DeFi is a real pain in the a** for banks!

How it can cause a demise of trillion dollar empires!

Existential crisis for banks

Flashback of 2008

We all remember the housing bubble in 2008 which led to the economic crisis for the people who don’t know what happened here is the short version of it.

The banks weren’t careful and gave out too many home loans to people who couldn’t pay them back. These were called “subprime” loans. The banks thought home prices would keep going up. But home prices started going down instead! Lots of people couldn’t pay back their loans, which hurt the banks a lot. Some big banks lost so much money they were in big trouble. This made it hard for people to get regular loans. Many people lost their jobs because businesses didn’t have money to keep them employed. The 2008 crisis showed us that banks need to be more careful not to give out so many risky loans just to make money. That can really hurt everyone!

“Banks extended an excessive number of home loans to borrowers who ultimately couldn’t afford them, leading to the crisis.”

The financial crisis in 2008 made regulators create strict rules for banks. These rules stop banks from taking too many risks by borrowing too much money without having enough assets to back it up. Interestingly, this crisis played a role in the creation of Bitcoin, which is sometimes called “digital gold.” Bitcoin uses a technology called blockchain. Now, you might be wondering how all of this connects to the idea of banks “burning up in the thumbnail.” Let’s explore this further.

“Bitcoin is a rebellious offspring of the economic crisis.”

Bitcoin was developed as a response to the 2008 financial crisis, offering an alternative, transparent, and decentralized financial system that aimed to address various issues revealed during the crisis. It was designed to be a digital currency and store of value outside the control of traditional financial institutions and governments.

But how can being decentralized address various issues revealed during the crisis?

• Reduced Dependency on Central Authorities: Traditional financial systems are heavily reliant on central banks and governments. During the 2008 financial crisis, it became evident that these central authorities could make policy decisions that affect the entire financial system. By being decentralized, Bitcoin is not subject to the same central authority control. This can provide a level of independence and reduce the risk of government or central bank policies adversely impacting the currency.
• Transparency and Trust: The blockchain technology underlying Bitcoin is transparent and tamper resistant. All transactions are recorded in a public ledger that can be independently verified by anyone. This transparency helps build trust in the system, reducing the likelihood of fraudulent activities or hidden risks that were seen in the traditional financial sector.

This decentralized concept has led to Decentralized Finance also called as (DeFi), this will be a real pain for the banks if get adopted widely by the people.

In simple terms, DeFi, or Decentralized Finance, is like a digital financial system that operates on the internet without traditional banks. It works using smart contracts on blockchains, which are like digital agreements that automatically execute when certain conditions are met. People can use DeFi for things like borrowing and lending money, trading digital assets, and earning interest on their savings, all without going through a bank. It’s open and accessible to anyone with an internet connection, making it a new way to handle your money without relying on traditional financial institutions.

“DeFi is a real pain in the a** to the banks.”

What are advantages of using DeFi?

• Swift Cross-Border Payments: DeFi enables rapid international transactions, saving time and reducing delays.
• Reduced Centralized Risks: DeFi operates without central authorities, giving users more control and reducing the risk of policy-driven disruptions.
• Lower Transaction Costs: DeFi typically offers cost-effective financial services with lower fees compared to traditional banking systems.

How will adoption of DeFi effect traditional banks

• Increased Competition: DeFi offers faster, more cost-effective, and accessible financial services, intensifying competition for traditional banks. To stay relevant, banks will need to innovate and improve their offerings.
• Disintermediation and Revenue Reduction: DeFi’s decentralized nature reduces the need for intermediaries like banks, potentially reducing the demand for some banking services. This shift may impact banks’ revenue streams as they face the risk of losing out on fees and traditional financial intermediation.
• Impact on Lending and Borrowing: DeFi platforms offer very attractive interest rates for decentralized lending and borrowing that can potentially reduce the demand for traditional bank loans. As users turn to DeFi for peer-to-peer lending and borrowing, banks may face competition in this core area of their business, affecting their interest income and lending operations.

What can banks do to avoid their demise?

• Collaborate with DeFi: Banks can explore collaborations with DeFi projects to harness their innovative solutions. JP Morgan chase has already developed a blockchain based digital currency “Onyx” which will facilitate real time cross border transactions. Integrating DeFi elements can help banks remain competitive and offer cutting-edge services to their customers.
• Reducing rigidity and increasing transparency: Traditional banks are often perceived as rigid and opaque institutions. Customers may experience frustration when banks deny loans or credit cards without providing clear reasons for their decisions. This lack of transparency can drive customers to seek alternatives, including DeFi and peer-to-peer lending platforms. To retain and attract customers, banks should simplify their products and services, making them more user-friendly. Additionally, by maintaining transparency in their decision-making processes, banks can build trust and offer customers a clearer understanding of their financial interactions.
• Customer Empowerment: The banks should give account holders more autonomy and empower them like in DeFi, it gives customers greater control over their assets. Customers hold their private keys, reducing the risk of asset freezes or account closures. This empowers customers to have a more active role in managing their finances.

“DeFi provides flexibility, transparency and autonomy — the 3 things Next Gen cares”

Conclusion

I understand that DeFi has its problems like scalability and regulatory issues, but technology keeps getting better. The younger generation, like GenZ, gravitates towards simplicity, speed, and personal control in their financial interactions. They prefer financial systems that are easy to use and offer them greater autonomy. If banks don’t become more flexible and give more autonomy to customers, then options like DeFi could seriously challenge their existence.