There has already been some immediate fallout from the Wall Street Boys and GameStop saga, but one that piqued my interest the most has been the increasing mention of “the rise of DeFi” and how many are predicting that the end result of all of this uproar is Bitcoin and cryptocurrency adoption.
I have been following cryptocurrencies and blockchain finance applications since the mania of 2017, but until very recently I’ve mostly focused on Bitcoin and Ethereum and considered everything else as noise. It’s now clear to me that DeFi and other rising blockchain finance companies aren’t just “noise” and are going to disrupt the banking landscape.
But what I was unclear on what these new players do and how exactly they would disrupt. So I’ve spent the last few weeks researching and ingesting as much information on this topic as possible, and now I believe I can explain it in simple terms. And as I’ve gained a clearer picture of the landscape, I have started to think about the future of crypto banking — and I have some predictions.
A few notes — this is meant to be a basic summary (Feynman’s “explain it to a 5-yr old” principle) and is thus lacking a lot of technical detail. I’ve tried to keep this to the basics, so that a newcomer to crypto can walk away with a basic understanding of the current ecosystem.
Let’s start by defining the key players in what I’m calling TradFi, BlockFi and DeFi. Note that I’m focusing on those providing financial services function and not underlying tech (i.e. Ethereum is the primary player as providing the network supporting almost all of BlockFi and DeFi, but they don’t offer consumer finance products and thus are excluded for our purposes here).
· TradFi — your standard retail, commercial and investment banks, along with FinTechs (tech companies that operate in finance). Think Chase and Bank of America, along with FinTechs such as Paypal / Square. They are centralized, regulated by a series of government regulators, and have relatively strict Know Your Customer (KYC) controls as a component of large compliance programs.
· BlockFi — not BlockFi the company itself but blockchain finance. This is the entire set of new digital, blockchain-based banks that are centralized and regulated. This means they perform Know Your Customer (KYC) functions, essentially to appease their regulator (regulator = centralized in this context, and KYC restricts anonymity). They offer basic retail and investment banking products, like savings accounts, loans and a trading platform. Leaders in this sector are BlockFi (great name choice) and Celsius.
· DeFi — short for decentralized finance, this is the term for new digital blockchain based financial services startups that are 1) unregulated and 2) do not perform KYC and thus enable anonymous users. So decentralized applies to the lack of a central regulatory body here. Their primary purpose is to provide access to basic banking products like savings accounts or loans to anyone in the world without fear of censorship or restriction, and with full transparency because of the blockchain ledger. Key players include Aave, Uniswap, Compound and MakerDao.
That summarizes the 3 big types of players in the current banking space. Now let’s move to my predictions, with respect to disruption and the biggest winner of each period.
Short Term (next 1–3 years): Both BlockFi and DeFi are big disruptors, but BlockFi is the winner
The primary way BlockFi will disrupt is through consumer adoption of their savings product (offering up to 8% APY on crypto deposits) — which will drive consumers away from cash savings and into crypto products.
BlockFi’s lending product (founding product) will be attractive as well, with its primary advantage of an easier application process (crypto-secured loans can be approved in a day); along with its inherent margin-trading use case which is especially attractive to growing base of Robinhood Yolo’ers. These loans may very well serve the purposes of mortgage / auto loans, allowing crypto holders to leverage the BTC / crypto that’s already in their savings account as collateral, vs traditional lending collateral (i.e the physical house or car).
The most recent addition for BlockFi is the partnership with Visa and offering BTC credit cards. Visa recently made big waves by announcing its own Visa crypto software program, aiming to enable user to both purchase crypto as well as to spend it on normal goods and services via the Visa network. Visa’s CEO Al Kelly recently made the remarks below, explaining their strategy.
“Our strategy here is to work with wallets and exchanges to enable users to purchase these currencies using their Visa credentials or to cash out onto our Visa credential to make a fiat purchase at any of the 70 million merchants where Visa is accepted globally…”
To summarize, BlockFi has created crypto versions of savings accounts, loans and credit cards, and they also offer trading platforms. All crypto based and on the blockchain. This has enabled crypto-savvy people to move away from the cash versions of those products and into the crypto versions, which is the primary disruption to TradFi.
DeFi will disrupt in similar ways as BlockFi, but for slightly different reasons. There are DeFi savings accounts that mirror BlockFi’s, and there’s a wider variety of lending products. I’ve heard stories of people getting essentially rapidly approved mortgage loans based on BTC holdings, where TradFi had already turned them down. But the real adoption case is for the group of users who are fed up with the status quo, don’t trust the big banks and will flock to DeFi for its promise of transparency without censorship. This is tied more to the overall idea of a “revolution” and anti-Wall St rhetoric which will drive that base into DeFi. This is clearly already happening as DeFi assets have grown from <$1B in aggregate in Jan 2020 up to >$13B in Dec 2020.
TradFi is trailing here and a distant third. Big banks seem slow to build out any blockchain infrastructure and until very recently have essentially scoffed at crypto in general. While the FinTechs (Square and Paypal) are active in the crypto game now and are certainly a big factor in the recent bull run and in giving access to mainstream America, they’re product scope is severely limited, they have low $ caps for weekly and annual purchase, and crypto can’t even be moved off their platform in current state. The FinTechs certainly have an edge over the banks but trail far behind BlockFi/DeFi.
