Are we ready for DeFi?
Comparing central finance with decentralized options
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Do something that scares you every day.
I did exactly that by enrolling in a 30 day blockchain hackathon. What I knew about blockchain when I enrolled was that it’s a decentralized system and something I wanted to learn more about.
Blockchain technology promises increased transparency, lower costs, and being more secure than traditional banking. But what it actually means I am not too sure. But I was determined to find out, and what better way than to embark on a project with access to the best minds in the field.
And as I was accepted to participate in the hackathon and started to think about a concept, I discovered the theme is DeFi or decentralized finance.
Too late to pull out, I realized this is far above my comfort zone as I know even less about trading and economics than what I do about blockchain technology.
But alas, not willing to admit defeat, I decided to use it as a learning experience. I devoured all the material I could find on Ethereum and DeFi (decentralized finance) and were pleasantly surprised to discover an entire, fully functional, eco-system that promises to replace banking as we know it in a cheaper, more convenient and faster solution.
The blockchain, or rather the Ethereum blockchain (because it’s a total different system than the Bitcoin blockchain), is built with re-usability and connectivity in mind. Everything is open-source and contribution is encouraged. In fact, the purpose of this hackathon is to add onto the existing platform to make it even better than what it already is.
I was delighted to discover banking in such a different — and refreshing — alternative compared to the banking system where change happens slower than the ice caps melting!
So can we replace centralized banking yet?
All the building blocks are definitely there. You can save, lend, borrow, buy, sell, game, you name it! In fact, you can do much more than what you can with a traditional bank.
But how does it compare to our current banking experience? And is it ready for mass adoption?
The purpose of banks and money
Taking one step back, let’s start at the start and look at the purpose of money and banks.
Money
Money is simply a universal token of exchange that allows people to exchange goods.
In rural Mozambique, this token of exchange might be a handwritten note, also called an I-owe-you as we once delightfully discovered when we wanted to buy pao (the local bread) and the baker didn’t have change (as often happens in Africa). He wrote on a torn, dirty little piece of paper the exact amount he owed us in change, handed it to us with the pao’s, and walked away. We laughed, threw away the piece of paper, and enjoyed the rest of our holiday and our delicious coconut steamed pao’s.
But the memory stuck. In effect he borrowed the change he didn’t have and the piece of paper was a written contract solidifying the promise into something tangible and concrete. It was a not-so-smart-contract, but a contract nevertheless.
In developed America this token of exchange is much fancier and called a dollar bill. But it’s the same thing. It is simply a token that promises another person something you don’t have right now but will in the future. Hopefully. Most probably.
Money, as such, doesn’t mean that much. It’s just a piece of paper with a promise written on it. It’s worth as much as the integrity of the person who wrote it. Anybody can make promises, but it’s only worth something when you deliver on those promises.
Banks
Banks, on the other hand, is an old and outdated concept that has become a prison rather than the promised palace it once was.
Banks used to be physical places where you could store your money in a safe place. Except that it stopped being safe a long time ago and is increasingly digital rather than physical. It’s also increasingly enforced rather than an optional service. The issued notes used to be linked to physical assets such as gold. Today, however, it’s as easy as government deciding to add a 0 and magically, more currency is injected into the system.
The trust that was the primary benefit offered by banks has disappeared a long time ago.
Banks are just more convenient for most of us so we continue using them. But there’s no need for a bank in itself and I’m struggling to compile a list of benefits to be honest as I’m writing this. I simply can’t think of a personal reason why it is better for me to bank my money rather than store cash under my pillow.
In Africa a lot of people don’t have bank accounts at all and I lived happily for more than a year without access to any bank account at all.
So what is the core value proposition if it is not trust and safety?
Benefits of banks
Simon says “Start with why” so let’s follow his advice.
What is the core value proposition(s) of access to banks and money? Why would someone use it? What makes it valuable and worth paying for as service? Here are the core reasons I can think of:
- Receiving interest on capital (more interest than fees) or wealth creation in the form of compound interest.
- Access to loans in order to create more assets.
- Safe store of assets.
- Ability to easily transact to buy and sell goods and services.
- Ability to pay and get paid globally (probably the most important value proposition of a digital currency).
Taking this checklist let’s see whether DeFi is a good value proposition for the average Joe on the street and compare centralized finance (CeFi) or traditional banks with the decentralized (DeFi) options available to us on the Ethereum blockchain.
