Even if you have never heard of it, DeFi (for decentralised finance) is very much part of the world we live in. In short: decentralised finance uses new technologies like blockchain that avoids traditional financial intermediaries like brokerages, exchanges, or banks to provide financial services. What are the benefits? Consumers and small businesses lose up to 3% of a transaction’s value when using a credit card. Remittance fees are up to 7%. It takes days to settle a transaction. DeFi can remove all of these inefficiencies.
But talking about DeFi almost requires learning a new language. A new paper by economists Cambell Harvey, Ashwin Ramachandran and Joey Santoro entitled ‘Defi and the Future of Finance’ provides a valuable synopsis of the building blocks of DeFi: blockchain, cryptocurrencies, smart contracts, oracles, stablecoins, and dApps. These tools allow for digital transactions, the use of fungible and nonfungible tokens (and the associated minting and burning of these coins), staking rewards, swaps, collateralised loans, and flash loans.
To make sense of this, I asked Marius Reitz, General Manager Africa at Luno, Africa’s leading cryptocurrency platform, to begin by explaining cryptocurrencies. ‘Over the past thousands of years, the way the world thinks about and uses money has changed many times. These changes occur when three things happen: our collective mindset changes, there is consumer demand for it, and there is technology available to support this change.’
‘Crypto is set to disrupt the world of money in the same way the internet disrupted everything. This includes 1) having money that can be moved around cheaper, faster and safer; 2) cutting out unnecessary intermediaries and accruing this value to consumers; 3) products and services that are completely interoperable with a good balance between transparency and privacy, with a much better user experience, and 4) a fair financial system with open and equal access for everyone.’
I counter. Many see crypto simply as a new asset class, and one that is highly volatile to boot. What are its other advantages?
‘One of the most compelling use cases for crypto is decentralised finance (DeFi). It creates the ability to access financial services like loans, savings, insurance, and trading without the need for an intermediary such as a bank or broker. With over 1.7 billion unbanked and underbanked individuals across the world who struggle to borrow money legitimately, the idea of connecting borrowers and lenders directly and eliminating the need for credit checks makes sense, given that digital assets can be collateralised instead.’
There is a high likelihood that DeFi will disrupt – and potentially even destroy – traditional banking. Yet some traditional banks are not resting on their laurels. I asked Ian Putter, a Standard Bank executive who heads up digital innovation, whether traditional banking and blockchain is even compatible?
‘We recognise the potential of blockchain on multiple fronts. We cannot ignore something that we believe will create a more efficient and transparent world. But banks still have an important role to play; banks bring trust, and trust is important when adopting any new technology. Standard Bank originally experimented by integrating private permissioned blockchains with legacy technology and collaborating with regulators, auditors, and blockchain experts to build solutions that was digestible for all stakeholders. From that wide collaboration, co-creation and rapid experimentation learning were possible to enable us to move to the next phase.’
The next phase will involve slower-moving stakeholders, like government. The South African Reserve Bank, in the year it is celebrating its centenary, announced a feasibility study into a central bank digital currency (or CBDC). I asked Putter his thoughts on this announcement.
‘Stablecoins are a more acceptable form of value that brings stable value with all the benefits of cryptocurrency’, explains Putter. ‘The Bank of England recently announced the approach they will follow to regulate stablecoins and now require feedback. This suggests to me that stablecoins will start to play a bigger role. The onboarding and offboarding from crypto to fiat will be revolutionised through the intro of CBDC’s. My vision for the future? CBDC’s will be universally acceptable legal tender. Crypto will be a different asset class, similar to shares. Equities, derivatives, and other financial instruments will be tokenised and will with the establishment of CDBC enable a seamless integrated digital settlement environment.’
This future might not be too far off. Luno already has more than 8 million users in more than 40 countries. Says Reitz: ‘We are focused on making it as safe and easy as possible for people to use their fiat currency to access cryptocurrencies such as Bitcoin and Ethereum. We try not to overcomplicate things and only offer a small selection of just six cryptocurrencies on our platform despite thousands of coins available globally. Cryptocurrencies are still in their infancy. We are building a bridge between the current financial system and a new future financial system.’
What might this future system look like?
‘The transition from the current to a new financial system will take time, so we envisage many hybrid products and services that bridge the gap as the industry evolves. In the not too distant future, e-commerce merchants will accept crypto directly with no intermediaries, saving billions of dollars globally in fees. Money transfer will become frictionless and transparent with no exchange fees. We have already started to see tokenized versions of local currencies in the form of stablecoins such as USDC, offering low volatility whilst ensuring cheap and fast transactions.’
‘Human progress is largely driven by collaboration and the consolidation of resources and money is no different. Truly decentralised and global cryptocurrencies can significantly increase trade, drive down the costs of remittance and e-commerce costs and expand GDPs by bringing millions of people into the financial system.’
‘Africa is one of if not the most promising region for the adoption of cryptocurrencies due to its unique combination of economic and demographic trends. Taking into account demographic and societal trends, with a fast-growing, young and mobile-native population, Africa is well-suited to the rapid adoption of cryptocurrencies.’