With having the highest fintech adoption rate of 87% in emerging markets, as compared to global average of 64% (as per report published by EY & IVCA), India provides huge opportunities for a decentralized banking system to exist. Already being progressively adopted in the US and EU, decentralized finance (DeFi) is expected to take off in India and as well as other Asian markets. It could be a potential market for tapping and expanding into the underbanked/unbanked population in the country. 

Decentralized Finance (DeFi) is a financial ecosystem that uses cryptocurrency and blockchain technology for executing financial transactions. In layman’s language, it allows consumers to trade, borrow, transfer, and lend a digital currency, independently of traditional financial institutions and regulatory structures. It eliminates the need for middlemen for transactions.

Centralized Finance (CeFi): Present Ecosystem

Today, almost every aspect of financial services is managed by centralized systems, operated by governing and regulatory authorities. The consumers need to depend on the financial intermediaries for getting access to almost everything from loans/capital to trading in stocks.

As a result, it creates dependency for consumers as they cannot bypass the middlemen like banks, NBFCs, or exchanges, who get a share of income for every financial transaction.

 Decentralized Finance: The Future

DeFi is unbundling of this centralized financial system, enabling financial services anywhere for anyone, thereby empowering regular people via peer-to-peer exchanges. 

DeFi services are built and operate on blockchain technology and cryptocurrency, in a completely secured environment, with no manual intervention. Blockchain is a decentralized and distributed public ledger, where all transactions are recorded in encrypted code. It means that all parties will have access to an identical copy of the ledger that records each transaction in encrypted code. This secures the system by keeping anonymity of sensitive data of the users.

Further, all transactions are executed and recorded by parties who use the same blockchain, as there are no middlemen involved for managing the system. It provides users with more control over their money as this ecosystem caters to individual needs.

This makes the financial transactions transparent, low-cost, and more secure than the traditional systems employed in CeFi.

How to use DeFi?

It is powered by decentralized applications or other programs called protocols. Currently, these apps and protocols handle transactions mainly in two cryptocurrencies, Bitcoin and Ethereum (more adaptable than Bitcoin for DeFi). 

Some of the current use cases of DeFi apps and protocols include the following:

• Traditional financial transactions
• Decentralized exchanges (DEXs)
• E-wallets
• Stable coins
• Non-fungible tokens (NFTs): Creating digital assets out of the non-tradeable assets

Adoption of DeFi is powered by the omnipresent nature of blockchain. Further, as they exist outside the purview of regulations of governing bodies, thereby increasing their potential benefits.

Downsides of DeFi

DeFi being a recent innovation, is still not defined by any regulations/rules. Some of the risks involved are:

1. In the absence of any regulation, the user has no protection/recourse in case of any error in executing a transaction
2. While there is no manual intervention, still the software systems pose a serious risk of being hacked and have potential threat of online data breach

DeFi: A Potential Revolution in India

DeFi in India can be the new front for Cryptocurrency market, provided the government defines a legal framework for digital currency. It will provide an opportunity to improve the livelihood of people, earlier excluded by traditional institutions by allowing them to engage in financial transactions cheaply and securely. It will provide with additional investment options to investors, through Bitcoin, Ethereum, etc., thereby providing financial independence on how and where to deploy their money.

Cryptocurrency has the potential for majority of the population to increase their consumption levels, achieve financial security and contribute to the economic development of the country.

Way ahead

These alternatives to traditional banking methods are seeing a positive response, predominantly by India’s young population, as they are recognizing the potential benefits that it will offer to the economy if successfully implemented. However, with lack of regulations and lack of necessary infrastructure, it is yet to be seen how it will play out in future.

With governments of many countries supporting the same and cryptocurrency market growing rapidly, it is only a matter of time when DeFi will become the new normal. 

With the global cryptocurrency market now worth more than $3 trillion, this is something which cannot be overlooked, thereby capturing the interest of investors, traders, financial service firms alike. But currently, with the RBI and government highlighting macroeconomic and financial stability concerns and want some form of regulation for cryptocurrencies, it still poses a challenge for its wide acceptance. Further such currencies are difficult to spend like one would do with regular money. 

However, in recent times new platforms and services are being introduced for better managing of such digital coins in day-to-day finances of people. Let us now understand about cryptocurrency banking, its benefits and at the same time what barriers it can have.

What is Cryptocurrency Banking?

This term can be sometime misleading, as these currencies are not yet regulated by any central authority. Moreover, the firms and exchange companies that provide such services aren’t banks, but they only provide ways to people to manage their cryptocurrency balances, by allowing them to hold it in digital wallets and spend it like traditional money.

What are the benefits of Cryptocurrency Banking?

The primary benefit that is envisaged is the use of it in issuing cryptocurrency debit cards. This will allow consumers to use their digital coin balance like any other money for daily expenses, purchases or withdraw it as cash rather than just keeping it for the purpose of investment. 

Prior to this, cryptocurrency could only be spent where it was directly accepted by retailers or sell it in exchange for dollars. Now, fintech firms are partnering with financial institutions and/or debit card issuers to issue such cards, using their partner’s regulatory structure to convert digital coins into an acceptable legal tender (say INR) and allowing retailers/vendors to accept it in exchange for their goods/services. This will allow digital currencies to be accepted wherever regular debit cards are accepted.

This in future can be further extended in the form of prepaid cards, that can be loaded with cryptocurrency for making online/offline purchases from merchants.

Barriers/risks in accepting Cryptocurrency Banking

The biggest barrier to spend and lend in cryptocurrency is how volatile it is. The same is valid in case of investing in it. The financial institutions rely on traditional currency for lending, spending for daily purchases, etc. because of the stability in its value, but the same is not possible with digital coins, currently in a manner that is safe and secure.

Moreover, while spending digital currency, one should be aware of the risk that its value can change after its spent, since the transactions are based on the real time value of the digital coin. 

Another barrier is that the regulators are still evaluating its credibility and validity, as there are no laws/regulations currently in place for them. They are decentralized and are not backed by any asset. Their value gets determined through demand and supply.

How will the future of money evolve?

With the regulatory bodies/government cognizant of the fact that this is an emerging technology, it will require them to keep a close watch and take proactive steps in the future. As this issue is span across geographical boundaries, it will further require global partnerships and collective strategies. 

The combination of cryptocurrency, CBDCs, stable coins and other digital payments could eventually lead to the “demise of [physical] cash”. However, one technology alone will not overtake it. 

Though the future of money is cashless, a dependence on these digital payments will not lead to an efficient system. And eventually all this will affect not only money, but also the economy and society.