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Decentralized Finance And Cryptocurrency Banking – Future of finance world

Last Updated: April 13, 2022By

Cryptocurrencies, which have been touted as the financial future, are finally catching up to the centuries-old concept of earning money out of money. Professional and amateur investors are flocking to high-yielding crypto banking products because of the worldwide low-yield environment. The burgeoning digital currency market is spawning a parallel universe of banking, commerce, investment, and speculation that has the potential to alter the global economy and disrupt sectors. It is beginning to transform people’s borrowing and saving habits, as well as banking as we know it.

Cryptocurrency Banking

The rapidly expanding crypto finance industry is making inroads into regular banks. Interest-bearing accounts and collateralized loans backed by crypto asset deposits and other services are being offered by crypto banks, however, at substantially higher interest rates and yields than regular banks. Customers are attracted to crypto banking platforms because they provide annual percentage yields. For coins like bitcoin and stablecoins, APYs of 7 to 12 percent are common. The most considerable dividends are usually found in niche currencies and younger crypto ventures with higher risks. The appeal of achieving outsized profits in a low-yield global economy is catching the attention of the general public as well.

What accounts for the high yields?

Traditional banks lend out pooled deposits and pay a portion of the returns as an interest to their depositors. Traditional banks, on the other hand, are heavily regulated and required to protect consumer money. They must set aside funds for bad loans and avoid excessively speculative lending, leading to low returns on capital and, as a result, low yields on bank deposits.

Like traditional banks, crypto finance platforms pool crypto deposits to issue loans and pay interest to depositors. They use staking, a technique of locking cryptocurrency in exchange for rewards, and lending services to entice depositors/investors to supply liquidity in the crypto-assets market. Crypto finance platforms are primarily unregulated, lack reserve restrictions, and engage in opaque lending or lending to unnamed third parties and institutions that can take risks in order to create significant returns on crypto deposits.

Crypto trading and speculation are at the heart of crypto finance.

Because speculative trading in crypto assets can yield huge returns, there is a high demand for crypto borrowing. Hedge funds and speculators take advantage of market weaknesses to make highly profitable bets on price differences between the crypto market and crypto futures. On the crypto borrowing, these speculators pay large profits to the crypto banking platforms. The premium payments come to primary crypto holders as yields, much beyond what is available from traditional bank accounts, minus the crypto banking platform cut. Due to existing market inefficiencies and rising demand for cryptos borrowed for speculating, high yields are possible.

The developing crypto banking business covers a wide range of platforms, including traditional Centralized Finance (CeFi) systems and innovative Decentralized Finance (DeFi) platforms.

DeFi is a global ecosystem of smart contract apps that enable algorithmic lending, saving, yield farming, flash loans, trading, and more without the use of human intermediaries such as brokers, bank clerks, traders, or institutions like banks or payment processors. Smart-contract algorithms built within blockchains are used to oversee the entire approval process for financial transactions.

Agriculture with a high yield

Yield farming is an investment technique for collecting interest and other rewards in exchange for lending or staking cryptocurrency that falls under the DeFi umbrella. Users can exchange cryptocurrency on these DeFi services for a short period of time at algorithmically calculated rates. Yield farmers use complicated strategies to maximize earnings and raise yields, such as transferring their cryptos between various liquidity pools or lending platforms, always pursuing the collection with the highest APY. “Practically, it replicates a strategy in traditional banking — a foreign currency carry trade — where a trader attempts to borrow the currency with a lower interest rate and lend the one with a larger return,” according to a Harvard Business Review article. The large yields promised by DeFi yield farming come with significant hazards that are underappreciated by naïve investors, complicating the risk-return balance.

Loans in a hurry

Flash loans are uncollateralized loans that must be repaid quickly within the same block transaction, thanks to decentralized finance protocols. Within the same transaction, the smart contracts execute the requested loan and pay back principal, plus interest and fees. The original transaction is reversed if the borrower fails to repay. A flash loan is a one-of-a-kind, inventive, and practical method for increasing liquidity for arbitrage trading and debt refinancing. It’s a specialized financial tool for DeFi users who are tech-savvy. Smart contract exploits, fraud, and hacking are all common threats to flash loans.