So who has the edge here — DeFi of BlockFi. I’m more bullish on BlockFi in the near term and I’ll explain why.
First I firmly believe we are in the top of the first inning with respect to crypto user adoption, and I believe 2021 will see a huge surge in mainstream America buying and holding crypto for the first time. But there is a big difference in the savviness of mainstream America vs early adopters. Most Americans aren’t moving crypto to cold wallets or dealing with self-storage (handling of their own Bitcoin keys in their own online or offline digital wallet). They will choose to go the custody route, meaning they want an institution to hold those keys and store their BTC/crypto for them. BlockFi has a key advantage here, based on their custody protocols and general ease of entry (user friendly apps, can set up an account in minutes).
Second, regulators aren’t going away any time soon. This is a big edge for BlockFi and a huge risk for DeFi, as there is an open question of how big DeFi can get before a regulator steps in (or products get banned in some capacity). But I also think mainstream America wants their money in a regulated account. It gives a greater sense of security, even if that’s a false sense. It also helps relieve the biggest fear of hacking and losing your holdings, at least optically.
Reinforcing that prediction is that new activeness that new members of Congress are bringing to the US government. Senator Cynthia Lummis from WY has been vocal about her desire to “explain Bitcoin to Congress”, and she was just recently appointed to the Senate Banking Committee. While in the very early stages, if the US Government is open to crypto expansion it bodes best for centralized and regulated — TradFi and DeFi.
So overall, I think BlockFi will be the winner in the near term. But I think they have the potential to be the biggest loser in the long term.
Long term (10–20 years out) — TradFi replicates BlockFi functionality, and while DeFi grows its base, the status quo remains somewhat in place.
The primary risk I see for BlockFi is that big banks and/or FinTechs will build blockchain infrastructure and essentially push them out. Right now, BlockFi’s advantage is in its products (high interest savings, easy loans), but the only barrier to entry is the blockchain. BlockFi deserves credit for establishing this market, but I don’t see why TradFi doesn’t enter this space in the coming years and offer similar enough products to steal BlockFi adopters back. I know for me personally, if Chase offered the same crypto products as BlockFi, I would keep everything within Chase as a one-stop shop for my personal finances. I believe most of mainstream America and this new wave of adopters would make the same choice.
We’re already seeing signs of TradFi progression. I mentioned Visa above, but the recent OCC ruling (Interpretative Letter 1174) is even bigger as it paves the way for new payment rails for regulated banks/FinTechs to use to facilitate customer payments, as well as allowing the use of stablecoins. Previously the primary payment “rails” were the ACH network, SWIFT wire, etc., and thus this introduction of blockchain payment rails that are approved is the first step in TradFi being cleared to enter this space.
The introduction of stablecoins is important because it enables a path for traditional banks to interact with new and existing blockchain networks. Kristin Smith, Executive Director of the Blockchain Association was recently quoted on this topic, stating:
“The OCC’s interpretive letter shows that there are those in government who actually understand that cryptocurrency networks are the foundation of a next generation payments system. Stablecoins, like USDC, can power faster, 24-hour real time payments in a way that existing US payments infrastructure can’t handle.”
Quick aside — what are stablecoins? Stablecoins are cryptocurrency whose value is tied to an outside asset, such as gold or $US dollars, to “stabilize” the price. The US Dollar coin is the 2nd biggest stablecoin in market size (behind Tether), and its value is derived from the current value of the $USD. So the $US Dollar coin is a blockchain enabled $USD and is considered a cryptocurrency.
These are some early leading indicators that TradFi institutions are seeing the value of the blockchain and cryptocurrencies, and my view is that it’s only a matter of time until they make large scale investments in infrastructure to remain competitive with rising BlockFi and DeFi competitors.
So where does this all go? Here is a fairly likely future scenario, based on what I’ve been reading from leading crypto enthusiasts and founders.
Year 2030. Banking is totally digital, and Bitcoin is serving as the primary digital currency. Each central government / bank has its own digital currency stablecoin, which will serve as its primary digital currency which will allow its residents to interact with Bitcoin and other cryptocurrencies. Employees in the US for example are paid in $USD coin, which has a native value relative to the price of Bitcoin. Playing this out, the Euro-coin would have a different value but also staked to Bitcoin, China-coin, etc.
DeFi still exists and has grown its base, as an increasing base chooses to opt out from centralized oversight and potential censorship. But it’s still orders of magnitude smaller than TradFi which has now embraced cryptocurrencies and has built the underlying infrastructure, and is regulated and centralized. The increasing adoption by central governments has reinforced TradFi in this scenario and the status quo remains somewhat in place.
The bull case for DeFi over TradFi here would essentially require a New World Order, where no governments are interfering or regulating the global monetary system. And I can’t quite see that happening yet, primarily because I don’t believe regulators will allow it to happen and will interfere enough to keep TradFi as the leader.
These are my current short and long term predictions. I’m most bullish on BlockFi in the near term but not long term, and TradFi is my bet long term although DeFi will maintain a prominent role. But the world is changing rapidly and the pace of change will only increase, and thus whether or not Bitcoin will persevere or be surpassed is still unclear. One thing that is clear — it’s becoming increasingly important for individuals to keep up with the rapidly changing banking environment or risk investing/saving in very sub-optimal and outdated methods.