Decentralized Financial System

The decentralized financial system already offers better banking in many respects, and yet most people are not yet confident enough to make the switch.

From my own experience I know how confusing the whole crypto world can be at the beginning. It is a completely new system and just like the internet and its possibilities were hardly understood by anyone at the beginning, the blockchain and Bitcoin are still elusive for many. Why is that? Well Blockchain is a paradigm shift from centralized to decentralized systems. And this is what is causing confusion around the world: in the existing system, a central party is inherently linked to the exchange of value.

We have become accustomed to abdicating responsibility in many matters and relying on centralized parties. That’s why I’m trying here to give as simple an overview as possible and to show the possibilities of decentralized systems. However, I am not an expert but “only” a user and through this blog article I would like to encourage others to get involved with Bitcoin, blockchain technology and crypto banking themselves.

In the same way that the Internet allowed people to share information around the world, the Blockchain allows us to securely exchange value around the world instantly. This is without intermediaries (e.g., banks) and counterparties that need to be trusted for transactions. A wide variety of ecosystems run on blockchains, which will gradually replace existing systems because they are cheaper, more transparent and more efficient. The most important areas include financial services (“be your own bank”), electronic administrative systems (e.g., identities, voting, patient dossiers), games, and property (e.g., land ownership).

The decentralized financial services (DeFi) already show what we can expect in the future. A world in which not a few, large companies and banks manage and control data and funds, but where we ourselves have responsibility and control over them. This in turn implies that we are ready to take full responsibility for ourselves. There is no customer hotline in the blockchain world.

Not to mention that about 1.7 billion people do not have access to the financial system but can use Blockchain-based financial services through their smartphones. Bill Gates predicted back in the 90s, “The world needs banking but it does not need banks.” The way to a decentralized financial system is through decentralized apps (DApps). These apps already offer what only banks could offer until now, and for a fraction of the normal costs.

Centralized, decentralized or both?

Our political system as well as our financial system are built on ancient systems, which makes it difficult to change to a new, modern system. These outdated systems hardly fit our times and slow down processes unnecessarily. As humans, we think in rather short time spans and see the given as unchangeable. Yet new concepts are entirely possible.

As already in the tobacco industry or currently in the car industry, people try to keep the outdated system running as long as possible and fight the new one. Once the masses understand what Bitcoin and blockchain technology really offer society, there will be no stopping them.

Just as tobacco companies are now producing e-cigarettes or traditional carmakers are trying to catch up in e-mobility, central banks and states themselves will enter the market with their own cryptocurrencies. Each country will digitize its currency, and paper money and coins will increasingly disappear. The problem with this is that FIAT money and gold have been the only ways to really have control over one’s finances until now.

This is where decentralization via a blockchain comes into play, making digital but pseudonymous and non-centrally controlled financial services and contracts possible. One system does not exclude the other, and so there will probably be a coexistence of both systems for the time being. However, the traditional banks will have to dress warmly, because customers will go where it is easier and they get more for their money.

For their part, the dApps in the DeFi ecosystem should make sure that their services become even more user-friendly to facilitate access.

As always in the history of mankind, it takes not only “talk” but also “execution” to trigger disruption. Let’s take Tesla as an example – everyone knows that electric cars are the future. However, for a long time it was very difficult to implement this vision and make it suitable for the masses. Currently, Tesla is the most valuable car manufacturer in the world because they have made an existing product simpler and more efficient. And this is exactly what the crypto world needs. Projects that bring the benefits of decentralized applications to average Joes in a simple way and without cryptographic gobbledygook. These hurdles will be overcome and there will be more and more such projects.

Some Basics for Understanding

BitcoinSince the 1990s, the Cypherpunk movement has been trying to create a digital equivalent to cash using cryptographic methods.Bitcoin was created as a response to the financial crash of 2008. It was clear to the developers and mathematicians around the unknown Bitcoin inventor Satoshi Nakamoto that the existing system is at its end, and endless mountains of debt are being showered with newly printed money. It is obvious that this system is broken and we desperately need a contemporary solution. Bitcoin is the first and only truly decentralized cryptocurrency. Like gold, it is limited in supply (21 million) and is digitally mined.

There is no CEO, no one controls Bitcoin or can shut it down or hack it. So there is also no customer service to help you reverse a transaction that was transferred incorrectly. Since you are your own bank, you also have to be careful with that power. Bitcoin is not to be understood as an everyday payment currency but rather as digital gold. The blockchain on which Bitcoin runs is quite slow. For fast payments, there are special blockchains and cryptocurrencies like those of Ethereum (ETH) or Cardano (ADA).