The total value of crypto assets placed in DeFi protocols is valued at $220 billion, according to DefiLlama, a DeFi Total Value Locked (TVL) aggregator. Crypto banking platforms like Compound, Aave, MakerDao, MeanFi, and others are Defi players since they are decentralized and use automated lending and borrowing mechanisms. The compound uses distinct liquidity pools for each supported crypto asset and allows lenders to deposit cryptocurrency into various liquidity lending pools for access by borrowers, totaling about $7 billion in TVL. Aave owns more than $14 billion in TVL, while MakerDao has more than $15 billion. MeanFi.com is linking TradFi and DeFi with the help of Money Streams, a real-time finance system that allows businesses to set up payroll and banking in bitcoin. “With the Money Streaming Protocol, Mean DAO is ushering in the future of real-time finance, enabling a new generation of real-time finance applications. We’re giving money what Spotify gave music, “Michel Triana remarked. Mean DAO’s founder and CEO.

CeFi combines the yield advantages of DeFi with the convenience and security of standard financial-services products. It offers crypto-based accounts with the potential to generate substantially greater returns and is functionally similar to a typical savings account, with crypto debit cards and other features. The CeFi platform is in charge of preserving the savings, but it does so without the support of the traditional Federal Deposit Protection Corporation (FDIC) insurance. CeFI players include massive platforms like Nexo, Celisius, BlockFi, Genesis, and others, with yields ranging from 8% to 18%. These platforms manage billions of dollars in crypto assets, compete for money fiercely with incentives and token awards, and are now under regulatory investigation.

Is it safe to lend money in cryptocurrency?

The various yield-generating tactics used by DeFi and CeFi platforms do not highlight the crypto clients’ underlying risk exposures. Clients and depositors that contribute to liquidity pools have minimal visibility into what the platforms do with their crypto assets – this is known as opaque lending. Even though many lending platforms maintain high levels of collateral, depositors may be exposed to considerable hidden risks if they lend in highly volatile crypto assets. In their pursuit of enticing payouts, cryptocurrency investors may be blindsided by the underlying hazards in the largely unregulated crypto banking environment and may be lured into excessive volatility and deceptive schemes. Converting crypto tokens to traditional currencies might incur significant fees, lowering the overall payout.

There’s a chance that the cryptocurrency will face a spike in volatility. Its price could crash or spike while it is staked or loaned, resulting in temporary unrealized gains or losses, sometimes known as transitory loss. When one withdraws the staked coins, the profits or losses become permanent, and the interest and rewards gained may not be enough to compensate for the losses incurred as a result of the locked crypto’s price reductions. Farmers with high yields may unwittingly participate in fraudulent ventures or schemes. Rug Pull is a fraud in which cryptocurrency developers collect funding for a project and then abandon it without repaying the backers. The DeFi lending platforms’ smart contracts may include errors, have defective protocols, or be vulnerable to hackers, putting the investment in danger. Finally, the risks associated with crypto loans may result in more regulatory scrutiny and enforcement.

Also, read – How is Defi11 the solution to India’s potential Online Gaming ban?

Participants from institutions

In the current near-zero global return environment, crypto banking is an appealing alternative for yield-seeking investors. University endowments, insurance companies, retirement funds, and other risk-averse institutions are starting to dabble in cryptocurrency. Goldman Sachs, JPMorgan Chase, and Citigroup are among the traditional financial organizations that have begun to enter the crypto market. Visa V -1.6 percent and Mastercard MA -0.5 percent have partnered with crypto platforms to expand their presence in the nascent crypto-financial industry.

DeFi and CeFi are not designed for classic low-risk passive investors. These products do provide an alternative for intelligent investors looking for a greater yield but at the expense of unquantifiable speculative risk. The crypto financial services industry is a hive of activity. Crypto banking might extend its appeal when traditional banking institutions used to functioning in the highly regulated finance industry join in, and every family could have crypto assets working for them.

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About the Author: Diana Ambolis

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