The rapidly growing trend of decentralized finance – also known as DeFi – is progressively gaining the attention of mainstream media, especially as the seemingly parallel world of cryptocurrencies and the blockchain keeps impacting the real economy and the way people make transactions nowadays.
That said, a big step to keep demystifying decentralized finance involves explaining how this trend can shape the banking sector as we know it.
With that particular purpose in mind, the following article aims to explain how DeFi can change banking and whether that means – or not – that financial institutions will cease to exist if the technology is adopted at a global scale.
Yes, Decentralized Finance could change banking forever
The first thing you should know is that DeFi does have the potential to disrupt the way banking works as it diminishes – if not entirely disappears – the need for an intermediary in virtually all of the transactions that financial institutions facilitate nowadays.
This includes storing, lending, and transferring money – along with other processes – yet, to simplify this article’s scope, we will focus on those first three activities and how DeFi can have an impact on how they are performed.
Currently, banks play a key role in any functioning economy as they facilitate these three activities. The first of them, at the moment, mostly requires that the bank maintains transparent and accurate records of how much a client has in his account at any given point in time.
In this particular aspect, DeFi can perform that same function easily by using the blockchain and its distributed ledger technology to keep those same records without the need for involving a third party.
Additionally, DeFi gets rid of the dangers of corrupted data as transactions are validated by multiple parties before they are included in the ledger.
Furthermore, when it comes to lending, peer-to-peer (P2P) lending platforms have already shown that individuals can successfully lend money to each other as long as there are protocols in place that ensure the repayment of the amount lent, although those systems are still overly reliant on credit scores and other traditional banking tools to function.
In this regard, DeFi, through the use of smart contracts and other up-and-coming protocols, can regulate lending activities between individuals, providing a framework of understanding between the two (or more) parties involved to ensure a satisfactory outcome.
If a fully functional feature such as the one described above were to be launched, the lending arm of banks would probably take a big hit as savers will turn to DeFi to receive a higher return for their funds while borrowers will also turn to the blockchain due to the lower transaction fees and other benefits resulting from the absence of an intermediary.
Finally, when it comes to transferring money, the blockchain has already proven that the hassles and costs of doing so are so strikingly low compared to banks. In this sense, it seems highly likely that DeFi will completely revolutionize how money is transferred throughout the global economy in the following years.
There are multiple obstacles to overcome before that happens
So, is DeFi the end of banks as we know it? Possibly yes, but not yet.
The blockchain and the pace of its adoption, although moving at an accelerated pace, is still far from becoming the infrastructure on which people and organizations build their lives upon.
For many, using code is not something they are familiar with and that is an obstacle that DeFi must overcome before it can further advance.
Additionally, networks’ capacities remain limited up to this point, especially when it comes to handling contracts. In this regard, Ethereum – one of the most important smart contract blockchain – has seen the cost per transaction surge lately as its infrastructure experiences more and more demand.
Finally, people might not fully rely on DeFi until they are assured by their government that it is safe for use. That particular hurdle could end up slowing down the pace of its adoption, as governments prefer to have control over their economic and financial systems rather than handing them over to the people.
Changes in the regulatory framework, then, remain a potential threat to the DeFi revolution and banks are an important puzzle piece of government-regulated financial ecosystems.