How DeFi is changing financial institutions
Opinions expressed by Contractor the contributors are theirs.
You are reading Entrepreneur India, an international Entrepreneur Media franchise.
DeFi can have a big impact on how banks operate in the future and has the potential to change the structure of financial systems at the macroeconomic level. DeFi is an umbrella term for a financial system that operates without intermediaries such as banks, insurance companies or clearing houses. It is harnessed only by the power of smart contracts. DeFi applications serve the role of traditional finance (CeFi) in a universal and transparent manner.
The idea of a new financial system is part of the blockchain space and has been since its inception. Since 2020 DeFi has grown rapidly and today billions of dollars have been invested in the ecosystem. Growth is mainly driven by applications (protocols) built on the Ethereum blockchain.
The main business model of commercial banks is to take deposits and provide loans to customers. Borrowing and lending are the cornerstone of effective financial systems, as holders of funds are incentivized to provide liquidity to the markets. In return, they earn a return on assets that would otherwise be unproductive. DeFi protocols allow unknown participants to lend and borrow resources on a larger scale without involving intermediaries.
These apps bring lenders and borrowers together and automatically determine interest rates based on supply and demand. Anyone can engage with these protocols at any time, regardless of location or amount. The recent hype around DeFi apps is driven by the growth of lending and borrowing protocols. In contrast, traditional financial loans in DeFi are usually secured by over-collateralization. Companies, including Aave, are trying to authorize unsecured loans similar to traditional finance.
Investment banks and issuers of financial instruments
The business model of investment banks generally involves advice on financial transactions. The trading or creation of complex financial products and the management of assets fall within the sector of investment banking. DeFi protocols offer similar products. For example: Synthetix is a derivatives issuance protocol, which enables the decentralized creation and trading of derivative products on assets, including stocks, currencies and commodities. Decentralized asset management for cryptocurrency is evolving. As an example, Yearn Finance is a stand-alone protocol and seeks their best returns in the DeFi space while simultaneously investing for its users.
Exchanges are used to organize the trading of different assets. These include stocks or foreign currencies that exist between two or more market participants. The exchange of cryptocurrency for fiat currency (e.g. US dollar) can be credited to CeFi. Regular cryptocurrency holders should use exchanges like Binance or Coinbase (centralized organizations) to exchange one unit of cryptocurrency for another.
With the new emergence of decentralized exchanges (DEX), crypto holders do not need to leave the crypto space to trade their tokens. A great example of a DEX is Uniswap. DEXs are made up of smart contracts that hold liquidity reserves and operate under defined pricing mechanisms. Automated liquidity protocols play an important role in the development of an independent decentralized ecosystem without any CeFi intermediary.
The most important function of insurance is to smooth out risks and secure market players. For example, a decentralized insurance model is Nexus Mutual. This offers insurance that covers bugs in smart contracts. Anything based on smart contracts in DeFi, especially the exposure in smart contract code, creates a higher risk for DeFi users. Decentralized insurance is still in its original phase. Larger and more sophisticated insurance models are expected to have the potential to emerge in the DeFi space.
Stablecoins are based on blockchain protocols whose principle of price stability is encoded so that they perform the function of reserve currency. The introduction of stable coins laid the foundation for the functioning of the decentralized financial system. It allows participants to engage with each other without the underlying risk of price volatility.
There are three options for how a crypto can achieve price stability:
- Stablecoins can achieve high degrees of price stability by pegging a currency to other assets. For example, for each unit of USD coin issued, an actual US dollar is held in reserve.
- DeFi Perspective: Another interesting approach is the issuance of stablecoins using other crypto as collateral. The central protocol of the DeFi ecosystem is Maker DAO. The DAI crypto is backed by other cryptos and guarantees with its algorithm that the value of 1 DAI is around 1 US dollar.
- The experimental approach aims to achieve price stability without the use of collateral. For example, the Ampleforth protocol automatically adjusts the token supply based on demand.
How Nimbus could fit into the bank
Nimbus is a DAO-ruled dApp ecosystem that provides 16 revenue streams to users based on IPO participation, loans, crypto-trading, and more. So far, Nimbus has 50,000 users and continues to grow. The main stakeholder offerings of Nimbus are that it has 16 revenue strategies for users on a single platform. It has unique access to IPOs, seed funding, and other opportunities, now available in crypto. So far it has two tokens giving access to everything: NBU and GNBU. Nimbus may become more integrated with the bank as it continues to expand its user base. With a lot to offer its stakeholders, including special access to its IPO offering, there are plenty of incentives for users and stakeholders to sign up for Nimbus and become more integrated. As crypto trading becomes more popular as a source of income for users, Nimbus will continue to intertwine more with banking as a for-profit entity. With lending, borrowing and trading options for crypto users, Nimbus is rapidly expanding its user base and is likely to grow exponentially in the near future. One thing is for sure, Nimbus will continue to integrate as the ecosystem expands and develops.
Note: Investing in cryptocurrency is subject to risk and readers should exercise due diligence. Entrepreneur Media does not approve of such an investment.