How is Decentralized Finance making Wealth building more inclusive?
DeFi it the new Wave in Finance bringing Inclusivity & Access for the Unbanked Global Population
The emerging model of Decentralized Finance enabled by technology, driven by innovation with the immense need for inclusiveness for the less privileged is changing the investing landscape by bringing inclusiveness to the “less privileged”. The Fintech revolution has broken through the traditional barriers of entry into the wealth-building sphere.
Traditionally, we in the Western economies, have had ample opportunities to grow & protect our wealth with access to sound knowledge, an abundance of banks, vibrant markets and availability of a wide variety of investment assets like stocks, options, bonds, mutual funds, etc. But people in remote areas of the world don’t have access to all these services, however, with the onset of smartphone revolution & global internet access, Anyone with an internet connection and/or a smartphone can now access financial services.
Importance of Investing
Why is investing so important? Why not just save the money in the good old piggy bank? Well, for starters, money does not grow automatically. You need to put it to work in financial assets where it can not only grow by providing a hedge against inflation, compounding wealth & Protecting the same in periods of chaos & financial turmoil like the one we saw in the last financial crisis (2007–08).
As you can see in the figure above, the U.S dollar (global reserve currency) has consistently lost value since 1925 at an average rate of 2.97%, while the stocks have provided a real return of 6.7% in the same period.
Clearly outlines the fact that saving Cash is not going to get you anywhere with your investment goals, as your savings wither away with inflation, while wealth-building strategies like investing in varied financial assets compound your wealth. Also, a well-balanced & diversified investment portfolio prevents you from external shocks like the financial crisis or prolonged recessions.
Barriers to entry
But the problem with the current financial system is that it does not provide equal opportunity for wealth-building. The first of these barriers to investing in your geographic location. As evident from the charts above, there are huge disparities between the wealth owned by individuals depending on their geographic location — most of the wealthy are concentrated in the western hemisphere, Oceania & Japan. The disparity translates in the investing behavior as well (second figure above) — while more than half of Americans invest in stock markets a mere 2% do so in neighboring Mexico & the fastest growing economy of India.
Without adequate financial literacy, it is much more difficult to navigate the global financial markets much less make any sound investment decisions. People need to understand concepts like Inflation, Compound interest & diversification and apply them by experimenting in smaller investments.
As per the figure above, only about 20–30% of adults in most countries have any kind of financial literacy or understanding of basic financial concepts. Again, most of the financial knowledge bases are skewed towards the western economies.
Even if someone can overcome the geographical & financial literacy barrier and is ready to invest, political & economic turmoil in their local economy can make it impossible to build wealth by investing. Case in point — Venezuela, Argentina & Turkey which faced a similar situation in 2018 as their markets went into a tailspin (chart below). Imagine what would have happened to the portfolios of investors who had everything invested in these local markets.
This problem can be sold by investing in stable foreign markets, however, a small investor from a third world country might find it impossible to buy expensive foreign currency financial assets.
Even if they have the buying power to do so, there are other associated fees with conducting these transactions like — brokerage commissions, taxes, currency conversion fees & stamp duties, etc. The U.S stocks (figure below) are an example of how some of the American equities may be out of reach of an average overseas investor from a third world country.
How can Decentralized Finance help?
This is where Decentralized finance can help solve these problems. Investing Apps built by Fintechs on public blockchains like Bitcoin & Ethereum can allow more people to become investors. These Decentralized, Permissionless & Programmable public blockchains can help bring the much-needed inclusiveness.
- Decentralized — They are publicly accessible from anywhere on the globe
- Permissionless — No restriction to join based on status or credentials
- Programmable — Low cost & interoperable services save time & money
More innovations like the smart contracts coupled with these basic features of public blockchains can help address the global inequality of investing in financial markets. Smart contracts are basically self-executing instructions which were introduced by the Ethereum blockchain.
When two parties enter an agreement, a smart contract enforces the terms of an agreement — In financial markets, this could mean automation of trades & removal of cost bearing intermediaries. Smart contracts could also enable domestic investors to instantaneously invest in overseas markets without being physically present there or incurring any additional fees or delay.
Apart from this, DLT has also introduced the concept of fractional & micro-investing via the tokenization of assets. These digitally fractioned assets provide fractional ownership to the investors without buying the whole thing — just as you can buy digital currencies in fractions ~ 0.1 BTC.
This way more people can have a stake in the financial markets utilizing micro-investing enabled by tokenized assets (STOs). As in the figure above, it would not be possible for a small investor to buy those expensive stocks, but with new investment methods on the blockchain, they can own a fraction of all three. And all of this would not have been possible with location independence that Internet access & Smartphones have provided.
According to Juniper Research, there are about 2 billion digital banking users globally. The new smartphone Apps have become the torchbearers of the disruptive new model of decentralized finance. As they become more intuitive & simpler to use, barriers to investing would crumble and financial access & wealth-building would become universal.
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Originally published at https://www.datadriveninvestor.com on April 25, 2019.