Do We Really Want to be Our Own Banks?
Sometimes we need to be careful what we wish for. Blockchain technology and crypto currency have gotten together and created this baby called Decentralized Finance – DeFi. (I am aware that Blockchain is essentially the technology behind crypto anyway. However, I feel like the tech and the theses went separate directions for a while) One of the many mantras of DeFi is to be your own bank.
When Bitcoin was devised, code launched, and the first block was mined, the goal was to disintermediate – to take out the excess layers from the financial system – and therefore to take away the control that those intermediaries held. Satoshi didn’t want governments to control the monetary policy, and hold power over their populations by deciding how much money there will be, and who has access to it.
Satoshi also saw that banks controlled the entry and exit of the financial system, as well as all the roads in between. We have to constantly pay our tolls in the form of fees, and go at their speed limit, especially when they had to slow us down so their antiquated technology could keep up with the speed and distance of our transactions.
Now we have DeFi – a world where we can hold our money outside of banks, but not have to walk around with wads of cash in our pockets. We can borrow and lend to a pool of people we don’t know, and earn interest many times that which the banks are paying to hold our money.
In some countries, like Argentina, anyone can hold digital assets to save themselves a bit from the wild 70% inflation their Central Bank has caused. In other countries, like Turkey, anyone can hold digital assets in case their country goes to war and they want to leave, or their government decides to halt bank transfers so they can pay for the war.
We now have the technology to take back the power, which is part of the point. Money can be moved around the world in a few minutes, for a minuscule fee, without anyone asking any questions. Either for a big purchase or several times an hour for micro-payments.
We can invest in digital assets, or derivatives of digital assets, have them professionally managed, earn interest by contributing to a liquidity pool or lending directly.
All the DeFi protocols and Decentralized Applications (DApps) are fiddler around with because we like being on the edge, and we don’t mind having to jump through some hoops. We also know to not use all our money, and that we are ok if something goes wrong and we lose it.
As the applications are built on top of each other, and we rejoice at the growth of our new Decentralized economy, we need to be very careful jumping in too quickly.
People have a habit of wanting to DIY when it comes to finances. They wanted to break free from the old, conservative pension plans in the 1980’s, which fueled the growth of 401k retirement plans. In the early 2000’s they wanted to manage all their own investments, leading to the online discount brokerages.
The research has proven that individuals are NOT very good at managing their own money. People in the developed world are less prepared financially for retirement than they were in the days of pension plans. To be fair, this partly due to increases in changing jobs, longer life spans, and increased potential expenses during retirement.
However, when I could offload that responsibility onto another party – my employer – I could go about my job knowing that they would have to provide a certain income stream for me during my retirement. Of course, many pensions are seeing deficiencies now due to some of the same issues highlighted above.
When individuals have the choice to save for retirement, they have often chosen against it. Having managed 401k plans ourselves, we hear the usual “I’ll get started next year,” all the time.
When those workers have chosen to invest in their future with a 401k plan, they again try to manage their own funds instead of opting for the Target Date Funds. While most research, and all fund managers, show that individual funds outperform target date funds, the investors who use target date funds have outperformed those that choose their own portfolio.
Why? Most people vastly overestimate their financial knowledge, and their time they can devote to managing a portfolio.
When individuals were given the keys to their own brokerage accounts through E-Trade, Schwab, etc., they showed their lack of understanding, lack of knowledge, and greed. I know there are many people that have done very well managing their own funds, and I applaud them. However, as a whole, individuals need help with finances.
Where does DeFi fit into this admittedly negative narrative?
We want so badly to be free from the evil governments who are printing money and putting restrictions on us, and from the evil banks that are charging us fees and lending our money without compensating us.
However, it is sometimes nice to offload that responsibility, and that risk, onto others. We have banks for the very purpose of centralizing the responsibility and the risk. They have grown in power for several good reasons, and one is that we need someone to be the intermediary.
If my bank account, credit card account, etc. gets compromised, the bank can make me whole, and it is incumbent on them to have the requisite security and insurance to keep themselves afloat while insuring my funds. If there is an economic downturn that causes the banks to not have the funds to supply all their account holders, the bank gets to turn to the federal government.
In the US, we’ve become accustomed to having a “throat to choke” when there is a problem. There are potentially multiple throats. It has allowed us to be a little more lax, less vigilant about where we use credit cards, how we send money, whom we give our information to. It has basically allowed us to conduct our lives relatively free from worry, knowing that, if there is some sort of compromise, we can text, email, chat or call the bank, and they can probably fix it.
How does that translate to a decentralized protocol that calls itself a bank? How vigilant are we going to be about our private keys, passphrases, seed words, etc.? Will the extra interest and lessened friction compensate us for the risks we are taking by circumventing banks.
And what about those that are the unbanked or underbanked? While DeFi is a huge step forward for them, losing their funds through either a hack, poor management, poor understanding of the systems can be disastrous.
Who is going to take it upon themselves to audit, monitor, and insure the funds? Once that happens, are then back to be centralized? I’m not sure the answer.
We are obviously huge fans of Blockchain, and Decentralized Finance. We see so many efficiencies, use cases, and improvements over the current system. This is just a note of caution that as much as we want to be rebellious and excited about the new technology and the ecosystem is provides, we also need to be careful and understand what we’re wishing for.