Why Crypto Is The Future Of Finance
In this article, we’ll touch on:
How crypto improves upon traditional finance (TradFi)
How I personally use crypto finance (or better known as decentralized finance (DeFi) today
First off, thank you for reading and as always, nothing you read or hear of my content is financial advice. It is simply content to help you think more about the ever changing landscape of finance/technology and where I believe we are headed in the future.
My goal in creating this Substack/Twitter (follow me @cryptoonramp) is to onramp 100 people into crypto, so I would appreciate it if you could please subscribe and share if this article hits the spot!
I get it. The world of cryptocurrency over the past 5 years has been portrayed by the mainstream media as a high stakes casino in which there are no rules and the house has access to a magnet that determines where the roulette ball will land on the wheel.
For a large part of the current crypto ecosystem, it’s hard to argue the contrary. As with all new industries and inventions, there will be a period of time at the start in which it’s basically the Wild Wild West. Just look at the dot-com bubble in the late 1990s.
Heck, even to this day the internet is home to a ton of illegal activity, porn, and generally not socially acceptable things. Simply put, if you can think of it, someone has posted relevant content somewhere in cyberspace.
Despite all of this, I do believe that cryptocurrency (and blockchain) has come a long way since the inception of Bitcoin in 2009, and there are signs of history defining technology being implemented at record breaking speed. That is not to say the technology is scalable for mass adoption just yet, but it is definitely worth paying attention to.
After all, the early bird gets the worm.
Given my personal background in accounting/finance, the one I am most excited about is DeFi.
For the uninitiated, TradFi or traditional finance is the current financial system we have in place. More specifically, the parts that an average retail investor such as you or I would interact with that is considered TradFi include bank accounts, banks, stock market, retirement savings plans, etc. These institutions are largely centralized in governance and operations.
DeFi or decentralized finance is a generalized term to describe peer-to-peer (P2P) financial services on public blockchains. Simply put, DeFi aims to democratize the financial system through eliminating third parties and making everything public for all to see. As an example of P2P transactions, if you’ve ever illegally downloaded movies/music online, chances are you’ve used a P2P network such as Limewire or Napster (RIP)!
There are a number of reasons why I believe it is inevitable that DeFi will end up being the core infrastructure of the current TradFi system sooner or later, and I will lay them out below.
How DeFi Improves Upon TradFi
Before we get started, I want to make it clear that the current TradFi system is an incredibly complex system that has served billions of people very well in its ability to promote wealth and prosperity. It is arguably the primary reason for the exponentially improving quality of life we experience as we continue through human evolution.
However, there are a number of issues with the current system that makes it hard to use, or excludes all from accessing. Let’s go through some of them below:
Hours of Operation - Most banks in North America are open 9-5 and closed on Sundays. Sure, you can still withdraw cash at an ATM 24 hours a day, but wires, ACH payments, etc are limited to those set hours. Stock markets are only open Monday to Friday during business hours.
DeFi is accessible 24/7/365 anywhere on earth with an internet connection.
Payment Processing Time - Whether it be sending a wire payment, moving large sums of money between banks, or cashing a cheque, most TradFi institutions have a processing time lag from when you make the transaction to when you receive the cash. These can range anywhere from a couple hours to a couple of days. When it is stuck, you literally have no idea where it is in the process and are at the mercy of the banking system.
DeFi transactions take anywhere from a couple seconds to a couple of minutes depending on the blockchain you choose. If one blockchain is too slow for you, you can easily move your assets onto a faster one! In addition, once a transaction is processed, you can follow it along through the blockchain to see where it is.
Cost of Making Payments - TradFi services nickel and dime you for literally any movement of cash you want to make, from buying/selling stocks to making wire/ACH payments. These fees can range from $5 to $30.
While there are transaction fees on DeFi protocols/blockchains, the cheapest blockchains charge pennies for each transaction.
