Decentralized finance has long been promoted as a means of lowering transaction costs and overheads in the banking industry, making lenders leaner while fattening their margins. But less attention has been paid to how those cost savings might translate into benefits — or risks — for bank customers.
Now, however, lower costs appear to be supporting the emergence of savings products that bear interest at rates undreamt of by customers who for years have seen their cash savings stagnate in accounts that pay little or even no interest.
So-called challenger banks and fintech start-ups — quick to take advantage of DeFi’s phenomenal growth last year to offer loans and payment products more cheaply than established lenders — are building the borrowing side of their businesses by offering savings interest rates in the mid- to high percentage point range.
Tony Thompson, a co-founder of UK-based fintech start-up Fluma, says the savings interest rates paid by traditional banks to their customers are miserly, and he decries what he characterizes as a lack of transparency around returns to savers.
“[Traditional banks] trade your savings … and if they’re doing that and still only offering 0.15%, personally, I think that’s unfair,” Thompson says. “People are out there working hard for their money and they need a real product, a real system that is actually going to make money in a very transparent way.”
Leveraging DeFi, Fluma is among the new crop of lenders beginning to offer rates of 5% or higher on both fiat and cryptocurrency deposits.
Crypto.com, for instance, offers a savings product for its own cryptocurrency, Crypto.org Coin, paying interest at an annual rate of 5%.
Canada-headquartered, Africa-focused challenger bank Be Mobile offers a savings product available in 22 fiat currencies that bears interest at the rate of 5% per annum.
BlockFi.com offers similar accounts to Crypto.com across a range of coins, including stablecoin Gemini, on which it pays an interest rate of 8.6% a year.
And Fluma, set to launch in June, will pay customers an annual percentage yield of up to 7% on a Bitcoin savings account.
Thompson said he was confident that Fluma would be able consistently to deliver the high returns it promises its customers through partnerships with crypto exchanges such as Coinbase and Kraken. He even suggested that it could pay interest at rates as high as 9% if its business grew strongly.
Mysterious model
Yet even rates around the 5% mark raises eyebrows among some market observers. After all, how are these banking industry newcomers able to fund returns to investors that so massively outstrip those offered by traditional lenders?
Lenders in the DeFi space are tight-lipped about how they manage to offer such generous rates of interest. Cedric Jeannot, a co-founder of Be Mobile, says only that the Africa-targeted bank converts savers’ fiat currencies into stablecoins and securities that it manages as assets to support its interest payments — much in the way a traditional lender uses deposits to generate returns for itself and its customers. Others among the new breed of lenders have even less to say about the details of their business models.
This has led industry watchers to speculate as to how such high yields are feasible. Government bonds and term deposits offer low interest rates because of the relative certainty of a return on investment. So, they ask, how is it that challenger banks are able to guarantee returns in the long run while offering such high rates ?
“It seems the majority of the revenue source [for these challenger banks] is the crypto assets ecosystem with [its] meteoric price increases,” says Abdullah Tansel, a professor of information systems and statistics at the City University of New York. “How much of this revenue has a sound basis is a very relevant question. Higher rates are not sustainable in the long run unless there is a revenue source to support them — any efficient market wouldn’t allow it.”
As the crypto market’s supercharged bull run seems to have ended — at least for now — uncertainties may be emerging around the viability of highly leveraged DeFi models. Yet Tansel doesn’t believe the crypto crunch will have a lasting significant impact on DeFi’s growth.
“There may be a crisis in the system, and people may become more risk averse, and they don’t want to experiment with these platforms, so they may lose a little momentum. But eventually I think they will come back,” he says.
Despite the uncertainties, the appeal of traditional lenders’ offerings — which typically top out at 0.3% per annum in most countries — appears persistently limited by comparison with the rates challenger banks are touting.
DeFi’s mainstream momentum
In addition to customers’ growing interest rate expectations, another dynamic contributing to pressure on traditional lenders to incorporate DeFi into their business models is its sheer proliferation.
Yet challenges still remain before widespread institutional adoption of DeFi methodology becomes possible. Compliance with know-your-customer and anti-money laundering regulations, for instance, can be a challenge to enforce in DeFi, whose origins lie precisely in seeking to avoid strictures imposed by centralized authorities.
An additional hurdle is what Maurizio Raffone, CFO of Credify, which offers enterprise products for embedded finance, refers to as the “philosophical challenge” of institutional adoption.
“[That is] going to business and essentially unbundling services and trying to evolve the business model, which probably means going from 100,000 employees to maybe 5,000,” Raffone says. “These are fairly substantial things that the CEOs of big banks should be thinking about.”
And despite the apparent and potential advantages enjoyed by challenger banks and their customers, traditional lenders continue to occupy the commanding heights of the finance industry, thanks to their longstanding regulatory compliance and a number of other factors.
Brand recognition, for instance, is hard won and built over time. Translating into trust among consumers and commercial customers is something that newcomers to the financial services market must cultivate.
Traditional banks also have deep experience of risk management in established markets that new industry players may struggle to match as they learn how to navigate new and developing digital asset classes.
These resources allow traditional banks to prevail over their would-be challengers when it comes to offering certain financial products, such as mortgages or lending facilities, that require rigorous analysis of underlying risk.
Raffone says that developing DeFi to the extent that challenger players can begin to offer these types of products requires further innovation, possibly including the integration of AI.
“Distributed ledger technology by itself is not going to do it,” he says. “Regardless of how smart the protocols become and how smart the business model overlay becomes, I think you need other elements in there to create some of the higher-margin products that still sit with banks.”
Yet despite the clear differences between traditional banking and DeFi, signs of increasing convergence are not difficult to find. Doug Schwenk, chairman of Digital Asset Research, which provides crypto market analysis to institutional investors, says large finance sector players have expressed growing interest in DeFi in recent years.
Schwenk says Digital Asset Research’s clients have been attracted by the high prices attained by certain digital assets and by new DeFi functionalities and uses, and are seeking to learn how to incorporate them into their business models.
He says the discourse around DeFi often fails to recognize the advances taking place in the field and efforts to tackle the many challenges involved in achieving critical mass adoption.
“[There is a] tremendous amount of innovation and intellectual energy being devoted to the DeFi space to try to solve the problems,” says Schwenk. “There’s a tremendous amount of change being prepared, and innovation and experimentation that’s going to lead to some really interesting outcomes in the next one to five years as these experiments turn into real products that people can use.”
For customers of traditional banks who may be growing restless as their rates of return remain stubbornly low, such changes probably cannot come soon enough.
