The Fintech Forecast is a series of guest articles published each month from thought leaders atACI Worldwide.
Author: Elise Thrale
Decentralised finance (DeFi), the open-source alternative to heavily regulated and centralised finance systems, is rapidly gaining traction. As an initial use case, DeFi has proven itself to be an enabler of innovation for speculative trading in cryptocurrency. Bitcoin, among other forms of crypto, has now matured into a reserved asset, and overtook the market cap of Apple in April 2021. The question is, how much have new innovations been inspired by traditional banking when compared to the various DeFi related innovations and how the traditional centralised finance industry can mirror or augment the benefits of DeFi to foster conjugal innovation? I have spoken with ACIs CBDC expert, Francis Souza to help answer these questions.
How is DeFi supercharging innovation?
The growth of crypto is creating an alternate economy that is invisible to the traditional financial universe. Blockchain has introduced the highly secure and encrypted distributed ledger technology (DLT) that powers DeFi applications. The aim is to democratise the movement of money by replacing the existing payments methods of centralised entities including central banks, while making the transactions anonymous, instant, and extremely affordable.
While cryptocurrency has seen huge growth, they are known to be unstable. This is where Stablecoins come in linked with fiat currencies such as the U.S. dollar. They dont experience fluctuations seen by cryptocurrencies such as the Bitcoin and Ethereum. Stablecoins could pose a greater threat to the sovereignty of central banks in the future. Once they achieve ubiquity worldwide, Stablecoins have the ability of creating a new world order.
The advent of DLT has brought another wave of innovation, disrupting global finance markets. On a global scale, there is no barrier created by the central banks for processing cross-border P2P payments that is DeFi today, enables cross-border marketplaces where cryptocurrencies can be transacted freely without a central authority.
In this way public blockchains, which makes transaction data visible to the public and yet secure through encryption and aliases, can be leveraged for newer innovations in the cross-border marketplaces through active investment strategies. In addition to crypto and DeFi, central bank digital currencies and Stablecoins (permissioned DLT) and to a small extent, permissionless DeFi platforms) are now being utilised for several other industry applications for example KYC, AML and cross-border payments.
What is the answer from traditional banks to DeFi?
As the traditional universe looks on to the growing, inter-connected, alternate, decentralised universe or the metaverse in a single word as we call it today, this could fast-track innovations for the central banks in the low value payments space as well as the high value payments space for real-time cross-border payments.
The traditional banking sector i.e., the central banks and the commercial banks, can learn from DeFi by encouraging the adoption of Central Bank Digital Currencies (CBDCs). We are already seeing this happening. Nigeria has already released its CBDC, the eNaira, Canada is piloting its version of digital currency, and the UK is already assessing the possibility of a Britcoin.
CBDC has the potential to bolster financial inclusion in largely unbanked countries and foster sovereign independence for small countries with weaker currencies. It has huge potential to promote economic growth, resilience, transparency, and it is an effective tool for the central banks to apply real-time monetary policies in the economy. In regions such as Europe, a CBDC transacting at zero or affordable fees, depending on the type of payments transaction, could rival huge network processors such as Visa and Mastercard, pushing the financial services industry to the edge of uncomfortable disruption where innovation is the key to survival.
Disrupting the status quo
DeFi is silently but increasingly levelling the playing field for global innovation, and the time is now for banks and financial institutions to think carefully about their next move. The financial services industry is no exception to disruptors making changes to the status quo. We have seen a paradigm shift over the last two decades, with challenger banks and fintech entering the market, challenging incumbent players for market share and customer loyalty. This has led to a boom in new services from the banks and more flexibility for customers in their payments method of choice.
Looking forward, banks need to establish a comprehensive decentralised finance business strategy across all the payment lines, ensuring they can continue to add value for customers with new payment types such as CBDCs as they enter the new payments landscape in a meaningful way. However, CBDCs will require a large amount of consideration and constant governance. They will face adoption and acceptance challenges once launched, with various governments devising different policies towards how the CBDCs will work in their economy. It would be highly optimistic to expect CBDCs to boom in the short term.