clock is ticking!