Bank Fees - Most banks will charge you monthly “maintenance” fees to keep your account, which can sometimes be waived if you keep a certain minimum balance that is stuck in perpetuity earning 0% interest. Most credit cards also charge an annual fee.
DeFi does not charge any fees to hold your money in your own wallet, regardless of the amount.
Moving Large Sums of Money - Most countries have rules and regulations in place to screen large transactions over a certain dollar amount. These usually require additional information before the funds are transferred or received. In Canada where I live, this is any amount over $10K that goes into or out of a bank.
DeFi has no restrictions in terms of the amount of money you can move, and no need to justify to anyone why the funds are being moved.
Access to a Bank Account - A large portion of the population, especially in third world countries, do not have access to a bank account for a number of different reasons, whether it be lack of ID, screening from banks, living in rural areas that don’t have physical bank locations, international sanctions, etc. Even if they are able to open up a bank account, most of those same people are limited or unable to access USD funds, instead forced by government regulations to hold the local currency that just so happens to be hyperinflating, making it virtually impossible to save.
In DeFi, anyone can create and maintain a wallet on the blockchain as long as they have an internet connection. Banking for all!
Ability to Borrow Money - In TradFi, an individual’s ability to access funding is largely dependent on a banking institution’s assessment of their credit score/history, which is in and of itself a pretty arbitrary number. It is the decision of the institution and they can decide to turn down any applicant for any reason they choose. This leaves room for profiling, racism, discrimination, and can negatively impact individuals from building wealth based on their race, gender, occupation, or even where they live.
In DeFi, an individual is able to borrow any amount of money as long as the loans are fully collateralized. There is no request for credit/job history, etc. If you can put up the assets required, you can borrow money.
While TradFi has a lot of benefits and has created tremendous wealth/innovation, hopefully you can see above that there is still lots of room to improve upon the existing system that makes finance better for all!
Current DeFi Technology/Protocols Solutions
I spent the previous section listing out a number of places in which TradFi can be improved upon. Below I will outline some of the current DeFi technology in existence and how I am using them to optimize my personal wealth (again, NOT FINANCIAL ADVICE). I have added the protocol name that I use in brackets:
Lending Protocols (AAVE):
There are a number of trustless lending protocols in crypto today with proven track records and billions in total value locked within the protocol. These protocols are simply open sourced code (smart contracts) and protocol changes are completed through a democratized token voting system, meaning they are less likely to be manipulated or attacked through a centralized actor.
Trustless lending protocols allow any individual wallet to borrow funds against their assets, without needing KYC (know your customer) or a credit application.
How this works can be thought of like a home equity line of credit (HELOC), except instead of your home, you are using cryptocurrency as the asset. As a general concept, most lending protocols allow you to borrow up to 70-75% of your asset value.
For example, I am able to deposit $100 worth of Bitcoin, and borrow $75 worth of another cryptocurrency (USDC, USDT, ETH, BTC, etc). If at any point my asset value decreases and the ratio of my lending is higher than 75%, the smart contract automatically liquidates my asset in order to pay off my borrowed amount. However, I still get to keep the amount I borrowed. Given how volatile cryptocurrency prices are, most people don’t borrow anywhere near their limits.
You may wonder why anyone would want to do this. Why wouldn’t I just sell $75 of my $100 of Bitcoin if I wanted $75 USD? The simple answer is that most smart investors don’t like selling appreciating assets and attempt to build wealth through leveraging them, which are assumed to go up in nominal price in a long enough timeframe given the never ending increase in monetary supply. Just like real estate, why would I want to sell an asset that I believe will appreciate in value over time (Bitcoin)?