CeFi vs DeFi
As a personal experiment, I compared my current Capitec Bank experience with the DeFi options available to me. Capitec being one of the more innovative banks in South Africa that disrupted banking by introducing low monthly fees that forced the other banks to drastically drop their fees.
Having previously banked with both Absa and FNB, two of the main players in South Africa, the only difference is that Capitec offers less sophisticated products (which is a benefit in my opinion) and have much lower monthly fees. In terms of service they’re comparable to the other banks and might even be slightly better only as a result of newer technology being a much newer bank. Going to a bank has become as painful as interacting with any government service like renewing your driver’s license or getting your new ID issued (which is why I still have my old one).
That brings up the question whether a service that looks after your most valuable assets is worth it when it has become so painful?
For DeFi I looked for specific offerings that would allow me to perform the same functions as what I currently do with a centralize bank with no previous knowledge or affiliation with any of the products. I was literally a blank slate as I embarked on my research and went on recommendations from economists and other more knowledgeable people from various and diverse sources.
But I digress.
Let’s compare the value proposition between DeFi and CeFi.
1. Interest rate on savings
Capitec offers 3–8.5% interest your transactional account with the full 2020 interest rates available here. Simply having money in my transaction accounts offers me 3% interest, and having more than R25,000 increases it to 4.1%, which is pretty good for banks. Most months, they pay me to bank with them, which I feel is a fair deal as they use my money to trade and invest and earn interest while keeping it. Win-win. I like it.
On DeFi there are a multitude of options to choose from and lending rates varies from as low as 0.01% to as high as 12.27%. The only difference is that with a bank the banker chooses where to invest and trade my money, whereas on DeFi I’m in full control of where my money is invested. O, and of course, there’s no paperwork. BIG benefit!
I didn’t have the courage to actually save and simply kept my tokens in my wallet (roughly the equivalent of a bank account), where I was pleasantly surprised to see the volatile but upward trend.
Simply storing money in a CeFi account vs a DeFi account, without investing, lending or trading, is more risky and volatile in DeFi, but with much higher growth than the no-growth of CeFi.
But interest is the one part of the equation and on the other hand is the fees. My Capitec bank account totals R6.50 per month (which is pretty much free) with very straight forward fees. Card transactions are free with payments R1.50 per transaction and a monthly R5.00 standard account fee.
Comparing this to DeFi is very hard as the fees are not as straightforward or fixed. There are no standard monthly fees to have a wallet. However, each transaction includes what is called gas, or a transaction fee, which changes based on the load on the network. To complicate matters even more, it is presented in the ETH format which similar to the bitcoin format consist of a large number of decimal points, way too complicated for an average person to exchange in their heads.
It typically looks like this.
I exchanged R569.42 and I got BTC 0.0032816 at an exchange rate of 170 117 BTC / ZAR.
There is an estimated fee of R11.39 and in all honesty I don’t know how this is calculated. The 2% fee is the service provider’s fee and I don’t know whether the gas is added on top of this or included in the estimate.
This is the fee for buying the bitcoin, which is higher than most exchanges, so be very careful to do your homework before you sign up. They also charge a fee for depositing the money and when I finally withdrew it was again charged a similarly high fee. Having read their fee structure beforehand made it sound much cheaper than what my actual experience was, so my trust of course immediately dropped.
The upward growth of the currency compensates for the high fees and most people probably don’t put much thought into it, but all in all I lost about R61,67 on my initial investment of R1, 000 even though the growth was 15% and 32% respectively on Bitcoin and Ethereum.
The R1 000 I deposited ended up being R938,33 in value after a month. Maybe I was unlucky. But DeFi is definitely not living up to the promise of fast and cheaper than traditional from a pure practical perspective.
The winner in terms of daily savings (liquid option) thus is Capitec with the ease, accessibility and stability offered. For longer term investments I would however opt for DeFi as the growth is so much higher and the fee structure is per transaction whereas with a bank it is monthly.
However, the average user wants a simple savings account and the ability to transact daily. Investments or long term savings are usually done via a financial service provider outside the bank.
2. Access to loans or credit
Getting a loan at a traditional bank is paved with paperwork and extortionately high fees. Traditional banks also tend to only give money to people who don’t really need it as a source of bank income and longer term hook.