The currencies of these projects are called Alternative Coins (Altcoins). They offer extended possibilities of decentralized technology, such as the conclusion of digital contracts and insurances (e.g. there is an insurance by AXA, which reimburses flight delays with Smart Contracts) or the payment of wages. In the future, social platforms, patient data and the entire e-government will probably also be handled via a blockchain.

Administrative processes can be simplified via a blockchain. Databases for companies, vehicles, land or real estate can be kept in real time, transparent and tamper-proof for everyone.

In addition to Altcoins, there are Stable Coins that are backed by FIAT or hard assets and always hold the dollar value. These Stable Coins are effectively the neutral zone in the DeFi space. They can be held to generate interest or to avoid price fluctuations of Bitcoins or Altcoins. Stable Coins are actually nothing more than the digital representation of a FIAT currency (e.g. CHF) in the form of a cryptographic token. Bitcoin is bought via a digital bank account, the so-called wallet.

This is linked to a credit card or paid directly from the bank account. Wallets like Coinbase, Celsius, Gemini or Kraken are relatively secure and easy to use. However, there is always a residual risk if cryptocurrencies are not stored in one’s own wallet but on third-party platforms. Within the crypto ecosystem there are hardly any fees. Millions can be moved securely around the world for a few centimes without any company, government or any form of authority being able to influence it.

Advantages of Cryptocurrencies and DeFi Services

There are various reasons that lead one into the world of Bitcoin Economy: Some see mainly the profit of the most successful asset in the world for years, others are looking for an alternative for gold with the advantages of digitality, still others want control over their own assets without a third party involved, while some are interested in the aspect , that even large sums can be sent quickly around the world peer to peer at any time without fees. The fact that Bitcoin is deflationary, unlike FIAT money, is also important. It means that its purchasing power increases over time since it cannot be printed at will by central banks.

Those who find the currently still quite volatile Bitcoin too risky have the option to switch to a stable cryptocurrency (so-called stablecoins) such as the USDC, GUSD or DAI. They always maintain a stable level and can even generate interest on an appropriate platform. Almost everything that a bank offers today is also available in the DeFi area, only there it is as it should be: without third parties who take opaque fees and process payments via outdated and very slow systems like SWIFT, where you sometimes wait six days until an international payment arrives.

So even now, at a fairly early stage of this new technology, there are quite a few advantages and tools that work and have good usability. Nevertheless, ease of access must be one of the top priorities to convince a broad mass of users.

Disadvantages of cryptocurrencies and decentralized financial services

As mentioned several times in this article, you have to be ready to take full responsibility. If you have your cryptocurrencies on a wallet, you have to take care of the private keys; if they are gone, so is the cryptocurrency. If you do not entrust your money to banks or a wallet but to companies like a DeFi financial service provider, you bear an additional risk. There are large companies with a trustworthy basis and good security concepts, but there are also less trustworthy providers.

The additional security measures often also worsen usability. The whole crypto world is still at the beginning and many solutions are still a big experiment for which the final foundation has to be found first: e.g. the consensus algorithm is still very much in the early stages (proof-of-work vs. proof-of-stake). There are generic drawbacks or technical hurdles which can lead to generic drawbacks. Volatility can also be a disadvantage if the price of a cryptocurrency suddenly drops, if you then panic and sell, you lose the money. However, if you inform yourself well beforehand, you reduce the risk, as is the case everywhere in life.

Banking as it should be

What does decentralized crypto banking look like in practice?

Basically, you can do everything in one app, but by splitting it up, specific advantages of certain platforms can be used and the risk is spread across different wallets.

Receive Interest

In a broad-based portfolio today, one no longer has only real estate, stocks and gold, but also the digital gold Bitcoin and the possibility of investing in future technologies in the form of altcoins such as ETH, ADA or LINK. If you do not want to expose your money to volatility, i.e. the daily price fluctuations of Bitcoin or Altcoins, you can also let your assets work with Stablecoins and receive interest.

On platforms like Celsius, Nexo or BlockFi, this is very easy and quick to set up. For Stablecoins you currently get between 8.6% and 11.9% per year, for Bitcoins around 6%. This is far more than the negative interest rates you have to pay the banks in this country. The crypto money can also be exchanged into another currency or back to the bank in FIAT at any time.

