Decentralized finance refers to a financial system that merges the services provided by traditional banks with next-generation technologies such as blockchain and cryptocurrency.
Thanks to these unique foundations, DeFi is able to meet the needs of businesses and consumers, giving them access to loans, savings and checking accounts, trading, interest generation and more, the all without the intervention of a centralized third party.
The popularity of DeFi has grew up fast and today it offers services rivaling nearly every facet of traditional banking. One of the reasons is that DeFi helps people who live in remote areas to access money and credit through a safe and reliable medium. It has also created new and unique opportunities for people to generate a profit that they cannot get elsewhere.
Access is one of the main challenges in traditional finance. To open a bank account, a person must show government-issued identification. To be approved for a loan, one must have an appropriate credit score, income, and meet other requirements. This person may very well need a lump sum to cover this loan, but they will not be approved if they do not meet the strict requirements of the bank. For anyone deemed eligible by their bank, this means they are out of luck.
Being unbanked is not profitable
What is shocking is that at present, billions of people around the world cannot open a bank account due to the strict rules of the traditional financial system. A 2017 World Bank Index report estimates that there is approximately 1.7 billion adults around the world who do not have a bank account. While people living in underdeveloped countries make up the bulk of this number, there are alarming numbers of unbanked people living in developed countries who also lack access to a bank account.
True, few people like their relationship with the bank. They cause a lot of headaches and they make a lot of money from their clients, but very often not having a bank account is worse for someone’s financial health. Without a bank account, people are unable to perform financial transactions that many take for granted, such as cashing a check, saving money, and taking out a loan. They are forced to carry cash everywhere they go and bear the associated risks, including higher fees.
In the United States, for example, only 40% of adults have a passport, while only 75% have a driver’s license. As a result, many people do not have the ID to open a bank account. According to FDIC data, about 25% of U.S. households are either unbanked or underbanked.
This can have a devastating effect from an economic point of view. Although prepaid cards have mitigated the impact, approximately 70% of the payroll in the United States is still made using paper checks. For those who cannot deposit this into a bank account, they are forced to use a check teller service which will charge high fees for the privilege of turning it into cash. Since most unbanked people tend to be in the lower income bracket, these fees can eat up a lot of their income.
Unbanked people in the United States are also subject to more predatory lending practices. While someone with a bank account and a high credit score can borrow at an interest rate of around 3% to 6%, those forced to rely on so-called payday loans can pay anything from 300% to 400% to borrow much-needed money.
Meanwhile, in the developing world, the ability to emerge from financial conflict is closely linked to access to affordable credit. In South Africa, access to credit can have a dramatic change on a person’s economic prospects, allowing them to take out a loan to buy farmland and grow crops, buy a car to get to work, or pay for an education. But for many it’s a no-start because they don’t have access. Very often, being unbanked leads to the worst financial inequalities and can have a devastating impact on people’s quality of life.
How DeFi can make finance more accessible
The reason so many people are unbanked is mainly due to systemic problems within the traditional banking sector. Banks are for-profit institutions and they have a financial incentive to make their services available to anyone who can afford it. At the same time, banks are discouraged from providing their services to those who do not have an identity card or credit.
Since decentralized finance removes the middleman and instead relies on blockchain technology, it can facilitate transactions between two parties in a safe and very inexpensive way. Traditional finance has considerable barriers to entry, such as its expensive fee structure and ID requirement, while DeFi is accessible to everyone with a smartphone. DeFi also requires little infrastructure. While a bank would need to build a physical branch to make its services available in remote areas, all that is needed to access DeFi is basic WiFi service. Moreover, DeFi can operate 24/7, unlike traditional banks which only open their doors from 9am to 5pm. This means that transactions can be made at any time and are processed much faster than traditional financial transactions. Because DeFi is automated, transactions are also much cheaper. So while DeFi provides much of the same services as traditional finance, it is also far superior in many ways.
These features make DeFi accessible to anyone and everyone, without the need for a bank account, KYC checks, or any other type of proof. This, combined with its transparent rules, which are enforced by smart contracts, creates new opportunities for the unbanked to tap into the global financial ecosystem.
In addition to just depositing money and saving it, people can use DeFi products to send money to other countries, to get a microcreditWhere participate in micro-investments and create a passive income stream. What’s particularly smart about DeFi is that the infrastructure carefully spreads the risk of these investments, like providing capital for a loan, evenly across multiple investors funding it, meaning no one has to assume all risks.
DeFi is therefore particularly attractive to an unbanked entrepreneur in a developing country, as they can use its services to obtain funding for their fledgling business from investors located all over the world.
Why regulation will be the catalyst
The potential of DeFi is clear and yet it still has its shortcomings at present. One of the biggest challenges is the lack of regulation – an issue that deters many investors from participating in DeFi ecosystems.
A lack of regulation is often correlated with a lack of security, and there have certainly been plenty of incidents within the nascent DeFi sector. In most publicly disclosed security incidents, investors lost money due to issues with smart contracts, validators, or other issues. Some recent examples include mirror protocol violationwhich resulted in the loss of $90 million in user funds, or the Exploiting the Saddle Finance smart contract which resulted in another loss of $11 million. Then there are also exit scams, like BreedTech, where the founding team simply stole about $9.4 million money from early investors. The big problem with such incidents is that there is no way for investors to recover their funds once they have been stolen, and there won’t be until DeFi is unregulated.
That’s why there’s a lot of hope for projects like Phree, a new decentralized and compliant liquidity ecosystem that aims to regulate the DeFi space. What Phree aims to do is bridge the gap between DeFi and the compliance found in the traditional financial space to make it more attractive to the massive amounts of cash held by institutional investors and banks.
As Phree points out, while DeFi’s growth has clearly illustrated its potential, it will only realize its ambitions of banking the unbanked if it can tap into traditional finance. But that won’t happen until the issues around risk, security, fraud, price manipulation, and lack of KYC and AML are resolved.
Phree promises to solve these problems with a compliant DeFi ecosystem-as-a-service platform and a licensed asset manager that can create permissionless and transparent protocols that will attract traditional investors. It has also made great strides working with partners such as Parity Technologies, the company behind the Polkadot blockchain, PwC Switzerland and Mastercard towards the launch of its platform in 2023, which will include its own regulated and backed stablecoin. to assets.
By building a compliant DeFi platform, Phree hopes to be able to answer questions about what happens when stolen as a result of smart contract vulnerabilities and scams, giving users greater peace of mind. . At the same time, regulation will reduce the incidence of rug pulls as non-compliant DeFi protocols will struggle to attract investment.
While many continue to argue against compliance and regulatory oversight in DeFi, claiming that its implementation is impossible due to its decentralized nature, the fact is that there is always somewhere an entry or exit ramp to traditional finance. This is where the opportunity lies and this is where companies like Phree are creating solutions.
For DeFi to go mainstream, some sort of regulation is both desirable and necessary. DeFi represents the greatest hope for millions of unbanked people to gain fairer access to finance and improve their financial prospects. This alone is reason enough to do what is necessary to ensure that DeFi fulfills its potential.