If, for example, you are a business needing some startup capital or temporary loan the bank will most definitely not help you. If, however, you are a salary earner wanting a credit card to pay for a luxury holiday you can’t really afford they will happily give it to you, adding some forced insurance premiums and a high monthly fee on top of the interest on the debt.
On DeFi borrowing is much more accessible and risk is purely determined on your available collateral, or how much assets you have available. There is no paperwork to complete either. Simply a smart contract that runs in the background enforced without any discrimination or judgement.
The repayment rates on the debt are much lower than traditional banks offering anything from 0.3% to 16% making it a much better value proposition.
Unfortunately I don’t have any debt to compare, but I do have a credit card that I use for my daily transactions. With no overdue payments, my interest earned for the month was R0.05 and fees totaled R53.55. This fee consists of a monthly fee of R40 with the rest forced insurance. If I made use of the credit facility this monthly cost of debt would be much higher.
The winner by a high margin when it comes to access to loans is DeFi. They win on both fees, options and accessibility and there simply is no comparison between the two.
3. Safe store of assets
This is a tricky one and more complex for what my current skill level permits in terms of internet security. So let’s stick to what I do know and what it means to the average user out there.
A bank is pretty safe and hacking a bank a low probability as most banks still run on mainframe systems (or did last time I checked) of which the people who work there don’t understand it all, let alone an outsider. If I loose my card or my wallet is stolen, I simply report it, pay a small penalty and it is resolved. When I forget my pin, I simply reset it. No problem.
In the DeFi world it’s not so easy. There’s no number you can call when you forget your pin and if you make the wrong payment by accident, no turning back. It’s also more probable that it will be hacked and when this happens, there’s no-one to call to correct the injustice. Simply count your losses and move on.
That being said, there are a lot of work being done to make this private key more ‘human’ and the concept of a guardian is now available. Personally, I’m quite happy taking responsibility for my own money knowing if something happens it is my mistake and not anyone else’s.
In terms of accessibility of assets, or getting it out of safe storage, it’s generally easy enough when held in a bank.
Unlucky me, however, have emigrated to another country and even though I had enough and very legal money available, struggled to get access to it in my new country due to bureaucracy and rules in my old country. I thought it would be a simple international transaction. It ended up taking weeks and a lot of paperwork.
I also don’t think that when the banks go bankrupt they are going to care much about me, so I would be inclined to risk the online fraud and managing my own private key over trusting a centralized bank with my assets. Especially when the cost vs the interest ratio often results in a negative growth for assets. After all, if I pay for a service I would like to get some!
DeFi is thus the winner purely because I trust mathematics and cryptography and open source code more than banks and government to treat me fairly.
On the downside, however, there are a lot of options to choose from and without sound advice from someone you trust, the chances of putting your money in a fraudulent crypto wallet is much higher than with the highly legislated bank industry. So from a comfort and ease point of view traditional banking wins but from a trust point of view DeFi wins.
Given the choice, I would choose DeFi.
4. Easily buy and sell goods
Even though banks are traditionally a store for money, it is also more commonly used for transacting in day-to-day life using a card or electronic payments. Fewer and fewer people use cash and many stores prefer cards over cash.
In South Africa even small vendors and business owners accept card payments for small expenses like coffee with services such as Yoco.
Buying on the internet is a little more complicated due to all the safety precautions but still relatively easy and streamlined.
Buying and selling goods on DeFi is much harder for someone new in the field. Where with traditional banks we’ve figured out a lot of the complexity of dealing with cross-border exchanges with services like PayPal or credit cards, in the DeFi world there are many, many, many more currencies and services to deal with and due to the legislative requirements of each country, there are different exchanges and wallets that supports different countries and currencies.
To complicate it even more, some currencies run on a totally different blockchain, or network, which is something no-one tells you because it’s so obvious for those in the field that it’s not worth mentioning. I, however, knew that Bitcoin was on a different blockchain than Ethereum, but I still don’t understand why my wallet allows me the option to buy and sell both and exchange between the two easily, but not when I attempt a transaction elsewhere. Or rather, I understand why this is the way it is, I don’t understand why no-one has solved it yet as it seems to be a very basic requirement and easy to solve problem.
I, for example, was advised to use MetaMask as one of the most trusted wallets. However, after signing up and ready to deposit money discovered that I’m not able to deposit funds as South African cards are not supported. I then signed up at Luno, just to discover their extremely high fees and lack of options and services, making them a really good choice for someone only interested in using it as a savings account, but a really bad choice for someone who wants to make use of all the DApps (decentralized web applications) available. But it is a frustrating and disappointing experience when you expect services that isn’t available.
