DeFi is not just another failure for banks
The whole point of DeFi is that they allow you to do without centralized licensed money keepers, that is, traditional banks. This means that DeFi is not just another unwanted breakthrough of the crypto industry for existing banks. This is a real threat.
DeFi and cryptocurrency are part of a broader cultural shift, as a result of which consumers increasingly attach importance to digital assets such as NFT and cryptocurrency. If banks want to adopt DeFi, they must accept this shift, recognizing that cryptocurrency not only exists, but is also stored in it with a value of trillions of dollars.
A key step may be to provide consumers with greater access to DeFi through their banking services.
Some banks are taking steps in the right direction:
- Revolut has been supporting cryptocurrency trading since 2017, and has just added dogecoin to its offer;
- BBVA Recently Launched Its First Bitcoin Transaction and Storage Service;
- JP Morgan Chase became one of the first banks to try to use its own digital coin JPM in real conditions.
But for the most part, the traditional sector still holds the cryptocurrency brake, as it happens with HSBC and Barclays. This resistance is understandable, but the current players who continue to hesitate risk becoming the equivalent of a Blockbuster in the financial sector.
Adopt DeFi, and help shape regulation
Financial regulators and central banks are dealing with the issue of crypto assets and DeFi, recognizing that they can no longer afford to consider regulation and compliance as ways to block the next stage of evolution. Existing banks need to join this activity, ensuring their active role in shaping future regulation with the help of technical tools.
DeFi provides legacy banks with a greater opportunity to avoid the mistakes associated with open banking, where the inertia of the sector meant that the promotion of API-based innovations was left to the discretion of regulators.
Opportunities for banks to take a more proactive approach to DeFi include developing new DeFi proposals in collaboration with the crypto community and collaborating with regulators to develop how to build regulation based on these proposals, while maintaining the decentralized nature of DeFi.
At the same time, banks need to develop their own internal compliance workflows to link their banking services and the broader fiat money economy to the opportunities that DeFi is likely to offer. The key point is to consider DeFi through the prism of innovation. How can the compliance framework be adjusted so that DeFi can realize its potential?
One possible way forward is to shift the culture of banks ‘ compliance control departments from a risk-averse approach to an innovation-oriented approach by eliminating fragmentation and encouraging compliance teams to work with engineers, designers and product developers to test various compliance systems, and try to innovate in these spaces. Eventually, compliance will adapt to radical changes in adaptation: 20 years ago, it was unthinkable that consumers could open a bank account on their mobile phone in 5 minutes.
Creating bridges and developing medium options
Existing banks should use their experience and resources to develop reliable ways between the centralized ecosystem of financial services, and the new innovative approach of DeFi.
It is true that banks have experimented with solutions such as Ripple, however, these efforts have usually been little proof of the existence of conceptual projects. There are no large-scale exciting Ripple applications: for example, Santander does not want to use the Ripple XRP cryptocurrency for its international payment network, despite being the main partner.
Instead, any significant steps to create a bridge between traditional finance and cryptocurrency came from cryptocurrency players such as Coinbase. By launching an IPO in April 2021 and joining organizations such as the DeFi Alliance, Coinbase has established itself as a kind of ideological leader and a pioneer in the bridge-building industry, which banks should strive to emulate.
Now that Coinbase has paved the way by setting a precedent, there is no reason why major banks could not follow their example and offer an equivalent product, for example, Lloyds Bank or HSBC Coinbase, allowing customers interested in trading cryptocurrency to have a wider choice of platforms.
If DeFi becomes mainstream, a central bank-backed digital currency could become a key pillar of its ecosystem.
Surely, for those operating banks that are concerned about the volatility of the cryptocurrency sector, a safer option may be to support the rapidly developing world of central bank digital currencies (CBDC). If DeFi becomes mainstream, a central bank-backed digital currency could become a key pillar of its ecosystem. They can offer an alternative to the current stablecoins-cryptocurrencies tied to “stable” assets, such as fiat currencies, which are anchored by many DeFi protocols.
Banks need to start thinking about what their role will be in supporting and interacting with these officially approved cryptocurrencies, and see where this will lead them in terms of further development of decentralized products.
HSBC and Soc Gen are among several leading banks participating in the CBDC trial led by Banque de France, whose goals include studying the exchange of CBDC for crypto assets and testing the rules regarding CBDC and cross-border payments. For the banks participating in the trial in France, this is a great opportunity to study and participate in experiments conducted at the forefront of innovation.
Interaction with next-generation financial investors
There is a new wave of technically sophisticated, risk-taking investors who want to increase their wealth, but do not have the opportunity to look for profit in other markets. This group sees value in non-digital assets and rejects the patronizing narratives of existing banks that ” investing is too difficult for ordinary consumers.”
The Reddit/WallStreetBets community which gave Wall Street hedge funds the opportunity to make money through GameStop, is an example of this. In order for banks to get ahead of the DeFi curve, it is extremely important that they dynamically interact with this digital-oriented and financially savvy subgroup of the population. They should go beyond the paternalistic thinking, according to which only banks know best what and how when it comes to investing money. The last 15 years have provided enough evidence to expose the arrogance of this notion.
There is some movement in this direction, and Goldman Sachs has announced that it will make it easier for customers to invest in digital assets, including Bitcoin. This is currently limited to its private wealth management clients worth more than $ 25 million, but it could serve as a proof of concept for the broader wealth management sector.
Morgan Stanley, for example, made a similar step, but with a threshold of $2 million. Banks that want to interact with next-generation retail investors need to further democratize access to digital asset investments for next-generation investors who expect the same opportunities as wealthier investors.
Looking to the future, the next frontier will be asset management tools that will simplify the management of cryptocurrency for the broader market of retail investors. Given the complexity of investing in digital assets, the creation of asset management funds that simultaneously democratize and optimize cryptocurrency investments seems to be the next logical step for banks.
The coming rapprochement
It is easy to think of the traditional “centralized” banking infrastructure and DeFi as competitive or opposing forces, but in fact they can come together over time. There is even a chance that DeFi can help financial markets become more resilient, avoiding points of friction and the fragmentation of centralized financing.
The traditional “centralized” banking infrastructure and DeFi are likely to get closer over time.
Eventually, the blockchain-based principles that DeFi relies on will probably merge with the basic architecture of global finance. Faster international transactions, opportunities to make money work harder, easier access to credit and openness to innovation are just some of the potential benefits that may arise.
One thing is clear: from enhanced digital identity to tokenization of derivatives and payment solutions for the low-income, DeFi is where innovation takes place. How well traditional banking operations respond may be the key to the next stage of innovation.