Could Defi spell the end for banks?

  • Traditionally, retail banks have always made their money by taking in short term deposits and lending out long term loans, charging the interest spread in between. The reason they could do that is that the banks have to spend time and effort in evaluating the debtors that come to them for loans to determine how much money they are willing to lend out based on the debtor's background, ie credit history, income level, current assets and liabilities. The banks operate as a middle man to transfer the risk away from savers who want to earn interest on their savings but don't know who is reliable enough to loan their money to.

    However, with the growth of the Defi space, many Defi platforms including Switcheo is rolling out platforms where people can loan and borrow money peer to peer without the need for a 3rd party to be involved.

    This has 2 main benefits.

    1. Reduce costs for the people. Walk around any major city today and you will easily spot huge skyscrapers with bank logos sprawling across the CBD, the banks have profited largely from this business. While banks have benefited society as a whole, providing funds where it is needed and keeping the economic system moving. Blockchain and defi, has presented a better way to achieve these outcomes without having to go through banks.

    2. Take away the need to trust a 3rd party. While banks are generally trusted, this is not always the case. I think many people might remember the 2008 financial crisis where the banks were lending out indiscriminately to subprime borrowers and the result was that regular savers like you and me suffered from their mismanagement. Defi eliminates the need and risk of trusting a person, instead loans are backed up by collateral and smart contracts ensure that no human is tempted to take what does not belong to them. With such large sums of money in the custody of people, there are bound to be temptations despite strict regulations and checks. We only see the ones that are actually caught. Insider trading due to asymmetric information and fraud will always be present, just last year 3 bankers were caught by the Monetary Authority of Singapore after 7 years of cheating the system and getting away with more than $2 million dollars each.

    With defi, lending and borrowing activities are done through a central pool of funds that is secured by a smart contract and earn higher interests than what a bank would offer. All lenders are considered equal so there is no discrimination based on income level, credit rating, race even, but based on the amount of collateral that is put up. While this technology is very much still in a beta phase with many new market entrants, I believe that defi could eventually replace traditional banks and return power back to you and me.

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