Due to the recent rise of cryptocurrency, decentralization, and blockchain, industry experts have many questions about what the future may hold for finance and banking. Could decentralization be at the center of this future? This blog post will explain the state of decentralized banking and look at specific situations where decentralized banking can be used effectively.
Decentralized Finance, or DeFi, is the collective name given to an ecosystem of financial applications built on top of the blockchain. This is also referred to as Decentralized Banking. Perhaps unsurprisingly, the rise in cryptocurrency's popularity has also led to confusion about decentralized banking, with some even referring to decentralized banking as "crypto banking." The confusion is understandable. Cryptocurrencies are, by design, decentralized, while fiat currency is centralized and usually under federal authority. Suffice it to say, DeFi and banking with cryptocurrency are not the same thing.
The idea of decentralized services is by no means unique. In the earliest days of trading, people transacted directly and without middlemen. However, as communities and distances between vendors began to grow, producers and manufacturers began to transact through middlemen and used centralized marketplaces. Today, the internet has made it much easier for consumers to gain direct access to companies, leading some to believe that decentralized marketplaces and banks will be at the center of the future.
By nature, we favor efficiency, so we gravitate towards centralized services. This is because centralized services offer simple and efficient ways of obtaining products and services.
Before we explore decentralized banking, though, we must first understand why we use banks in the first place. Ultimately, our reasons for using banks usually fall into one of three categories:
- Security: probably the most important reason we use banks is the reassurance they provide us that our money is safe and sound.
- Efficiency: when we carry debit and credit cards, and we link our banking information to services like PayPal, we can quickly and easily pay for products and services.
- Passive Income: keeping our money in a bank also brings us the reward of earning interest just for keeping money in the account.
So, if we were to introduce decentralization into our banking, would we be able to manage all three of these areas effectively? Ultimately, we do believe the answer is yes. However, it may not be a seamless transition from the centralized to the decentralized models. One of the possible hang-ups that can come with decentralized finance is the risk associated with it. Decentralized finance is, by definition, permissionless, so there's no "kill switch" to shut down or temporarily suspend a platform if it starts to malfunction or some kind of attack has occurred.
Decentralized Applications (dApps) are likely to play a key role in Decentralized Finance (DeFi)
What are the benefits, though? Billions of people carry cell phones, so decentralized banking has the potential to leverage that infrastructure to allow access to a decentralized bank. Simple mobile wallets can be used to store cryptocurrencies, while decentralized applications (dApps) can give people the opportunity to take out loans. Decentralized banks are also able to provide service to people in places that traditional, centralized banks simply cannot. Brick and mortar-based centralized banks are simply too bulky, especially in comparison to the unmatched agility cryptocurrencies have to offer.
The goal of decentralized banking is to create a financial service ecosystem that’s open source, permissionless, transparent and without any central authority. Within the ecosystem, users would have full control over their assets, and they can interact with the ecosystem through (dApps). Have questions, thoughts or ideas about the potential of DeFi? Hit us up and let's talk!