Decentralized finance, or DeFi, tries to take traditional banking services and put them on the blockchain.
I’m talking about making loans, borrowing, trading assets on exchanges and more.
But now, banks are trying to get into the DeFi space by offering crypto services to their clients. And it seems like they’re creating Frankenstein’s monster.
That’s because the banks are building something that could evaporate their own businesses.
In today’s Market Insights video, Steve Fernandez and I discuss why the crypto boom has put banks in a difficult situation.
(If you’d prefer to read a transcript, click here.)
Ian King: Hey everyone. Ian King here, editor at Smart Profits Daily with your weekly Market Insights video.
Joining me is my friend and colleague Steve Fernandez. Steve, what’s shaking this week?
Steve Fernandez: Really, it sounds like more of the same: Wall Street is moving into crypto.
It looks like Citigroup is now carving out a division specifically for digital assets in its wealth management arm. So, it’s looking to add crypto exposure for its clients.
And that just adds to the other institutions that are already making those moves, like Goldman Sachs or Morgan Stanley, for example.
Ian: So, the empire strikes back.
Basically, cryptocurrency launched its first initiative, decentralized finance (DeFi), which we’ve covered at length on these Market Insights videos.
And now it sounds like Wall Street is firing back with some offerings of its own … although it’s not really trying to compete with DeFi as much as it’s sort of exposing its clients to these digital assets and giving them away to custodies.
Is that correct?
Steve: Absolutely. It’s a relatively slow rollout right now.
I mean, who knows how long this will take, and how much risk they’ll allow their clients to gain exposure to.
It may not be like Coinbase or Binance, where there are a ton of digital assets that you can choose from.
Ian: Right. What I find interesting about that is, obviously, what a lot of what DeFi does is it tries to take the traditional banking services and put them on the blockchain. So, I’m talking about making loans and borrowing and trading with decentralized exchanges and derivative contracts.
And it almost sounds to me like the banks are creating sort of Frankenstein’s monster here.
They’re exposing their clients to these digital assets because a lot of the buy side now wants cryptocurrency exposure. But in the end, I feel like they’re building something that could do away with a lot of the banks’ traditional businesses.
For the retail customers at least, who likes going to the bank anymore?
HOW DEFI WORKS
let me give our viewers just a little bit of insight on how DeFi works. Because, like I said, we’ve discussed this before.
So, think about an interstate highway. Maybe some of you live on the East Coast along I-95, and you know that you pay tolls on this highway. And when you pay the tolls, it’s used to upkeep the roads, and you have to pay it to a centralized government organization. They take care of it.
DeFi is like a toll road that is autonomously taken care of by anyone who wants to participate in the network. So, there’s not a centralized state or government that’s taking care of this toll road. Basically, anyone who’s a developer and has development skills can go in and fix this toll road.
What’s really interesting about different protocols like Uniswap and Aave and others is a lot of them are evolving, and they keep putting out new versions. But once this infrastructure is in the wild, it pretty much just runs on its own.
I mean, you go to Uniswap, and there are certain rules you have to abide by. But if you want to trade your bitcoin for Ethereum, or Ethereum for another crypto token, it’s just there. It’s not like there’s a thousand people working on it.
Is that correct?
Steve: Right. I mean, pretty much everything is using a smart contract, which automates the entire process.
So, with banks looking to get exposure to that, you could hypothetically say they’re really making their own poison.
But if they don’t, they’re going to be one of those companies that doesn’t offer crypto when almost every Wall Street institution is offering some sort of DeFi exposure.
Ian: Right. And a lot of this has to do with getting rid of the middleman.
If I want to go to Uniswap and trade a smart contract, I’m trading against another individual user of cryptocurrency. I’m not trading against a market maker or a centralized exchange.
That’s a lot of Wall Street business right there that I think is just going to evaporate in the same way that we saw a lot of traditional brick-and-mortar retailers become e-commerce along the way. So, that’s how I think about it.
And in another sense, think about what Netflix did to Blockbuster Video 20 years ago.
On Friday night, you’d drive to the video store, and you’d peruse through the aisles. You’d be so angry when all the new releases were out. Right, Steve?
Now you don’t have to worry about all the new releases being sold out. You just go to Netflix. You don’t have to go anywhere — you can do it from your own couch.
So, it’s sort of a similar analogy, except with cryptocurrency, it’s going to be anyone who owns cryptocurrency can participate in this and become a market maker. And it’s going to unlock the value of basically idle capital that’s sitting around.
Is that how you see it as well?
Steve: Yeah, I agree with that. And I think Wall Street will find a way to try to make money off of whatever comes our way.
So, what I foresee happening is if it’s losing whatever it might be — orders, flow or a commission business —because of DeFi, or maybe it’s not getting the interest rates that it was in terms of funding, it may try to participate in the protocols itself with volume.
That would still be good for DeFi, as it would improve liquidity and make it less risky, potentially. But at the same time, DeFi participants may not be able to get these lucrative returns that they are now.
I still expect they’re going to be higher than, you know, if you were to go through a banking alternative just because there’s not going to be those human capital expenses or anything like that.
But in general, I expect Wall Street to still try to take part in DeFi, probably in a big way, too.
Ian: I mean, the Goldman Sachs decentralized exchange just sounds like a video meme.
You know, I’m sure the larger crypto community isn’t going to be too enthused about Goldman Sachs launching their own “decentralized protocol.” So, we’ll see how that actually works out.
Editor, Strategic Fortunes