To make it even more complicated, each DeFi service or product requires an exchange to a different token which can be extremely overwhelming and confusing for a new person to the DeFi world.
Personally, I would love a global Euro type of currency. One currency that means exactly the same everywhere.
Maybe in my next life… I do however feel there can be a slightly more simplified solution to the exchanging of tokens and collectables.
While in principle I really like the idea of gas and pay-per-use as it reduces spam and pays for the people who build the service, it is so variable that it’s simply not possible to have an exact amount in any transaction.
Coming from a lean and agile background, this means a lot of waste. You have to estimate the deposit made and always add a little to cover the gas. But you also need to take into consideration the volatility and constant fluctuation. For each transaction the same applies so you end up with small little piles of value everywhere that doesn’t really allow you to do anything sensibly.
The biggest disadvantage and most confusing aspect relating to daily transacting with crypto is that when you go and buy a bread, a normal person can not quickly do an exchange in their head to translate 0.00212422 bitcoin or Ethereum to a local currency.
When you travel and have to deal with exchanges it is easy enough to calculate a rounded up exchange between the two currencies without a calculator. R100 for example is roughly 5 US Dollars. It’s easy enough to then calculate $10 or $50.
I often also use something like the price of coffee as baseline to determine a relative value when I’m new in a country. For example, in South Africa a cup of coffee is about R30 or $1.50 US dollars. When I travel to the US and the average price is $3.50 for a cup of coffee, I roughly know to triple my rand estimates of value when deciding on how valuable something is to me. With crypto, I haven’t figured out a hack to relate the value back to my physical day-to-day life. Maybe it just takes time getting used to.
With the presentation of digital currencies usually with a lot of decimals, this is impossible (for the normal person) making it a guessing game and quite scary and risky for a new person. Add onto that the complexity in terms of gas fees I personally don’t see the benefit of transacting daily using crypto. It only makes sense for larger purchases done less frequently.
So even though I absolutely love the choices and access to financial services that DeFi offers, I choose traditional banks for their simplicity and accessibility when it comes to daily transactions right now.
I do, however, foresee that this will soon change with all the work being done and the rollout of Ethereum 2.0, which will make crypto a much better choice than traditional banks.
5. Globally earn and pay people
So I haven’t paid or earned crypto and can’t give an accurate opinion, but from what I do know DeFi is the clear winner here.
Except for the KYC red tape imposed by regulations, once you are on the blockchain via an exchange in your country, you’re ready to go and paying for bread at your local deli is exactly the same as paying someone in the Philippines. It thus makes much more sense using crypto for cross-border transactions and higher value transactions as the fees are more cost effective.
There are a few (though not many) crypto wallets and exchanges (I’m still to figure out the correct words as it is not used consistently and mean different things for different products) that offers credit cards that can be used as a regular credit card. One of the best options is Crypto.com which offers brilliant rewards for using your card and makes it a much better option than a traditional bank.
And the winner is….
With 3 points to decentralized banking and 2 points to traditional banks, DeFi wins, but with a small margin. The higher fees and complexity, however, still weighs lower than the pain of having to deal with a traditional bank in my opinion. I would rather struggle to figure out all the DApps than have to deal with a bank’s customer support.
Is it ready for mainstream adoption though?
I don’t think so. Not quite yet.
The learning curve is simply too high and there are still too few fully integrated options available.
The only two integrated banking solutions I could find (and is reputable) is Crypto.com and my personal favorite (right now) Argent.
Argent is one of the few apps that focus on usability and wins on ease of use, integration and fees (the gas fees are fully subsidized by Argent) and is by far the easiest to transact with.
Crypto wins purely because of their card offering which allows a user to replace their current bank, even though ideally we should do away with plastic totally and use our phones. I see no need for a plastic card when you already have more information that can be stored safely on your phone, however, the general public probably disagrees with me and feel safer with a physical card.
And the verdict is…
Definitely start exploring the world of DeFi. If you have extra money to play with, find a good wallet and start getting your feet wet because decentralized finance is here to stay!
It is getting better by the day and I predict that it will become the preferred choice sooner rather than later.
However, be responsible and do your due diligence. With great freedom comes great responsibility.
