The year 2020 was called the year of DeFi (Decentralized Finance) in the world of cryptocurrency. According to DeFi Pulse, the total assets deposited on DeFi platforms, also known as the total value locked in, was about $100 billion. Out of this, $64 billion was on the Ethereum blockchain alone.
With statistics such as these, we are forced to ask if decentralized finance will end retail banking and traditional financial services.
What Is DeFi?
For those of you who are uninitiated, DeFi is a system that provides financial services such as retail banking, exchanges, etc., for cryptocurrencies in a decentralized manner. Unlike traditional banking services, there is no central authority that controls the operations.
Instead, the DeFi space is run by smart contracts that are automated programs that perform all operations. Functions such as verification, transfers, etc., are performed via these smart contracts and verified by different nodes in the system.
How Will DeFi Disrupt Retail Banks And The Global Financial System?
Independence And Autonomy
In the DeFi model, the customers or users directly control assets, unlike in the traditional banking system, where everyone is at the mercy of a central authority.
Either the government or multinational corporations run the banks. Hence they control everything, and there is little to no democracy.
However, with DeFi, since there are no intermediaries like retail banks or other such institutions, anyone and everyone can access financial products and services. All they need is a good internet connection and access to a secure decentralized network.
Interest Rates And Returns
Banks have the worst interest rates imaginable, and though they run the global economy, DeFi is showcasing the shortcomings of traditional finance by solving challenges such as these.
When you invest in a decentralized network, the yield and returns are much higher than a retail bank. Here’s why. For instance, you deposit money into a savings account and earn an interest of 1%. Then, the banks will lend this money to others for an interest rate of 6%.
According to the DeFi protocols, there are no intermediaries. Hence, people will lend the money to the borrower directly, and thus people save the 5% difference and earn the total 6% interest rate.
The traditional financial products are not accessible to a huge chunk of the population. According to the World Bank, in 2018, 1.7 billion people across the globe did not have a bank account.
DeFi has the potential to change this because anybody from anywhere can access DeFi apps, buy digital assets make an investment and trading move, and use other crypto services.
Faster Processes And Transactions
Banking and financial transactions have always been a slow process. Making loans or borrowing money, or even trading stocks is a painful process where you have to jump through countless hoops, and your work will still not be done.
DeFi is a real innovation because it solves this challenge and improves speed by a large margin. Moreover, they show how traditional banks are entities of the old world, and the new world is going to be run by blockchain technologies such as this.
These are some of the most significant benefits of DeFi besides offering a variety of crypto services such as trading assets, staking, yield farming, etc., thus making it a real competition to traditional banks.
Challenges Of DeFi
Everything has its pros and cons, and DeFi is no exception to this law. Here are a few challenges that come with this new world.
Security And Smart Contract Risks
Security remains a constant threat to the users of DeFi platforms. Since these apps function over the internet, they’re exposed to more hack attempts.
Furthermore, smart contracts use external integrations where info has to be provided to other parties who are off-chain. This poses a potential threat to security since hackers can exploit it.
Moreover, cyberattacks are evolving with each passing day, and the platforms need to update their security so that there is no harm to their users and customers.
The number of users on the blockchain is at an all-time high, and there are congestion issues already surfacing. However, the protocols used lack scalability and need to be rethought and restructured so that more people can use the space with ease.
Companies and crypto projects such as Polkadot and Fantom have started addressing this and even have come up with promising solutions.
Lack Of Understandability
DeFi apps were initially designed for crypto users. However, this means that it alienates a large chunk of the global population who do not understand blockchain and its concepts.
Even if there are explanations provided, they contain too much jargon, and hence the process of debuting onto a platform and learning how to use it becomes a considerable challenge.
Though this has been improving now, we still need easier and simpler methods of explanation to expedite the process of mass adoption.
The entire blockchain space is still new and in its nascent stages. However, it has immense potential, so it’s also the right time for everyone to join the bandwagon.
Though the traditional banks resist change, when an irresistible opportunity is presented to the masses, they are inclined to grab it while they can.
In essence, DeFi definitely has the potential to destroy the traditional banking systems in the years to come, and people have to move towards it inevitably.
Anish loves reading, researching, and writing about crypto and blockchain. He started his crypto journey early in 2017, what started as a fad is now a full-time hobby. He curates guides after thorough research on platforms and is responsible for the most in-depth guides on the site. You will find him walking his dog (not Doge) when he is from his Laptop.