Hisham Khan is the Co-founder and CEO of Aldrin, a developer of a DeFi ecosystem.
Now more than ever, traditional financial services are responding to the needs and demands of their customers, recognizing that the increasing adoption of crypto assets as an investment class, the normalization of digital currencies, and the highly challenging landscape in which they operate, both operationally and regulatory wise, makes their ability to adapt and innovate critical to its survival.
DeFi is an emerging technology that is set to revolutionize the TradFi (traditional finance) sector. The need for such a player to bring an open and transparent ecosystem that can be utilized by the masses is the key impetus behind DeFi and TradFi bridging discussions.
Banks recognize this sector as a major disruptor in their operating environment, but also increasingly as opportunities, with most major banks now forced to have divisions and teams devoted to cryptocurrency and digital asset strategy and innovation. What the DeFi world should focus on is the latter by finding ways to work together to integrate and educate.
Unlocking access: Banks partner with global crypto players
Recently, Goldman Sachs said that DeFi offers advantages over traditional finance, namely in providing access for underbanked populations and faster settlement for its users. Other advantages include its unique products, faster pace of innovation, higher transparency, more efficiency, and lower cost cross-border payments.
As their report points out, DeFi is a work in progress and faces hurdles from policymakers concerned about consumer protection, while at the same time helps fix issues that continue to plague TradFi: clunky services, inefficient use of data, and a lack of access to underserved communities.
Major US banks have already declared the crypto sector as “too large to ignore” that even when Bitcoin (BTC) was once denounced by banking executives, it has later enthusiastically embraced the blockchain technology behind it, the benefits of which cannot be ignored. In 2019, JPMorgan Chase became the first global bank to design a network to facilitate instantaneous payments using blockchain technology through the creation of JPM Coin, enabling 24/7 money movement which helps solve the common hurdles of traditional cross-border payments.
More recently, it extended its banking services to crypto exchanges including Coinbase and Gemini, indicating an increasing appetite of banks for crypto platforms. The trio of banking giants of JPMorgan, Goldman Sachs, and Morgan Stanley are also offering its wealth management clients access to crypto funds, proving that despite its ambivalence towards bitcoin, they are listening and responding to growing investor interest in digital currencies.
Another clear example of this is the recent announcement by the Commonwealth Bank (CBA), Australia’s largest financial services institution, that it has partnered with Gemini and Chainalysis to offer crypto services to its customers. This marks the first time an Australian bank is providing customers the ability to trade crypto assets directly through its app.
More importantly, CBA’s partnership with Gemini and Chainalysis sees the integration of DeFi 2.0 protocols into a TradFi platform via APIs, which connect blockchains to external systems. Dave Abner, Global Head of Business Development at Gemini, one of the largest regulated crypto exchanges and custodians, stated that these partnerships would set new standards for banks and financial platforms within the country, and across the globe.
Developments like these bring greater legitimacy to the crypto space and speak to the need for TradFi to innovate in a playing field filled with new players and business models.
The common conundrum of inclusivity through tech
Whilst the integration of centralized traditional financial platforms may raise controversy or alarm bells for some given DeFI aims to be decentralized, we should welcome these kinds of TradFi adoption developments. Ultimately, banks doing business with blockchain is a win for the DeFi world.
First, it is a nod to the proliferation of crypto and digital currencies among the mainstream population. Second, it introduces their users to crypto and DeFi concepts, protocols, and benefits that don’t yet exist in TradFi. In turn, TradFi brings to the table a regulated ecosystem, which DeFi has yet to achieve. By offering users regulated and safe access to DeFi it puts traditional financial services back in the driving seat, but at the same time makes DeFi more accessible and user-friendly.
DeFi’s lack of mainstream adoption highlights a paradoxical conundrum common to innovative technology: the desire to be inclusive and democratise accessibility through technology; yet, due to its technical nature, excessive use of niche terminology and jargon, complex platforms that require highly tech-savvy users, and mediocre user experience infrastructure, the barriers to entry for the mass market are high.
Through such an integration like the CBA example, it allows consumers to use more decentralized financial protocols from within centralized TradFi apps and interfaces that they may not otherwise have been exposed to had it not been on a platform that they are already familiar with.
We also continue to see the Fintech sector embrace crypto lending platforms, and the benefits that are transforming the Fintech industry can also translate to traditional financial institutions. This includes fintech giant Block (previously Square) planning a platform for DeFi services on the Bitcoin blockchain. Aave (AAVE), a DeFi lending platform, has also launched a protocol catered for institutional investors with strict know-your-customer (KYC) procedures and regulatory requirements on both the lending and borrowing sides. Outside of the banking system, companies like Paperchain are using DeFi to speed streaming payments to musicians by using invoices as collateral for DeFi loans.
Integrate to innovate: Incentives for TradFi
Efficiency, cost-effectiveness, and risk minimization are key considerations for TradFi when determining whether to adopt innovative technology. One clear benefit for the adoption of crypto and blockchain technology is greater security and lesser risk, as the use of cryptography renders transactions more irreversible and reduces cyber attack and money laundering risks, which have plagued banks in recent years.
The increase in frauds and scams targeting traditional financial institutions could also be mitigated by better-secured payment options offered by blockchain-based currency. In addition, the ability to conduct real-time transactions and settlements which can be facilitated by blockchain technology is of great importance to banks and the customers that they serve. All of these are clear incentives for TradFi to adopt new technologies into its systems and conquer new frontiers.
The longer-running trends of digitalization, globalization, and declining trust in centralized institutions only help to accelerate TradFi’s need to innovate and create synergies with DeFi, which in turn helps the DeFi movement. For this to advance, instead of viewing it from a purely competitive lens, we need to be ready to welcome adoption in order to maximize disruption in existing financial systems. While the stakes are high for the integration of TradFi and DeFi, there are obvious benefits for all, and it is an important bridge to build for the world of DeFi in its mission to foster greater inclusivity and accessibility for wealth generation.
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