Introduction to DeFi
Banking the Unbanked with DeFi
Decentralized finance (DeFi) has seen substantial growth in terms of popularity and monetary value locked in 2020. Along with it came an explosion of new financial products built on the blockchain. While DeFi is geared towards disrupting the existing financial system and its intermediaries, the question remains: can decentralized finance play a role in increasing financial inclusion?
Before we start, let’s have a look at what DeFi is before we explore how it can contribute towards banking the unbanked.
What Is DeFi?
Decentralized finance (DeFi) can be best understood as an umbrella term for a wide variety of financial products and applications powered by blockchain technology. Drawing from the idea of blockchain, DeFi seeks to replace centralized financial products with public, decentralized solutions built on blockchain networks. Rather than depending on (oftentimes costly) brokerages, gatekeepers, and middlemen such as banks, DeFi seeks to establish a decentralized financial system in which financial products are available publicly and are open for anyone to use.
By utilizing distributed lecher technologies, DeFi products enable parties to interact with each other peer-to-peer by using smart contracts and other software-based middlemen instead of centralized companies or institutions. In many cases, DeFi products utilize a variety of technologies and protocols to accomplish the aim of decentralization. As such, a DeFi system may use a mix of blockchain technology, smart contracts, open-source software, and proprietary software.
Regardless of the technology or platform used, DeFi systems are designed to remove intermediaries between transacting parties.
Decentralized Dinance (DeFi) Definition, Investopedia
The challenge of banking the unbanked
While it is apparent that DeFi has the potential to fundamentally disrupt traditional finance, it is interesting to ask how it can contribute towards increasing financial inclusion.
Why are people unbanked or underbanked in the first place?
While it may seem almost impossible to manage your life without a credit card or bank account, a large percentage of people living in developing countries do not have access to the most basic financial services. Estimates highlight that there are more than 2 billion people who do not have access to the services of financial organizations such as banks. As a result of having no chance of participating in the financial system, the unbanked are unable to safely save money, which introduces a wide variety of issues on a personal and societal level.
Systemic issues within the banking industry are predominantly responsible for why people are unable to gain access to financial services. Banks are profit-oriented, centralized institutions and therefore have a financial incentive to include all those who can afford their services while remaining exclusive to those who cannot. Within the traditional banking industry, it is considered unlucrative and risky to bank the unbanked as they are unable to gain a profit from it.
Financial institutions are not altruistic and seek to maximize returns. For this reason, is not likely that innovations within the area of financial inclusion will ever originate from this sector.
How DeFi helps to bank the unbanked
Decentralized finance provides an attractive value proposition: by cutting out the unnecessary middlemen (such as banks) and by utilizing modern blockchain technology, it is able to facilitate transactions between two parties in a safe and inexpensive manner. While traditional finance has set in place considerable entry barriers (such as costly fee structures and the need for identity confirmation), DeFi is accessible to all those with a compatible smartphone. Thanks to the growing adoption of DeFi, the unbanked can gain access to services that would normally have required them to open a bank account.
Quite contrary to the traditional financial system, DeFi can be used by anyone – oftentimes without the need for KYC and/or a bank account. By establishing transparent rules that are observed by smart contracts, new opportunities for the unbanked are starting to open themselves up. Aside from simply depositing money and saving it for future purposes, DeFi products can be used to replace costly international wire transfers.
Some approaches within the area of DeFi, such as Eco, charge no fees and are even able to pay interest on the deposited money and provide a cashback for every purchase a customer makes. The way Eco accomplishes this is by excluding costly middlemen and by forwarding the profits of this to its users.
DeFi is establishing a more transparent, more efficient, and less expensive system. By utilizing distributed lecher technologies, it is able to conduct transactions in a considerably cheaper manner than traditional, centralized institutions are able to. While it remains to be seen how DeFi can gain widespread adoption amongst the unbanked, it offers a use case to all those that are excluded from financial services. As such, it is a technology that can potentially have a large impact on the lives of the unbanked and should therefore be taken into consideration to increase financial inclusion.