As blockchain-enabled systems and crypto (mainly) flourish, pundits claim there’s a non-bank future before us with lower fees, faster transactions and instant exchanges of value from person to person.
Payments Cards & Mobile’s James Woods looks at the potential – and pitfalls – of the new world of Decentralised Finance…
More than twenty years ago, the payments world rang with talk of something called “omnichannel payments” – the capacity to pay for anything, anywhere, over any type of device.
Over two decades later, we’re just about realising omnichannel payments in advanced markets such as Asia, the Nordics, the UK and North America.
That said, omnichannel is a way off in much of Eastern Europe, the Middle East and Africa – and the least developed markets are still using cash in up to eighty percent of transactions.
The case of omnichannel payments is worth bearing in mind when we hear breathless talk of decentralised finance, or DeFi, today.
For all its promise, there are significant hurdles to clear before we can talk of a world of lower fees, instant settlement and peer-to-peer or consumer-to-business transactions without intermediaries.
The DeFi promise
Decentralised Finance hinges on the capacity of blockchain to communicate rapidly between user-owned wallets, using crypto assets (chiefly stablecoins, or crypto pegged to the value of a fiat currency) as a mode of exchange.
From a consumer perspective, a fully decentralised financial system would eliminate the wide range of third parties currently charging consumers (and, it should be noted, financial institutions) to undertake transactions.
Consumers would be fully responsible for their own funds, holding them in a private wallet, and access to a “DeFi” system would be available to anyone with access to the internet.
Finally, funds transfer would be possible in real time between individuals, and between companies and individuals, thanks to the speed and rich data blockchain enables, plus the capacity to tie user authentication to a device or computer.
The knock-on effects can also be good news for consumers, since retail investors could interact directly with wealth managers from their wallet, reducing management fees and intermediaries and improving their returns.
Likewise, providers could compete for consumer attention with products such as mortgages and loans based on an individual’s accurate, independently-verified credit score – another outcome that would give prudent consumers a better deal.
In summary, DeFi could be to finance what “personalised medicine” is to healthcare – the promise to create individually-tailored treatments that work better in the consumer’s particular circumstances.
Getting to that point, however, is no simple task.
“Predictions for the size of the DeFi market ignore the many challenges that remain.”
Such promise has led to overly-optimistic forecasts from some analysts that – because crypto acceptance and transactions are rising fast – the world of decentralised finance will be with us in the next five to ten years.
The problem with assessing what’s happening in DeFi is complicated by the fact that valuations can include the total crypto/blockchain ecosystem.
Thus, if the crypto market is worth $800 billion, and projections for blockchain-enabled systems see that market rising to $75 billion by 2026, pretty soon it becomes possible to value DeFi at a trillion dollars inside five years – yet doing so would ignore the many problems that remain to be solved.
What’s in the way?
“There are more UK card transactions every day than global crypto transactions per month.”
Here are some of the problems that stand between where we are today and a full-decentralised future.
To start with, there’s a very long way to go in the consumer uptake of blockchain. There are around 300 million crypto holders world-wide, roughly three-quarters of whom want to use crypto as a means of exchange.
For context, that’s less than a quarter of the population of China or India.
Likewise, maybe 10 or 11 million crypto payments are made each month world-wide.
Even though that figure is said to be doubling every two months, it’s just over half the number of card transactions that take place every day in the UK.
Then there are technical problems and the enormous amount of regulation required.
On the technical side, those accessing crypto must first sign up to an exchange, which involves both stringent KYC and AML checks and the creation of so-called “hot” and “cold” wallets, used respectively for trading and storing coins and secured by separate encryption keys.
To cut a long story short, the process of holding and spending crypto is, as things stand, complicated and time-consuming.
That said, a variety of solutions have emerged that simplify this process, such as the recent tie-up between crypto specialists hi.com and Banking-as-a-Service provider Contis.
This deal enables hi.com’s holders of crypto to spend their money at more than 60 million merchants without having to access their crypto wallets, enabled by a platform provided by Contis.
Sean Rach, co-founder of hi.com, told PCM that “for too long, the financial system has been rigged against the customer.
For instance, if you look at the recent record earnings from some banks – those profits went to share buybacks, rather than improving services.”
Squaring the circle: regulation and innovation
The deal between hi.com and Contis is a great example of innovating within the boundaries of existing regulation.
However, the sheer volume and scale of regulation that’s required in blockchain and crypto is staggering. If a market doesn’t take the approach of Thailand or India (outright bans), then there’s a great deal of planning and co-ordination ahead.
In the United States alone, some 21 bills were passed by Congress last year that affected either blockchain or crypto trading and payments – with more to come.
In 2022-2023, we can expect to see major legislation from the EU, UK, US, Australia and other regions and nations.
While this legislation will provide comfort to consumers and investors, it’s crucial that it shouldn’t stifle the innovation hurricane we’ve seen in the last decade.
As we’ve consistently said at Payments Cards & Mobile, we should be thinking about crypto and blockchain as a development every bit as significant as the internet has been over the last twenty years.
Caution optional: optimism necessary
While a cautious approach is necessary – especially at a time when research from Chainalysis reveals crypto theft and losses are growing – a degree of optimism and tenacity will be required in what we can expect to be a long road towards decentralised finance.
However, it’s clear the shift has begun, as Lee Johnstone, Managing Director at Contis, puts it: “While banks are becoming more involved in crypto, challenger banks are popping up because traditional banks have become legacy banks.”
Other open questions include the role financial institutions of any stripe will play in a decentralised finance scenario, and how to secure transactions happening one-to-one in near-real time.
“Last year, no fewer than 21 bills were passed by the US Congress relating to crypto and blockchain.”
A little imagination tells us that payments and personal finance would be utterly transformed by decentralised finance.
Imagine a world in which you can spend instantly and hold one-to-one, real-time relationships with savings, investment and insurance providers: quite different from the layers of qualified persons and regulated companies who currently exist mainly to save us from our own mistakes.
Whether it all comes to pass will depend on technological, regulatory and above all social developments in the years ahead – will people always want to pay immediately, and will they want to take on the responsibility of managing their finances independently?
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