Defi: Banks spending money to effectively lose money?
Decentralized finance, or DeFi, manages financial transactions using cryptocurrencies and blockchain technology. By displacing established, centralized institutions with peer-to-peer networks that can offer the whole range of financial services, from standard banking, loans, and mortgages, to complex contractual arrangements and asset trading, DeFi seeks to democratize finance.?
Early Centralized Decentralized Finance
Let us discuss the arousal of decentralized finance with centralized infrastructure. In the foreign exchange market, there was a problem among bank customers in terms of payments in foreign currencies. For instance, if a company has to pay 100 million euros to buy a machine or infrastructure or anything related in Europe, their bank gave them a rate of conversion which is different from another customer at the same bank who has $100 million and wants to convert them to euros. The rates quoted to both customers are different and?the difference in the rate is called the spread this is the profit of the bank and it can be substantial.?
This led to a situation where a new idea was formed back when there was no bitcoin and or Ethereum. There only existed the underlying technology and that is peer-to-peer nodes with non-volatile pieces of data that are cryptographically secured. People realized the amount going into spread while making transactions and many thought why not just put those bank customers together who want to make conversions? This is very powerful because if you put the customers together, you eliminate the spread. The banks could be benefited from a small fee to handle credit quality evaluation but the spread is gone, and this fee is nowhere near as much as the spread. ?
Technologists and business analysts are pitching this idea to the banks to invest in a technology that is going to highly reduce their profit in the form of spread or forex rate difference, so would banks spend money to effectively lose money??
Centralized Finance Today?
The majority of today's banking, lending, and trading activities are controlled by centralized systems that are run by regulating organizations and gatekeepers. To access anything from auto loans and mortgages to trading stocks and bonds, regular consumers must interact with a variety of financial intermediaries.?
The Securities and Exchange Commission (SEC) and the Federal Reserve determine the regulations for the world of centralized financial institutions and brokerages in the United States, and Congress periodically updates the regulations.?
Consumers have limited direct access points to money and financial services as a result. They are unable to avoid intermediaries like banks, exchangers, and lenders who benefit from every financial and banking transaction by taking a cut of the transaction.?
Of course, other types of businesses have also appeared in the Fintech sector. So, to expedite payments, PayPal was established in 2000. The payment technique Zell has been adopted by several banks, however, it's crucial to realize that these payment initiatives enhance customer experience and are thus beneficial. They are using the traditional banking framework, which was not intended to be quick, therefore they are only able to go so far.?
Decentralized Finance Tomorrow ?
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If the banks would have pitched with the idea to decentralize their customers' transactional records and to create an environment of match-an-exchange, to achieve openness they would have regrated and potentially thought this great technology a big threat to their business. ?
Today, many banks understand that centralized finance is just not feasible, and their customers are asking more questions from the banks?about the high transactional fee. The banks realized that they had to make innovations like this or?customers would seek non-bank solutions within the context of Fintech.?
The idea of dark pool trading which began in 1979, was the earliest application of peer-to-peer transactions. A dark pool is a privately organized financial forum or exchange for trading securities. Dark pools allow institutional investors to trade without exposure until after the trade has been executed and reported. ?
Today all traditional financial institutes are challenged by DeFi. Defi aims to disempower the middlemen and empower the common people and end users via peer-to-peer exchanges. ?
Tokenization is the future and everything will sooner or later get tokenized! as. said by Dan Doney the founder and CTO of Securrency
The company shares can be digitized and issued as tokens on the blockchain. Traditional financial securities such as stocks, bonds and other real-world assets are increasingly moving to blockchain infrastructure. This happens due to the many benefits of this technology, such as lightning-fast settlement, 24×7 trading, access to international investors and significantly increased liquidity.?
Nowadays, you might deposit your cash in an internet savings account and receive a 0.50% interest return. The bank then uses that money to lend to a different client at 3% interest while keeping the 2.5% profit. By directly lending their savings to others, DeFi users avoid the 2.5% profit loss and receive the full 3% return on their investment. With PayPal, Venmo or CashApp users have to link their debit card or bank account to send funds so these peer-to-peer payments are still reliant on centralized financial middlemen to work.?
How banks will get benefited from Defi??
There is no doubt that banks will lose the centralised chain of controlled barriers on top of their customer's financial activities with the decentralized world of freedom and liquidity. These barriers allow banks to charge high volumes of exchange fees but noble people at banks now understand that with existing technology, this way of banking the needs of people is just not sustainable, and we have to find other ways to be relevant.??
Since this is the evolving period of technology, and mainly it is either in the news or discussions, this is the prime time that banks should step up and provide the infrastructure to the technology.??
The current period of Blockchain and the Defi is similar to the evolutionary times of the internet in the nineties. No one in the world can understand the global need for decentralized finance more than the banks themselves, not a university, government or tech companies.? Hence, banks have to come up with the roadmap and infrastructural needs of the Defi before anyone else, because remember whoever has stepped in front either Microsoft or Google or the banks will lead the way forward.???
Overall, it may look that the banks may have no or minimal benefit by decentralizing the daily banking habits of their customers, but that’s not the case. Many banks understand the opportunities that lay ahead with institutional DeFi, but before that, there are several hurdles to overcome in the form of regulatory compliance, legal frameworks for smart contracts and data privacy. Let's look at some of the great positives for the banks in Defi.??