This post is part of CoinDesk’s 2019 Year in Review, a collection of 100 op-eds, interviews and takes on the state of blockchain and the world. Varun is co-founder and CEO of Juno, a neo bank that provides users a high yield account for savings. Prior to Juno, he co-founded Nuo, a decentralised debt protocol and BeeWise, a credit analytics platform.
2019 was clearly the year of decentralised finance (DeFi) and “earning interest” was its killer app. It’s time to take this mainstream and 2020 promises to be a defining year. Even more exciting, DeFi coincides with a broader trend in banking – the rise of fintech and so-called neo banks.
For the uninitiated, neo banks are challenger banks focused on creating a better banking interface using open banking APIs or by building a core banking system from the ground up. Startups like Chime, Monzo, N26, Revolut have acquired millions of users this year and have collectively raised over USD 5 Billion from marquee investors. At the same time, fintech upstarts including Wealthfront, Robinhood, Betterment, SoFi have attracted attention by introducing new age financial products across wealth management, investments and loans.
Interest is the new battleground
In the last 10 years, fintech has been slowly chipping away at the profits of banks by cutting out middlemen and serving customers directly. We have seen brokerage wars with the introduction of zero commission brokerage by Robinhood forcing incumbent firms to drop their fees and explore new avenues to monetize. Post-brokerage, interest has become the new battleground. It is also the most lucrative battle of them all. Banks are still heavily dependent on net interest margins for their revenues and profits.
Since the financial crisis, net interest margins are at a peak which means banks are able to pay more to their customers on deposits – they are clearly choosing not to. The interest rate banks pay has effectively been the same for the past 10 years, a timeline that begins when banks lowered interest rates to zero as a result of the financial crisis and learned they did not lose customers.
In the last few years, neo banks like N26, Monzo, Marcus and fintech startups like Wealthfront, Betterment, and Robinhood have used this opportunity to attract customers by providing a high yield “cash account” that pays between 1.5-2.5% APY on deposits through strategic bank partnerships. This interest rate advantage has helped Wealthfront successfully attract $8BN in customer deposits, while Marcus by Goldman Sachs is gaining $1BN deposits per month.
DeFi is fintech 2.0
DeFi takes this trend in banking to its culmination by cutting out the middlemen completely, by using open and decentralized peer to peer networks. The objective with DeFi is to build a multi-faceted financial system, native to crypto, that recreates, and improves upon, the legacy financial system. DeFi now represents a new fintech wave and DeFi neo banks will play a pivotal role to successfully bridge the gap between fintech and DeFi to attract new customers.
In the last few months, many projects including Juno, Dharma, Linen, Outlet have announced their intention to launch DeFi neo banks built using Compound and Nuo protocol. Their stated goal is to provide users a high-yield account for savings which competes with cash accounts of fintech startups like Wealthfront and neo banks like Monzo. This would be enabled by providing a simple alternate banking interface that blends crypto and traditional finance seamlessly.
Banks lowered interest rates to zero as a result of the financial crisis and learned they did not lose customers.
Not that rolling out these products will be easy. As these projects launch next year, there are quite a few challenges standing in the way, but they also present a huge opportunity for the crypto community as well.
As these neo banks attempt to bring new customers, one of the biggest challenges is to provide a competitive high yield at scale. This is directly correlated to the loan demand on interest-generating platforms like Compound, dydx and Nuo, which are currently limited due to lack of liquidity. Bringing bitcoin onto ethereum in a trustless way can scale this massively and many projects including Ren and Keep are working towards this goal. Also, since bank customers are used to the idea of a fixed interest rate on their savings, interest rate swaps will play a critical role as the ecosystem matures.
To bridge this adoption gap further, DeFi needs world-class fiat on-ramps and off-ramps with low fees and higher limits along with smart contract and volatility insurance to provide security in case of catastrophic events.
Lastly, these DeFi neo banks will also need a built in monetization strategy in order to acquire customers and funnel deposits to interest generating protocols. This will be enabled through fee sharing or native DeFi token distribution for interest generating platforms to incentivize projects to bring deposits and govern interest rates. With these challenges and opportunities in mind, 2020 promises to be an exciting year for DeFi.