Referring back to the same example, if I deposit $100 worth of Bitcoin as my collateral and borrow $75 USD (or USDC stablecoin), as Bitcoin value goes up over time, my borrowing ratio decreases (from 75% to a lower %) and I am at less and less risk of being liquidated. Over time, I can choose to use my Bitcoin collateral gains to pay down the debt, leaving me with more Bitcoin than if I had sold $75 worth of it instead of the loan, or I can choose to let the borrowed amount sit there forever. A third option would be to borrow even more money against the newly appreciated Bitcoin asset, but of course as with all things finance, it’s important to know your limit and play within it.
While there is a small cost to borrowing money as with any lending platform, as long as your borrowing ratio stays within the limit, there are no periodic monthly/quarterly/yearly payments necessary. This is unlike a bank loan where you are required to make a monthly payment until the loan is repaid, even if your home continues to appreciate in value.
In the past, this type of financial instrument was only accessible by the wealthy (those who owned property assets) and required you to go through a rigourous screening process/application at your local financial institution, resulting in the rich getting richer. With DeFi and an internet connection, it is now available to anyone at any level of wealth!
The platform I use is called AAVE (https://aave.com/).
Before using it, I would suggest doing more research and getting yourself caught up to speed on how the protocol works. As with all things in crypto, the tradeoff to decentralization and permissionless/trustless protocols is that you are also 100% responsible for your own actions. So make sure you know what you are doing, as there is no FDIC to insure your losses if you accidentally send funds to a wrong address!
Liquidity Pool Providers (Uniswap):
In Tradfi’s stock market system, there is a centralized order book that attempts to pair buyers with sellers. Simply put, the only way a transaction happens is if you can pair someone who wants to sell a share with someone who wants to buy a share at that same price.
In DeFi, there is a concept called automated market makers (AMM). They allow crypto to be traded in a permissionless and instant way by using liquidity pools (LPs) instead of an order book, as these exchanges are decentralized (known as DEXs). This allows for anyone to make any transaction they want between cryptocurrencies without needing a trading partner, as long as there is enough liquidity in the pool.
LPs are used to create liquidity for traders who wish to trade a certain pairing.
Let’s use the example of Bitcoin and USDC (a stablecoin pegged to USD). If I wanted to provide liquidity for the BTC/USDC pairing, I would have to input an equal amount of BTC and USDC into the LP. For this example, I input $500 worth of BTC and $500 worth of USDC into the LP. A trader comes along looking to sell $25 worth of BTC. When they initiate the trade on the DEX, they would add $25 worth of BTC to the LP, and take out $25 worth of USDC from the LP, leaving the LP to be $525 BTC and $475 USDC. The imbalance then subsequently changes the price of BTC/USDC.
This whole transaction occurs without the need for an intermediary, or a secondary party to take on the other side of the trade.
Now that you understand how AMMs work on DEXs through LPs (look at that crypto lingo… you’re becoming an expert!), the next important part is to understand why one would add liquidity to LPs.
The answer to that is fees!
In that previous example transaction, the trader is charged a nominal fee for the trade, and the fees are then split between all LP providers of that trade pair. The larger the portion of the LP you contribute, the more percentage of fees you receive.
In a way, you are essentially being a TradFi stock trading platform (like stock brokers such as Robinhood, Fidelity, TD, etc) and collecting fees on transactions! The future of finance eliminating the middle man and giving it all back to the people! Ironically, that is actually the tale of Robin Hood.
Before you go ahead and start adding liquidity to LPs, there is something you need to be aware of called impermanent loss. Impermanent loss happens when the price of the crypto you deposit into the LP upon withdrawal changes compared to when you deposited them. I won’t go into too much detail as this is outside the scope of this piece and oftentimes, the revenue in fees earned outweighs any potential impermanent loss unless we see drastic price swings, but it is something that you should do some research on before depositing into LPs.
A simple tip would be to look into stablecoin LPs such as USDT/USDC to start.
My favorite protocol (and the largest DEX in the world) is Uniswap (https://app.uniswap.org/#/swap)
Protocol Revenue Sharing (GMX):
In TradFi, it is the financial institution that generates and keeps all of the revenue. Sure, you have the ability to purchase shares of publicly traded companies, but you are subject to that entity’s operating costs and whether they decide to issue dividends or not. Companies can even choose profit decreasing activities such as spending heavy on acquiring companies/assets or R&D costs.
