We’re Turning to DeFi Because the Financial System is Failing Us
DeFi’s meteoric rise shows the world’s need for new financial instruments in an inflationary environment
The state of the world is pretty bleak from a personal finance perspective.
We know that the Federal Reserve is printing billions of dollars in order to keep the U.S. economy afloat during the COVID-induced recession (author’s note: this is obviously a gross oversimplification).
Because of this increase in the money supply — coupled with the low interest rate environment, the Fed has revised their stance on annual inflation, allowing it to go over the 2% target.
So our money is literally losing its value as it sits in our pockets — and at a faster-than-normal pace.
So what can we do?
Maybe we can put our money in a high-yield savings accounts? Except the best savings account in the country right now only gives us 0.9%.
So let’s do the math. If the interest rate is 0.9% and the inflation rate is over 2%, that means our money is losing at least 1.1% of its value every year.
Meaning if you had $10,000 in your savings account, you would effectively be losing $110 every year by the nature of it just sitting in a bank.
Can we prevent this from happening?
Well, we can invest our money in a series of financial instruments; we can purchase bonds, individual stocks, and ETFs for a decent annual return.
Only, we run into two problems:
- Bond yields absolutely suck right now. The U.S. 10-Year Treasury Note yield is currently ~0.69%, as of the writing of this article. So literally worse than a savings account. You can expect to lose money after inflation if you purchase bonds.
- Equities provide a decent return, but they’re incredibly volatile right now. Not everyone has the risk appetite to participate in the stock market, and even traditionally “safe” investments are not shielded from the historical volatility.
And this problem is only exacerbated for those without bank and brokerage accounts.
The Fed estimates that there are 55 million unbanked or underbanked adult Americans, roughly 22% of U.S. households.
Because of anachronistic underwriting frameworks, they are excluded from the financial system and can’t get access to bank accounts to save or brokerage accounts to invest.
These Americans don’t have the ability to protect their hard-earned money from the rising inflation. Every year, their money will lose 2% of its value.
And it’s even more bleak when we open the aperture and look beyond the United States. The World Bank estimates that nearly 2 billion adults are unbanked worldwide. And many of them likely live in countries with similar monetary policies that will devalue their native currencies in favor of economic stimulus.
In fact, we’ve seen countries have that have destroyed the livelihoods of their citizens because of unstable financial systems and rampant inflation: Venezuela and Zimbabwe come to mind, with Turkey and Lebanon on that trajectory as well. Citizens are stuck holding their native currencies while their lives’ work rapidly loses its worth.
Our money is losing its value every day—thanks to decisions made by central bankers who we didn’t even elect. Our financial institutions have screwed us, and a significant chunk of us can do nothing to fight it.
Except now we can fight back
Nearly 2 billion adults in the world are unbanked, yet the World Bank reports that more than two-thirds of those adults own a mobile phone.
And in today’s world, a smartphone is all you need in order to get access to financial services.
You don’t need a good credit score.
You don’t need a bank.
You don’t even need to live in a country.
All you need is a smartphone and the Internet— thanks to DeFi.
Decentralized finance (DeFi) is a rising movement in crypto. In layperson terms, DeFi refers to financial products built on blockchain technology.
DeFi instruments are just code — essentially automated contracts built on decentralized architecture, meaning that they can exist without the need for banks and even governments.
Author’s note: Too much jargon? Check out an easy primer on crypto here.
More importantly, DeFi has the lofty vision of creating an alternative financial industry that is open to anyone, a huge departure from today’s closed financial system.
DeFi has created savings and checking accounts, loans, asset trading, and other financial instruments that no one can be excluded from.
All you need is a mobile phone.
Since this time last year, DeFi has experienced unprecedented growth from ~$500M locked in DeFi products to now ~$9B locked (locked meaning “being used in DeFi apps”), with most of the growth coming in the past few months.
And this meteoric rise makes sense when you think about the monetary policies that central banks have put in place.
Instead of watching inflation slowly destroy the value of our money, we can proactively create new value by participating in this new decentralized financial movement.
Why should we participate in DeFi?
Three reasons (one tactical and two philosophical):
- It gives us a way to fight back against inflation and create wealth
- It democratizes finance and spreads the wealth to everyday people
- It ushers in a new era of open access to financial services for everyone
First and foremost, DeFi products give us a better annual return than any traditional financial product.
Instead of the meager 0.5-0.9% that bonds and saving accounts give us, we can earn at least 3% APY (on U.S. dollar stablecoins) on DeFi lending/borrowing apps like Compound.
Riskier financial instruments like Yearn can even net us ~100% APY.
Secondly and more philosophically, DeFi democratizes finance.
Today, banks are the only entities allowed to underwrite loans, and brokerage firms are the only entities allowed to offer trading. These companies take a profit off of every dollar that we borrow and every trade that we make.
In contrast, DeFi products are literally code that are written by and governed by everyday people. Every penny of profit made from these products is distributed to all the individuals who built and operate the code.
For example, Uniswap is a decentralized exchange that is, in part, maintained by liquidity pools that are supplied by everyday people. When an exchange is executed on Uniswap, the trading fees are proportionally distributed to the providers of the liquidity (vs. the trading fees going to TD Ameritrade, for example, in a traditional exchange).
Lastly, DeFi opens up unprecedented access to financial instruments for everyone.
For those who never qualified for a bank account, they can now have a savings product (e.g., staking with stablecoins), so their money can increase in value and overcome inflation. They can now borrow money (e.g., on Compound) when their savings get a bit tight.
For those who were never approved for a brokerage account, they can now have access to appreciating assets (e.g., crypto, digital gold) so that they can grow their wealth.
For those in countries with failing currencies, they can now have a safe, stable store-of-value vehicle (e.g., U.S. dollar stablecoin) so that they can retain their livelihoods.
Interested in DeFi?
That’s great! I’d love for you to join the movement toward open finance.
I think the first step is to get a foundational understanding of crypto and DeFi.
Some resources that I found helpful (as a visual learner):
Also know that, as a new technology, DeFi has associated risks:
- DeFi is code, and code can have bugs. A severe enough bug in the code can cause a loss of money.
- DeFi uses and leverages cryptocurrencies in many operations. Crypto is a volatile asset to hold, which may affect the integrity of some DeFi apps.
The next step is to get involved! Learn how to:
- Get crypto. I recommend starting off with a U.S. dollar stablecoin like USDC [video tutorial]
- Get a wallet (to hold your money). I recommend MetaMask because it’s an easy-to-use web browser plug-in. Coinbase Wallet is a great mobile wallet, if you prefer to use iOS/Android.
- Transfer your crypto into your wallet
- Get involved in DeFi apps (to start making money). Choose if you want to earn interest, borrow, trade, etc.
Right now, it’s a bit complex to get started because we’re recreating financial products that we used to have bundled together with a bank. It’ll get easier as time goes on.
For me, DeFi is not about replacing financial institutions, but about giving people the power to choose their own path toward financial well-being.
When a currency is failing its responsibility as a store-of-value, we should have the choice to pick another one.
When financial institutions are preventing a significant chunk of the population from joining, we should have the choice to pick other ones.
When a financial system fails to protect the livelihoods of its citizens, we should have the choice to pick another one.
We shouldn’t be beholden to any one system. We shouldn’t have to be punished for its faults and shortcomings.
With DeFi, we now have a choice.
Disclaimer: This article was made for entertainment purposes and should not be taken as investment advice.