How DeFi will innovate our financial ecosystems (part 5/7)

8 min readJan 1, 2021

[This is a cross-post. I first published this article on publish0x — always trying out something new]

DeFi opportunities for retail banks

As we’ve learned in part 1, DeFi imposes additional (and significant) pressure upon existing players in the financial ecosystem — especially retail banks. DeFi reinvents basic financial instruments on top of permission-less Blockchains and their powerful interoperable token infrastructure. This pressure is considerably more fundamental than the usual FinTech competitors that attack retail banks predominantly on the user experience level — but leave the core banking untouched — at least compared to DeFi.

A nice view upon the bank towers in Frankfurt/Germany. Photo by Pixabay from Pexels

As we’ve seen in parts 2 and 3, DeFi offers a lot of potential to end customers (who also happen to be current bank customers). As we’ve also learned from part 4, DeFi has some down-sides for end customers with limited funds and/or knowledge like transaction cost, technological risk and immature assets.

Which leads us to the interesting question:
How should retail banks react to this new DeFi phenomenon?

Ignore it?
Fight it?
Compete with it?
Or maybe: Embrace it?

Let’s investigate these options one after the other…

Ignoring DeFi…

…would certainly be the biggest mistake that current players in the financial ecosystem might make. As mentioned above: DeFi quickly reinvents the fundamental services financial institutions are offering — upon a young, but extremely powerful and superior tech stack.

If you want to compare it to telcos:
It’s like it was 1996 and you would still be ignoring the disruptive potential of the Internet for your vertical…

Fighting DeFi…

…could be the reaction many might expect from major retail banks. Their decision makers thinking: “Let’s use our good connections to government and its regulating bodies to protect our customers from this DeFi Wild West (and come up with regulatory hurdles to slow DeFi down to an innovation speed we can compete with…)”.

This simply won’t work due to the growing global acceptance of Bitcoin. Bitcoin first. Ethereum second. It will be very hard to put cryptocurrencies and their “killer apps” (like DeFi) back into Pandora’s box through domestic regulation. It would take a joint effort from (at least) the US, China and Europe to come up with a crypto/DeFi ban. I can’t imagine that to happen.

Competing with DeFi…

…could also be a natural reaction: Let’s investigate what’s going on in “DeFi land”, extract the best ideas and come up with our own (bank internal) solutions — based on our regulated operating standards and proven development processes.

Let me be very clear: No.Chance.
DeFi projects are innovating in such a stunning speed and with a coopetition mindset based on open source that no traditional financial institution will be able to compete adequately — no matter how agile they claim to be.

Embracing DeFi…

…is obviously THE option! There is enough complexity in DeFi that most users will readily pay a premium to “someone” (like a bank) who…

gives guidance,
hides technical complexity,
reduces the most critical risks and
creates simple services for “everyday people”.

If you work in a bank — these words should sound like a familiar promise to your clients, doesn’t it?

Your main task is to analyze and rate the different DeFi options, evaluate risks, choose wisely, set-up as portfolio and set your services on top of this new ecosystem.

It gets even better: Bundling the funds of many retail clients into a streamlined and balanced DeFi investment portfolio saves significant transaction costs. The more funds you manage, the better your options to spread the imminent platform and asset risks we covered in part 4.

Banks should see Ethereum as a new public good — a public infrastructure that can be used to integrate one’s own financial services even tighter into neighboring verticals like trade, insurance, art and even the gaming industry. Embracing DeFi is just the first step on this longer journey!

Where to start?

By now, you might ask: “But where should we (as a bank) start?”
Well — isn’t that obvious?

Start with the most fundamental banking service everybody needs but misses for years: An interest bearing savings account — backed by DeFi.

A DeFi-backed, interest bearing savings account could easily be your next “retail bank killer app”. Imagine a savings account with a fixed — let’s say 2% — interest rate. Who wouldn’t join in? Who wouldn’t recommend it to grandma or grandpa? The demand for something like this is so obvious — and huge.

Certainly, you would need to take away all the “crypto hassle” at the user interface and at the asset management layer: Clients would just see their local fiat currency in that system. Nothing else. DeFi would need to happen behind the scenes — potentially generating high yields for the bank. Your reward for encapsulating the risk and providing commodity to you retail clients.

Of course, this is no easy task for an established player in the financial ecosystem. There’s a lot of new territory to cover. You will have to handle manifold regulatory aspects to stay in legal boundaries. You will also hardly be able to tackle everything on your own. You’ll need new partners to enter this field, e.g. companies who act as custodians for the cryptocurrencies in play and integration partners who help to bring all these DeFi pieces together into a solid consumer-friendly solution. You might even want to separate out this kind of new business into a separate organizational entity that is set-up properly to succeed in this fast-moving space.

So, this won’t be an easy trip. But I bet it’s worth while the effort.

The race is on!

Guess what: I’m no genius. Services similar to the one described above are already appearing— as you might have expected. For sure, it’s not the established banks taking the first steps. It’s rather risk-taking crypto-born FinTech start-ups who pave that way. Because of their heritage, they think “crypto-first”. They want to revolutionize and disrupt the fiat system. This usually prevents them from hiding the crypto-aspects fully away — which might be their weak spot in creating mass adoption towards mainstream clients. So, this is your window of opportunity as a retail bank!

An example

You want an example? Let’s pick a company, whose journey I follow from their ICO end of 2017 onward — so warning: I’m obviously biased. Swissborg clearly acts in the direction I outlined above. They started with their own token $CHSB that can be used in Swissborg’s wealth app to reduce trading fees. Recently they started a new offering: a “smart yield account” based on the stable coin $USDC. You see: end-user friendly stable coin based yield farming is already here. It gets better: (a significant amount of) $CHSB can be locked (for twelve months) to get higher interest rates on your “yield wallet”. At the time of writing (2021–01–01) this means massive ~20% APY.

Compared to the ideal end user scenario I described above, you can still detect some weaknesses in the Swissborg approach:

Even if $USDC is pegged to the dollar, it’s still a cryptocurrency. Users might be cautious to go that route — and they would probably prefer the complete handling in their national currency.
You also see very high promises regarding yield, but no fixed “guarantee”. I don’t know if that’s a wise decision — at first glance, it sounds too good to be true.
You’ll also notice that Swissborg operates very international (e.g. with bank deposit accounts in Estonia). I don’t want to judge that, it’s certainly a compromise coming from regulatory issues in the early years of crypto. It will be interesting to see how these set-ups are changing with the recent big advancements in European legislation towards crypto custody etc..

[If you should consider to try out Swissborg, feel free to use my personal referral link (we could both profit 😎 — details here)]

Next?

Up to now, we have spoken about financial institutions and how they get challenged by DeFi in retail banking — and how they could embrace Blockchain and DeFi. That was just the left hand side of our macro view from the introduction article — do you remember this picture?

There is even more ground to cover: We’ll use the upcoming parts to discuss the right side of that picture: Commercial currencies and Central Bank Digital Currencies. Stay tuned…

In the meantime, I’ve published the following articles in this little series:

Disclaimer: This article is not intended to be an investment advice of any sort. Do your own research and search for professional support if you intend to invest in one of the projects mentioned in this article.

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