DeFi may have an important impact on how banks operate in the future and has the potential to change the structure of financial systems at the macroeconomic level. DeFi is an umbrella term for a financial system that functions without intermediaries such as banks, insurances or clearinghouses. It is operated solely by the power of smart contracts. DeFi applications serve the role of traditional finance (CeFi) in a universal and transparent manner.
The idea of a new financial system is a part of the blockchain space and has been since its inception. Since 2020, DeFi has been growing at a rapid pace and today, billions of USD have been put into the ecosystem. The growth is predominantly led by applications (protocols) built on the Ethereum blockchain.
The primary business model of commercial banks is to accept deposits and give loans to clients. Borrowing and lending form the cornerstone of effective financial systems since the holders of the funds receive an incentive to provide liquidity to the markets. In exchange they earn a return on assets that would otherwise be unproductive. DeFi protocols serve to enable unknown participants to both lend and borrow resources on a wider scale without involving intermediaries.
These applications bring lenders and borrowers together and determine interest rates automatically according to supply and demand. Anyone can engage with these protocols at any time regardless of location or amount. The recent hype around DeFi apps is driven by the growth of lending and borrowing protocols. By contrast, traditional finance loans in DeFi are commonly secured by overcollateralization. Companies including Aave are working on permitting uncollateralized loans akin to traditional finance.
Investment banks and issuers of financial instruments
The business model of investment banks typically involves the advisory on financial transactions. The trading or creating of complex financial products and management of assets fall into the sector of investment banks. DeFi protocols offer similar products. For example: Synthetix is a derivative issuance protocol, which enables decentralized creation and trading of derivatives on assets including stocks, currencies, and commodities. The decentralized asset management for cryptocurrency is evolving. As an example, Yearn Finance is an autonomous protocol, and searches for their best yields in the DeFi space while simultaneously investing for its users.
Exchanges serve to organize the trading of different assets. These include stocks or foreign currencies that exist between two or more market participants. The exchange of crypto currency against fiat money (for example the US dollar) can be credited to CeFi. Regular holders of cryptocurrencies must use exchanges like Binance or Coinbase (centralized organizations) to swap a unit of cryptocurrency against another.
With the new emergence of decentralized exchanges (DEX), holders of crypto don’t need to leave the crypto space to swap their tokens. One prime example of a DEX is Uniswap. DEX are compiled of smart contracts that hold liquidity reserves and function according to defined pricing mechanisms. The automated liquidity protocols play an important role in developing an independent decentralized ecosystem without any CeFi intermediaries.
The most important function of insurance is to smooth out risks and bring security for market participants. For example, one model of decentralized insurance is Nexus Mutual. This offers insurances that cover bugs in smart contracts. Everything based on smart contracts in DeFi—especially the exposure in the code of smart contracts—-creates a higher risk for DeFi users. Decentralized insurances are still in origin stages. It is anticipated that larger and more sophisticated insurance models have the potential to emerge in the DeFi space.
Stablecoins are based on blockchain protocols that have the principle of price stability encoded so they fulfill the function of a reserve currency. The introduction of stablecoins set the foundation of the functioning decentralized financial system. It enables participants to engage with each other without the underlying risk of price volatility.
There are three options for how a crypto can reach price stability:
- Stablecoins can reach high degrees of price stability by pegging a currency to other assets. For example, for each issued unit of USD coin, a real US dollar is held in reserve.
- DeFi perspective: another interesting approach is the issuance of stablecoins by using other crypto as collateral. The central protocol for the DeFi ecosystem is Maker DAO. The crypto DAI is backed by other cryptos and ensures with its algorithm that the value of 1 DAI is around 1 US Dollar.
- The experimental approach aims to reach price stability without use of collaterals. For example, protocol Ampleforth automatically adjusts the supply of token in accordance with demand.
How Nimbus might integrate itself with banking
Nimbus is a DAO-governed ecosystem of dApps that offers 16 revenue streams for users based on IPO participation, lending, crypto-trading, and more. So far Nimbus has 50,000 users and continues to grow. The key offerings to Nimbus stakeholders are that it has 16 earning strategies for users in one platform. It has unique access to IPOs, startup financing, and other opportunities, now available in crypto. So far it has two tokens providing access to it all: NBU and GNBU. Nimbus could integrate further with banking as it continues to expand its user base. With much to offer its stakeholders including special access to its IPO offering, there are many incentives for users and stakeholders to sign up for Nimbus and become further integrated. As crypto trading becomes more popular as a revenue stream for users, Nimbus will continue to become further entwined with the banking industry as a for profit entity. With options to lend, borrow, and trade for crypto users, Nimbus is rapidly expanding its user base and will likely see exponential growth in the coming future. One thing is for sure, Nimbus will continue to integrate further as the ecosystem expands and develops.
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