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A Brief Introduction to the World of Decentralized Finance

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A Brief Introduction to the World of Decentralized Finance

Imagine a fully functional, borderless, secure bank account that allows users to earn a high yield on capital without ever interacting with a commercial bank. Today, with the invention of blockchain technology and “cryptocurrency”, this is a reality. Released in late 2008 (just after the global financial crisis), Bitcoin was the first test of the power of decentralized finance. So far, so good, but the true potential of this nascent technology has not yet been realized. The biggest obstacle this technology must overcome to achieve widespread adoption is education. The sad truth is that not many are aware of the complexities of the traditional financial system, let alone the nuances of magical digital dollars. So how does the world of traditional centralized finance work?

With no pun intended, in traditional finance, everything starts with a country’s central bank. In America, this is the Federal Reserve so we will focus on the system set in motion on December 23rd, 1913 by the Federal Reserve Act. Typically, a nation’s central bank is responsible for monetary policy which entails setting interest rate targets and controlling the money supply to ensure price stability and trust in the state’s currency. The central bank may then make payments to commercial banks for holding reserves at a special central bank account only accessible to financial institutions through payments called interest on reserves (IOR). It is then assumed, since the Emergency Economic Stabilization Act passed in 2008, that commercial banks will then “pass-through” these interest rates to the general market. The expectations of government were sound, but in a world that has a history of corrupt behavior in banking, this is not exactly how things have played out since. Instead, citizens often go through a lengthy, old-fashioned, discriminatory process, only to receive a small fraction of the profits that commercial banks receive by taking money directly from consumers’ pockets in the form of deposits. Many central banks around the world are paying commercial banks up to 10% IOR while today, the average benefit to consumers is a 0.06% annual percentage yield on bank deposits. For consumers that already do not have much to save, this is not a great incentive to go out and set up a bank account. This leads to consumers having even fewer savings in the first place, and then falling into the trap of using “expensive nonbank credit products”, as mentioned by Morgan Ricks, John Crawford, and Lev Menand in their paper, “Digital Dollars”. It is legislation that has led many into this cycle of doom and created a great need for an alternative to the modern monetary system. Some may consider it a coincidence, but it was only eight days after President George W. Bush signed the Emergency Economic Stabilization Act that the Bitcoin whitepaper was released to the public as the alternative that the world was already itching for. 

Now that we’ve gone through some of the downfalls of traditional finance, what is all the hype around this “Bitcoin” thing? Blockchain applications such as the digital currency Bitcoin, allow users from all over the world to set up a “savings account” without ever having to step foot inside of a financial institution. No need to give away your social security number, no need to tell anyone about your financial history, no need to deal with a central bank at all. Instead, consumers only need a laptop or a smartphone to create a self-sovereign savings account. Access to technology may create a barrier to entry for decentralized finance, but in many countries that are considered “underbanked,” more citizens are predicted to have smartphones than bank accounts. With 2.5B people around the world unbanked, the ability to own your savings account and the money within is already outstanding, but the opportunity is much greater. Decoupling financial institutions from the creation and distribution of money open up a plethora of use cases for blockchain technology and even in 2020, we have only scratched the surface. The most straightforward use case that has been made possible due to the Ethereum blockchain and smart contracts, is decentralized finance in the form of earning interest and taking out loans using digital assets. Now, anyone in the world can get access to loans and competitive interest on deposits without having to worry about someone denying them the opportunity. We can all now lend money to one another and earn interest on our money without any intermediary, weakening the power of the traditional banking system. Websites like BlockFi, have started to implement this technology in real-time, but a more revolutionary aspect of  DeFi takes things a few steps further. 

DeFi Money Market (DMM) Foundation is bridging decentralized finance and the real world. Recently receiving backing from billionaire investor Tim Draper, the foundation is creating an ecosystem that allows users to earn interest on USDC, DAI, and most recently Ethereum. What makes this project different from others in the space is that all yield paid to users of the ecosystem is backed by real-world income-generating assets that are incorporated on-chain through the foundation’s partnership with Chainlink. Guaranteeing an annual yield percentage of 6.25% on digital assets, the  DeFi Money Market ecosystem is blowing traditional banks out of the water and is even giving projects like Maker DAO, failing to maintain a consistent yield for investors, a run for their money. In its infant stages, the DMM ecosystem is already proving itself worthy of attention, but they are only getting started. As time goes on, the foundation will be creating a DAO, a decentralized autonomous organization, that will be responsible for maintaining and growing the ecosystem. This takes things to yet another level, but to prevent diving too deep into the boring technical aspects of a DAO, we will save that talk for a later date. Even without the DAO, the DMM foundation has opened a new world of opportunity for the unbanked and underbanked populations around the world by providing a reliable digital platform backed with real-world assets. With a team that is passionate about serving these people, the DMM foundation is going to have a lasting real-world impact that has not been seen in the world of finance. 

A deeper understanding of how blockchain democratizes finance and how to interact with this new financial technology will be necessary for decentralized finance to find its place in society. Though most people that are even aware of distributed ledger technology believe that Bitcoin and cryptocurrency are far from being a part of daily life, American technology company Ripple Labs, Inc. even went as far as to call 2020 “The Year of the Digital Asset”. Whether or not 2020 will prove to be the year in which money goes off into the cryptosphere is still unknown, but the combination of civil unrest with the shift from centralization to systems that democratize power all amid a global health and financial crisis, money may be in for a trip to a part of cyberspace that it has not yet visited, faster than we could ever imagine. 

 

Keith Smith is a publicist, communications manager, content marketing strategist, and the founder of a communications agency based in South Florida. Working with public figures, e-commerce brands, and technology startups across the United States, Keith helps his clients create and develop persuasive stories that touch millions of people in the audiences that matter most. Get in touch: keithdmedia@gmail.com

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