DeFi: An opportunity or an existential threat to banks?

While the jury is out on the long term value and relevance of crypto currencies and digital assets, with strong views ranging from “another Ponzi scheme"¹ to “bankless society has officially begun"², there is no denying the fact that this new and emerging ecosystem has well and truly entered the mainstream in the last 2 years. This rise has also forced the incumbent financial industry and its regulators to accelerate their understanding, assessment and responses to its risks and opportunities.

We therefore took the opportunity to run a spot survey at the AFR Banking Summit 2022 on two key topics that are top of mind for the banking industry right now.

Banks are eager to play a prominent role in the DeFi ecosystem

While there is no commonly accepted definition of Decentralised Finance (DeFi), it is a collective term used for financial services built on decentralised infrastructures that do not rely on financial intermediaries like central or commercial banks. Real-world applications include products like crypto “savings/deposits”, crypto payments or crypto-backed loans generally offered by unregulated crypto-native fintechs. A new research report by blockchain data provider Amberdata estimates total value locked in DeFi at USD239B in April 2022, a 40,000% rise from the start of 2020.³

DeFi has the potential to deliver seismic shifts in the global financial system and incumbent financial institutions need to consider forward-looking business strategies to position themselves appropriately in this rapidly evolving digital asset economy, with due consideration given to two key points. Firstly, incumbents could choose to play or sit this out, with either being a legitimate business strategy, as long as it is a deliberate and informed choice that is continuously revisited in light of new developments. Secondly, it is critical to stay close to regulatory activity in this space which will impact risks and opportunities (and Australia is looking to be at the forefront of crypto regulation).⁴

Findings from our spot survey at the AFR Banking Summit:

Question 1. DeFi is….

A. An existential threat to banks

B. An opportunity for banks

C. A passing fad

D. What is DeFi?

Question 2. How do you think banks should respond to DeFi?  

A. Partner with crypto and DeFi platforms to enable access and new services for customers

B. Offer support services to DeFi platforms (e.g., on and off ramp, digital identity)

C. Play an influencing role in crypto and DeFi policy and regulation

D. Do nothing

Our spot survey found that 36% of respondents consider DeFi more of an opportunity rather than an existential threat to banks. While the major players in the banking industry did exhibit awareness of the DeFi space there is still a significant portion (32% of the industry respondents) that lacked awareness of or a perspective on DeFi.,

Graph 1: Survey Response 1

“We want to offer buy and sell capabilities to our customers, but what about regulations around money laundering?” - Survey respondent

While banks are exploring their play in the DeFi space, partnering with the likes of crypto-natives is becoming an increasingly interesting proposition provided concerns around risk, compliance and corresponding liability are addressed. It is also evident that the banking industry wants to and will need to play an increasingly active role in defining the policy and regulations related to DeFi.

Retail CBDC seen as a solution to achieve faster payments and reduce fraud

CBDCs (Central Bank Digital Currency) have the potential to be the most pervasive innovation in the digital and payments space which can fundamentally impact all participants in the global financial services industry. A CBDC is a digital payment instrument, denominated in the national unit of account, that is typically a direct liability of the Central Bank (depending on the design).⁵ Currently, only commercial banks and certain permitted financial institutions can hold Central Bank money in accounts with the Central Bank while the retail public can hold Central Bank money only in the form of physical bank notes. With cash usage declining over most economies, CBDCs can play a role in maintaining and streamlining the Central Bank’s function of providing money, financial stability and ensuring continued access in a purely digital economy.

87 countries⁶ are actively engaging in some form of work on CBDCs, exploring both wholesale and retail use cases. Here in Australia, the RBA has been looking at wholesale use cases for cross-border payments and syndicated loans since 2020 and announced its intention of looking at “potential economic benefits, opportunities and risks” of a retail e-AUD in December 2021, in close collaboration with industry partners⁷. Given Australia’s status as one of the leading electronic payments markets in the world, the most obvious use cases for retail CBDC like reducing cash and financial inclusion will be somewhat less relevant here, while advanced use cases like programmable money and eliminating black economy will be more interesting and make for a fascinating exploration.

Findings from our spot survey at the AFR Banking Summit:

Question 3. Retail Central Bank Digital Currency (CBDC) in Australia is:

A. A solution looking for problems

B. A potential solution to real problems

C.  The end of cash

D. What is retail CBDC?

Question 4. What real problems can retail CBDC solve in Australia?

A.  Reduce cash hoarding and operational inefficiencies of cash

B.  Reduce crime, frauds and scams

C. Social and emergency payments

D.  Instant payments and settlement

Graph 2: Survey Response 2

“Introducing a retail CBDC will not stop those people who hoard cash from continuing to do so- that can only be resolved by the end of cash, which we are still a long way away from.” – Survey respondent

“Social and emergency payments are a relatively smaller issue compared to the macro big picture challenges of financial crime and instant payments – a retail CBDC can help with all of these.” – Survey respondent

Respondents do believe that a retail CBDC can address real problems in Australia including achieving instantaneous payments and reducing financial crime, however, there does not seem to be a pressing urgency for a retail CBDC in Australia.

Deloitte has been actively helping its clients in defining and executing their digital assets strategic plays and assists regulators and industry bodies in shaping industry perspectives on key topics related to digital assets.

For any questions, or if you would like to discuss these topics in more detail, please contact Marc Bender or Arjun Gupta from our payments and crypto advisory practice.

References:

[1] Australian Financial Review, The great crypto Ponzi scheme finally crashes, Christopher Joye, (Columnist), 13/05/22
[2] Thomson Reuters, Bye-bye, banks! Hello DeFi… Our bankless society has officially begun, Joesph Raczynski (Technologist & Futurist), 17/05/21
[3] Amberdata, DeFi and the Transformation of institutional finance, 18/03/21
[4] Australian Financial Review, Crypto experts praise Bragg tech report, sceptical of delivery, Jessica Sier, 21/10/21
[5] CBDC definition, Bank for Internal Settlements, 2020
[6] Atlantic Council, Central Bank Digital Currency Tracker, 19/02/21
[7] Reserve Bank of Australia, Reserve Bank and Industry Partners complete Wholesale CBDC Research Project, 8/12/21