Here’s What You Need To Know About Decentralized Finance And Banks

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Even before the full economic fallout of the COVID-19 pandemic can be assessed, it’s evident that the poorest in society will become even poorer. In the United States, over a million people are now claiming jobless benefits. Latin America already has over 190 million people living in poverty, but the IMF is predicting that the region will suffer the worst economic contraction compared to other parts of the world.

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How the crisis plays out in different countries is yet to be seen, but the global financial crisis of 2008 provides some insights. When the banks start to tighten their purse strings, it can lead to a rise in unscrupulous lenders charging extortionate interest rates for short-term loans.

In poorer countries, US-dollar denominated debts result in national currencies starting to lose their value. In these circumstances, even the wealthiest people can see their savings and investments dwindle to nothing.

Although the 2008 crisis can give some indicators about what to expect, there is one variable that didn’t exist at that time. It’s widely believed that the creator of bitcoin, Satoshi Nakamoto, developed the cryptocurrency out of a sense of disillusionment with the existing financial regime. In launching bitcoin, he started up a whole new asset class, out of which has emerged a new financial system that’s largely untethered from its traditional predecessor.

A stable store of wealth?

The prevailing perception of cryptocurrencies is that they’re incredibly volatile compared to other asset classes. This is a fair assessment based on the price movements of bitcoin over its lifetime. It’s worth pointing out though that this has been a mostly stable economic period, at least in many developed countries.

However, looking to countries in Latin America such as Brazil or Argentina, where the national currencies have displayed significant volatility, and the adoption of cryptocurrencies tells a different story. In these countries, around 16% of people say they own or use digital assets. In Nigeria, the high cost of remittances has led to nearly a third of people adopting cryptocurrencies.

Bitcoin has made a solid case a possible steady store of wealth and safe haven, as a deflationary asset in a time of global economic uncertainty. Additionally, bitcoin has Outperformed most assets since the pandemic panic of March 12th, for instance, Oil has rallied just over 26%, S&P 500 which is closely associated with Bitcoin movement has rallied just over 36%, Gold as the main contender to bitcoin as a store of value rallied 18% while bitcoin 230%

“Bitcoin has been performing quite well in the past several months after the March 12 collapse. The current USD instability creates the ultimate driver for a breakout but several reasons have contributed to the modest gains. Additionally, bitcoin has outperformed most of the traditional assets like oil, stock, and some precious metals.

Of course, Institutional investors such as Warren Buffett will always lean towards an asset that has been there for a while and that they understand. Bitcoin has been correlated with the S&P 500 movement pretty closely and Investors are wary of another drop in stocks causing the bitcoin to plunge again. These fears are temporary and we expect bitcoin to break out as more and more institutional players start to learn and appreciate the design, integrity, and efficiency of Bitcoin,” Bilal Hammoud, CEO and Founder of Canada-based crypto exchange NDAX said.

The variation in types of currencies is no doubt part of the reason for their popularity in developing economies. Users can easily get their hands on a wide variety of stablecoins pegged to more stable currencies such as the Tether’s USDT . These coins also offer users the opportunity to bypass national capital controls such as those imposed on countries like South Africa, which also sees a high level of cryptocurrency usage.

An open financial system

The emergence of stablecoins is, in part, responsible for another evolution in the cryptocurrency space - decentralized finance, or DeFi. Currently, it’s a massive craze among fans of ethereum, with users creating complex chains of debts and leveraged trading in pursuit of “yield farming.”

However, as a financial system open to anyone that wants to participate, DeFi offers huge potential to the poor and unbanked. Over one billion people in the world are excluded from traditional financial systems because they don’t have a government-issued ID. Furthermore, with the COVID-19 crisis starting to bite, many people in poverty, even those with an ID, will feel they have no choice but to take a loan from unscrupulous lenders.

Anyone with a smartphone and an internet connection can participate in decentralized finance. Two of the biggest applications are Maker and Compound. Using these together allows someone to deposit ethereum as collateral, issue a stablecoin loan, and stake it to earn interest.

Decentralized Finance vs. Traditional Banks

Users who want to take advantage of decentralized finance loans will often also find cheaper interest rates than banks or credit cards will typically charge. For example, someone wanting to borrow Tether’s USDT or Circle’s USDC can get interest rates as low as 2.5% using a DeFi protocol such as Aave.

Even pre-COVID-19, the average lending interest rate in the US was more than twice that level, making a DeFi loan a potentially more attractive proposition.

Any discussion about decentralized finance should also be tempered with the warning that the sector is currently very much in its infancy. Nevertheless, the availability of an open, inclusive financial system during the onset of a global recession offers an intriguing potential, particularly for those who could be hit hardest. The global pandemic could end up becoming a tipping point for the adoption of DeFi.