While fintech startups challenge the banks and deliver new innovation to the sector, blockchain companies fundamentally change the rules of the game with ’Decentralised Finance.’
There is no denying that banks and fintech companies have made our daily lives easier and our lifestyles more affordable, thanks to thoughtful innovations. Even so, Rune Christensen – the founder of the blockchain project MakerDAO – suggests that more significant changes will emerge following the adoption of decentralised finance (DeFi):
Neobanks have repackaged the traditional banking infrastructure, which had existed for over 80 years. This has been great for consumers and brought innovation to the industry. Yet, there is a limitation on innovation when solely focusing on the packaging. Instead of starting with the packaging, we start by building the inner parts from scratch using blockchain,”
MakerDAO is one of the first DeFi-projects based on blockchain. The project aims to create the same financial products we know – such as transfers, loans, and savings. The difference lies in the infrastructure.
A stable currency and interest rate
Alongside an army of similar blockchain projects, MakerDAO is creating an open, worldwide infrastructure for financial services, free of intermediaries. Their first major contribution to the DeFi-movement was the cryptocurrency, Dai – a ‘stablecoin’ whose value is equivalent to one US dollar. The price holds thanks to underlying assets from cryptocurrencies like Bitcoin and Ethereum, as well as the United States dollar.
The system is controlled by digital, programmable contracts, which are handled by the decentralised blockchain. Though it may sound highly theoretical and complex, it is actually quite simple. “It works like cash on the internet with a stable value. Other decentralised solutions use it as their unit of account, on which they can build solutions,” Christensen explains.
For example, Compound offers a financial solution built on top of MakerDao that distributes loans and enables users to earn interest rates on popular cryptocurrencies (their current interest rate for Dai is 3%). Departing from traditional loans, which involve several intermediaries, Dai is built on modern blockchain technology, so cash flows directly from those who hold Dai to those who lend Dai.
Well on its way to becoming a cornerstone in DeFi, Dai’s circulation has increased from 50 to 440 million dollars since 2017 – which is collateralised by assets for approx. 1.4 billion dollars.
Bridging the divide between traditional currency and cryptocurrency
So far, blockchain and cryptocurrency have mostly lived a life of their own outside the established financial system. We are not yet able to buy a cup of coffee at the local café directly with Bitcoin. Still, cryptocurrency and related DeFi solutions are used in other – and more important – areas, according to Niklas Nikolajsen, Founder of the crypto-financial service provider Bitcoin Suisse.
The unbanked are already banked; they just don’t know it yet. Today, you can buy a second-hand smartphone for five dollars, sell your services as a web developer, and send and receive payments via cryptocurrency, regardless of whether you’re in Denmark or on the Congo River. That’s amazingly beautiful. Contrary to the established financial system, which has excluded large segments of the world’s population, Bitcoin does not ask who you are. It’s decisions are made based on mathematics and encryption.”
Citizens of Argentina and Venezuela, among others, have taken advantage of crypto-financial service providers to exchange their local currencies for stable cryptocurrencies to avoid hyperinflation – a service that the countries’ established banks cannot provide the general population.
Despite their obvious differences, Nikolajsen sees a need and an opportunity for Bitcoin Suisse to bridge the gap between crypto and traditional currency through established banks. The company has recently applied for a banking license in Switzerland and has another application underway in Liechtenstein.
A neutral, worldwide system
DeFi holds the promise to become a global financial system that is truly decentralised and free of intermediaries. For Christensen, such a comprehensive system can only become a reality if nobody holds ultimate control over it:
“No one person or company can have full administrative oversight of the system. It must be completely transparent and governed by a community of people who use it and have invested in insuring the system. As a platform that exists for its users, it cannot have owners in the traditional sense. Because no central institution can assume control, the prospect of creating and making a secure global network is much more realistic.”
This has the further advantage of enabling anyone to connect to decentralised financial networks and use them to develop new products on equal terms. Without overstating, this holds the potential to unbundle the global banking business.
As an exampe: MakerDAO creates a stable internet-currency, which others can build upon. Another decentralised project specialises in determining the value of properties and translate the legal paperwork to a blockchain. This would enable users to obtain a loan or a mortgage much more effectively, perhaps through a third decentralised project:
“Similar to how you obtain a bank loan, your property could serve as collateral on the blockchain. A major difference is that, instead of having to talk to a person behind the counter at a bank and sign a lot of paperwork, you’d interface with a programme that runs on the blockchain. Within 10 seconds, the smart, programmable contracts could accept or decline your loan.”
The industry must reinvent itself
The DeFi movement seeks to reinvent financial services on the blockchain, so that they can become cheaper, more efficient, and accessible to users worldwide. As Christensen sees it:
“This can mean a lot for the financial industry: A lot of money can be saved and things can be done much quicker and more smoothly. In traditional banks, there is a massive difference in transferring money to Denmark or China. Alternatively, since blockchain is digital and global from the beginning, it is borderless. In the future, it will be possible for banks to harness this efficiency and speed.”
From the user’s viewpoint, the infrastructure is simply different in terms of how it allows them to assemble the financial services they require. While several intermediaries may disappear over time, there will still be a need for financial companies. The important point is that they will need to reinvent themselves.
No stranger to evolution, Nikolajsen points out:
“Originally, we were side-street exchangers, where people came and bought bitcoin for 500 Danish kroner. But we have developed into something else since then. Although we’re looking forward to receiving a banking license, I suspect that we will be able to hand back the license in 10 years. By that time, it will likely be old technology.”