Decentralized finance (DeFi) has turned into a nearly $100 billion dollar industry over the past year. This has led to much speculation that the centralized finance world will adopt a lot of these DeFi systems.
The chances of this happening appear quite low for a variety of reasons that we will list out. This is not a bad thing, though. In fact, the ideal financial system will have no centralized institutions (ie. banks) and rely entirely on decentralized protocols.
Anyway, here’s why it is basically impossible for traditional banks to adopt DeFi systems.
Why Banks Won’t Adopt DeFi
There are a lot of reasons for banks to not adopt DeFi. There are probably too many reasons to list out why it will not happen. But it almost entirely boils down to three broad points.
It Eats Their Profits
The biggest reason you will not see banks adopt DeFi is that decentralized systems like Uniswap and Yearn.finance will eat into the profits of banks.
The entire point of decentralization is that it’s all automated and runs on a trustless system. Automation means that the fees are far less because, well, it’s automated.
We will put it this way, people will realize that all the functions of a bank can be replaced by lines of code that rely on very low fees. At that point, people will realize that there is no purpose for a bank to charge so many fees and drop the bank.
This is why it’s in the best interest of a bank to ensure that DeFi does not gain any more ground than it has already gained.
DeFi Is Too Transparent
Another aspect of banks not talked about is the opaqueness of the institutions. Customers put money into what is essentially a black hole with the expectation (or hope) that the money will grow over time.
The first problem with this is that sometimes the money does not grow. But the banks and funds still have the nerve to charge a management fee despite the loss. In the event that there is a profit, then the bank will charge a 20% fee on the profits.
Frankly, that is a complete ripoff.
More importantly, the banks and funds do not really disclose what they do with the money because that would result in people replicating the success.
This brings us to the second problem with DeFi from the perspective of a bank – DeFi is far too transparent for a bank to use.
To summarize, a bank hides behind transparency in order to charge larger fees. That would not work with DeFi because all the actions are public, so people could easily replicate the transactions themselves.
DeFi Does Not Need Bankers
The final, and most critical, problem with DeFi from a bank’s perspective is that DeFi eliminates the need for bankers.
Remember, everything on DeFi is automated or relies on self-custody.
Banks are the polar opposite with most processes not being automated and the bank serving as a custodian of customers’ cash.
What exactly does this mean for banks?
It means that there is no need for the institution known as banks in a financial world that relies on decentralized systems.
To put it bluntly, there would be no job known as “Investment Banker” or “Financial Manager” in a world with DeFi because people could do that themselves using something like Yearn.finance or a venture capital DAO.
And, as mentioned previously, the fees for doing those actions on your own are/would be far less than having some banker at Goldman Sachs do it.
Will Funds Invest in DeFi?
Hedge funds and other venture capital firms will likely invest in DeFi.
Investment does not mean that the bank adopts the system, though. They simply invest in it because customers read stories about 16 year olds making 6 figures with DeFi and want in on the action.
Basically, banks invest in DeFi as a marketing strategy rather than because they actually support the system. Even then, banks investing in DeFi is not nearly as efficient as doing it yourself because banks charge extra fees on top of everything else.
The Future of Banks with DeFi
The future of banks and other centralized financial institutions looks very bleak at the moment. The margins in the banking industry are not nearly as high as most people believe. They currently stand around 22%.
Remember, banks have a large amount of human resources expenses and rental expenses that they must pay.
DeFi systems have to pay a few programmers to maintain some code. DeFi also has the advantage of being able to pay employees in native tokens rather than regular fiat currency.
Anyway, DeFi has the following advantages over centralized financial institutions like banks:
- The fees are lower.
- It’s more transparent.
- Less regulations allows more opportunity to everyone.
- DeFi lets customers control their own financial future (read: self-custody).
As we have mentioned before, the most important difference is that DeFi has lower fees. Customers tend to gravitate towards whatever has the lowest fees.
Due to this, banks will likely experience a loss in customers as multiple factors combine as a sort of death blow to banks. These factors that will destroy banks include the following:
- The emergence of DeFi.
- Inflations of fiat currencies.
- The almost certain introduction of central bank digital currencies (CBDCs).
- A general distrust of banks and Wall Street.
Those factors will likely combine with the general downfall of the centralized financial world over the next two decades. We know that sounds fast for the general downfall of an industry, but technology has a tendency to quickly eat industries that cannot adapt.
A good example of this would be Kodak in relation to photography. Sears is another example of a company that could not keep pace with companies utilizing technology (WalMart) and then completely fell apart when eCommerce became popular.
To further that point, banks are in an even worse spot because they have had virtually no viable competition, due to strict government regulations, for the past 100 years. Banks will have an extremely difficult time adapting to the competition.
That about sums it up for why traditional banks will not adopt DeFi systems. The general point is that traditional banks have no incentive to move to adopt DeFi.
They will likely market DeFi to customers as a sort of marketing trick, but the core part of DeFi (read: decentralization) will never be something that banks adopt because there is not enough room for a middleman with decentralized systems.
In fact, banks will likely face stiff competition from DeFi in the coming decades as the popularity of the protocols only grows over time.