Borrowing money

Since Bitcoin is an asset like gold, people are reluctant to sell it because of its long-term increasing value (More users, small amount) (in this context, people also talk about “hodling”, which implies “holding”, as holding the asset). For this reason, you can also borrow money on these platforms without having to sell the valuable Bitcoins for it.

For example, if I need 3000.- for a trip, but I haven’t received my salary yet, I can freeze the equivalent in Bitcoin on the platform. As soon as I pay back the 3000.- plus interest, the Bitcoin amount will be released for me again. A simple but ingenious principle, which is processed securely and easily through the blockchain. A loan can be processed in a few minutes this way, as we learn here.

Most crypto banking platforms are not yet completely decentralized as they are in exchange with the traditional banking world. There are also regulatory requirements (KYC, AML) for certain platforms depending on what crypto assets (cryptocurrency vs. digital stock) are being sold.

Blockchain Economy

These disruptive technologies go far beyond digital banking and will change and replace more and more legacy systems. For example, the art market will have entirely new opportunities. Digital art now has the ability to produce editions and originals that are guaranteed to exist only once. The blockchain manages who owns the image and also enables secure trading of digital art.

With so-called tokenization, where an asset, such as real estate or art, is packaged into a crypto token, that asset can then be traded on a blockchain.

Click here to read our blockchain blog articles about the blockchain economy.

Crypto Banking – Cut the Bullshit

A Crypto Credit Card (cashback 1-5%) can be used to make normal payments from a wallet that also earns interest. From 3% for more volatile currencies to 11.9% per year for Stable Coins. For example, if we had 30’000.- in the bank and moved this money to a wallet at Celsius, Nexo, crypto.com or BlockFi, this would yield up to 70.- interest every week from now on. That adds up to about 3600.- per year.

As early as the 19th century, the Scottish economist Henry Dunning McLeod described banks not as asset managers but much more as “money factories”. Banks earn money through loans, transaction and service fees, commissions, interest differential transactions or with stock exchange trading. Banks used to return some of this to investors in the form of interest, but that was a long time ago.

Why don’t Banks actually pay Interest anymore?

Due to low interest rates, investors in Germany alone have lost over 570 billion euros in interest income since 2010. In order to be able to maintain the existing system and not let a global economic crisis arise, the central banks lowered interest rates and even charge their customers penalty interest. The big losers are the savers, for them a switch to decentralized finance should actually be a no brainer.

The new crypto financial service providers can handle banking transactions more directly, more efficiently and without intermediaries, thereby giving up interest again because they are based on a completely new system. The funds are also not tied up and can be withdrawn or transferred to another wallet at any time. Even though DeFi is still in its infancy, it already shows how banking actually works better.

The assets are subject to different market laws and can thus hedge each other. Gold and Bitcoin against the Inflationary FIAT Currency. FIAT and Stable Coins versus the volatile prices of stocks and cryptocurrencies. Bitcoin, Ethereum and many Altcoins are only at the beginning of their potential and so large price gains are foreseeable in the medium and long term.

The fixed amount of 21 million and the halving of mining rewards every 4 years (halving) makes the long-term price of Bitcoin much more predictable than a stock. The price movement follows surprisingly closely mathematical models such as the Stock to Flow model (Stock = how much is currently available, Flow = how much will be available in the future) because the increase in value is highly dependent on the halvings.

The resulting modeling sees BTC at around $100,000 as of April 2021, which of course could have been messed up by the crazy year of 2020. These are all reasons why many hold their Bitcoins for the long term, hence the term “HODL”.

Conclusion

Control over one’s own wealth can now be taken into one’s own hands, without the influence of governments or central banks. For the first time in our lives, there is a possibility of financial freedom. Bitcoin and the whole Crypto Economy is still quite young and yet it has already proven itself over 10 years and has become more and more established.

Currently it is an alternative to the existing system, but it is becoming more and more obvious that Bitcoin and the new decentralized financial system is here to stay and give people back control over their own finances and data. Those who still believe Bitcoin is a scam or just another speculative asset have not understood the fundamentals and do not see how poorly the current system actually works. The transformation has just begun and those who make the change earlier than others will be rewarded.

Hopefully, other platforms and social networks like Facebook and Twitter will also become more decentralized. We should be able to determine and control ourselves whether we want to sell our data or not. The blockchain allows for secure trading, ownership evaluation and tracking of data.

I hope this somewhat long article was able to arouse interest in Bitcoin, Blockchain and decentralized finance.

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