In DeFi, you have the ability to purchase tokens of certain protocols that choose to share its revenue with token holders through the code embedded into the protocol. This means that your portion of the revenue pie can be calculated with relative certainty and isn’t at the discretion of the Board or management. The protocol can only be changed with enough of the vote, and in most cases, the votes are allocated based on the number of tokens you own.
In addition, as DeFi is open sourced and public, it is easy to see the revenue generated for each protocol in real time. In fact, there are websites such as cryptofees.info that make it easy to see! No need to wait for the next quarterly financial statements to be produced and audited like publicly traded financial institutions.
One of my favorite protocol revenue sharing tokens is $GMX (gmx.io). 100% of revenue generated from trading and perps liquidations are shared with token holders.
Wouldn’t it be nice if JP Morgan did that!
Depositing USD To Earn Interest (Curve, AAVE, Beefy Finance):
This is the simplest one to understand. The beauty of this is that this strategy can be used just on USD stablecoins, and as a result, are not subject to the wild price volatility that exists in crypto.
Most of us hold spare cash/emergency funds in high interest savings accounts at our bank because they’re easy to withdraw and are accessible to us at any time in case we need it.
The issue is that the interest rates of these savings accounts suck!
Depending on where you are storing your money and with which financial institution, rates can range from 0.1% to a high of around 2% at the time of this piece.
Sure you can put your money into treasury bonds or GICs, but then you’re either subject to lock in periods or have to wait until they vest to get your money back.
DeFi solves this problem. There are numerous places where you can stake your USD stablecoins (USDC, USDT, etc) that generate yields on average between 3% during bear markets to 25%+ in extreme bull markets!
The reason for this stems back to our first technology of lending protocols. As DeFi has very minimal intermediaries and no central entity, it relies on user deposits to provide liquidity for the system. In the case of lending/borrowing, DeFi protocols such as AAVE need to incentivize deposits by offering attractive interest rates. The funds deposited are then lent out to a borrower at a higher rate. These rates fluctuate based on supply and demand, hence are lower in bear markets when people are less hesitant to borrow and higher in bull markets when people borrow to invest in other projects.
My preferred protocols to use include Curve (https://curve.fi/), AAVE, and Beefy Finance (https://app.beefy.finance/).
There are sites like Coindix (https://coindix.com/) that help you find the highest interest rates. Of course, rule of thumb as with all investments, the higher the rate, the higher the risk. Less trusted protocols will often offer higher rates to attract deposits.
Funds deposited in these DeFi accounts can be withdrawn anytime, but are subject to certain risks that you wouldn’t normally encounter with a FDIC insured bank such as protocol risk in terms of code errors that could lead to hacks, etc.
As always, do your own research!
Of course, there are a lot more complexities in terms of how to use the protocols and certain risks involved in using them. DO YOUR OWN RESEARCH before you decide to get involved.
In addition, there’s still hurdles in terms of regulations, improved UI, etc, before we can really start to see this technology scale and be adopted by the masses, but hopefully this has helped you to see what I believe to be true. DeFi is the future, and sooner or later, the above technologies will be a regular staple of our financial system for the betterment of the often forgotten portion of society that isn’t in the 1%.
The status quo can be hard to change, especially when it’s controlled by the biggest benefactors, but change is really the only way we evolve as humans.
And finance will be no different.
It’s time to take back control of our own finances in terms of ownership, transparency, and permission. Media and powerful/rich people will try to convince you that crypto is for suckers and that it should be banned, but they are also the same entities reaping in all of the rewards in the current system, so why would they want change?
I leave you with this thought:
Does the current financial system benefit you and your family? If not, what do you have to lose in having an open mind about DeFi?