What if I told you that there was a “bank” that allowed you to take out loans within seconds and didn’t ask for your name, address or any identifying information? What if I told you that this bank not only earned you 5% yield per year on your collateralised deposit but even substantially subsidised your loan interest rate?
What if I told you that irrespective of whether you were Malaysian, American or Haitian, you could buy synthetic versions of Apple stock or Oil futures for just a 0.3% fee and without needing to pay exorbitant brokerage fees or suffering the hassle of going through a local bank?
What if I told you that you could send money to your family thousands of kilometres away for only a few ringgit instead of having to pay a hefty remittance fee? And what if I told you that the transfer would go through not in two to three business days but in mere minutes, irrespective of whether it was RM50 or RM5 million?
And what if I told you that while you were doing this, your money couldn’t be frozen or withheld from you irrespective of where you were in the world or what time it was?
Best of all, what if I told you that you could earn 8% annual percentage yield (APY) on your ringgit instead of having it rot away in a fixed deposit which pays you a pathetic 0.01% APY while rising inflation wastes your money away?
These are not mere pipe dreams but a new emerging reality. Welcome to the exciting new world of crypto-based decentralised finance (DeFi).
To understand this new world, we need to examine the roots of the problem with the current financial system.
For more than a century now, banks have been the gatekeepers to economic prosperity for billions around the world. Without a bank account, you were essentially cut off from the economy. Most of us in Malaysia take it for granted but that’s only because we’re fortunate enough to have the economic might to have bank accounts.
However, this simply isn’t the case for the 1.7 billion people in the world who are still unbanked, largely because they can’t afford the minimum deposit necessary to even have a bank account. Compound that with the fact that many areas in the world also lack basic banking services and you have a situation where the poor find themselves not even having the financial ladder they need to pull themselves out of poverty.
The irony of the situation is, many of these unbanked already have basic but fully functional smartphones. However, since they don’t have the financial on-ramp that banks provide, they can’t be part of the modern economy.
This is one of the biggest issues that cryptocurrency and its spawn – decentralised finance – solve. In brief, decentralised finance is crypto-based finance that operates outside the realm of gatekeepers and centralised authorities such as banks, central banks, and even fintech companies such as Venmo and PayPal.
Let’s look at an example of how this newfangled industry works: With a crypto wallet smartphone app, an unbanked person can now receive cryptocurrencies or stablecoins (a cryptocurrency that is pegged to the US dollar, Euro or a host of other national currencies) for services rendered or products made.
If the society or community they live in collectively decides to accept payment in crypto, they will now be able to integrate into the modern economy and possibly work their way out of poverty. In addition, if they decide to hold Bitcoin, they can rest easy knowing that they are holding the best performing asset of the past decade – one that has been appreciating at a staggering 230% annually.
And if they don’t want to be holding a volatile asset like Bitcoin, they can always opt to denominate their currency in synthetic US dollars (USDT, USDC and the like). With this, they can perform something called yield farming where they can lend or stake the money they possess to earn anywhere from 2% to even 60% APY. Of course, the higher the yield, the higher the risk but they’ll have the tools necessary to make informed choices of their own.
Compare this to conventional banks which offer a paltry 0.01% APY on their deposits, offering higher yields for only their higher net worth clients and you can start to see why many would find the crypto economy irresistible.
But to make it crystal clear, let’s do some simple maths. Let’s say you have RM1,000 sitting in your bank. According to the Department of Statistics Malaysia, the annual inflation, as measured by the Consumer Price Index (CPI), rose to 4.7% year on year in April 2021.
Assuming this inflation rate continues into the future, this means that for every year that passes, your money loses 4.7% of its purchasing power. This might not seem like much but in 10 years, your RM1,000’s purchasing power reduces to RM631.73. Imagine thinking that you’re saving hard earned money only to see more than a third of it disappear into thin air in a mere 10 years – a situation that will get worse as time goes on. This is the sad reality we live in today.
However, let’s say you decide to put your RM1,000 into a decentralised finance platform such as Bancor, which today offers a solid 9.43% APY on the stablecoin USDC (a USD-pegged cryptocurrency). In this scenario, if you take the 9.43% you’ll be earning a year and subtract the rate at which you’re losing your purchasing power annually – 4.7% – you’ll end up with an APY of 4.73%.
In this scenario, in 10 years, your purchasing power should have increased to RM1,600.35, in theory at least. If you compare this with the scenario where you keep your money in the bank, the difference is night and day – instead of losing 37% of your wealth in 10 years, you’d be gaining 60% on it. This is but one of the many financial instruments that the world of crypto and decentralised finance opens up to people with even the smallest amount of capital.
How does it generate such good yields you ask? One major reason is the lack of infrastructure, employees and overheads. Maybank, Malaysia’s largest bank, has a market cap of RM93.5 billion, employs over 43,000 people and has more than 2,600 branches.
Aave – the largest decentralised “bank” in the world – has a market cap of RM12.5 billion, employs a grand total of 46 people and has zero branches. No wonder it provides such good yields.
Crypto and decentralised finance don’t discriminate based on wealth, social status, nationality, race, creed, or gender. All you need is a smartphone and a newfangled, inclusive, and barrier-free financial world opens up – one where rentseekers and gatekeepers are replaced by non-discriminatory computer code.
But don’t get too excited just yet, as it isn’t all rainbows and sunshine. And please don’t get me wrong. I am not recommending that you jump into this, as decentralised finance is currently the wild west of finance. If you decide to enter this territory, you should tread very, very carefully and only after considering all the pros and cons yourself.
Yes, the gains can be good and yes it is the most inclusive financial system the world has ever seen, but there are also dangers aplenty.
Almost every month, there is news of rug pulls and hacks that cost people millions of their hard earned money. To dabble in decentralised finance, you not only need to know the risks involved, you also need to do the research necessary to be educated on how to manoeuvre the space.
However, thanks to the popularity of decentralised “banks” and exchanges such as Aave, Bancor, Compound and Uniswap, there are now even crypto insurance companies such as Nexus Mutual that will insure your investment for a percentage of the yield you generate. This is an option for those wanting to invest in legitimate decentralised finance platforms without worrying too much about smart contract hacks or bugs that might drain away their hard-earned money.
Another drawback with decentralised finance platforms is that they only allow users to borrow less than the collateral they have in the system – called hypercollateralized loans. They still don’t have a mechanism to allow people to take out a loan to buy a house or a car but I’m sure that will come as the technology evolves and gets better.
If all this sounds exciting, keep in mind that this is only the beginning of the beginning. Crypto-based decentralised finance has only come into its own in the past two years. But in this short period of time, there is already a staggering RM192 billion locked in the ecosystem. I expect to see the nascent industry grow into a multi-trillion ringgit behemoth in the next decade.
If I were a banker, I’d be worried. Very worried.
The writer can be contacted at [email protected].
The views expressed are those of the writer and do not necessarily reflect those of FMT.