Decentralised finance a tremendous opportunity for Europe

02 December 2020 5 min. read

Although limited in its value for financial services so far, blockchain-based decentralised finance might be a boon for Europe’s small and medium enterprise (SME) segment. BCG Platinion and weigh up the centralised versus decentralised finance debate.

Decentralised finance – or DeFi as the researchers call it – is explained in the report as: “Financial services that are built on public blockchains and based on open protocols and decentralised applications (dApps), allowing all aspects of the platform to be automated and performed without a central authority or intermediary.”

“Conversely traditional finance relies on intermediaries and centralised institutions.” As it stands, these centralised bodies exert tight control on financial activity, with strict conditions on who can access funding and how. Well suited for the wealthy, the system has grown to leave a range of low-income entrepreneurs and SMEs out in the cold.

DeFi value has surged this year

The researchers revealed that Europe is home to 24 million SMEs that contribut over €7 trillion to the region’s economy. Still, the risk profile attached with startups and small businesses has combined with high regulatory credit thresholds to push European SMEs and startups away from banks and towards investors.

Many position DeFi as a solution to this problem. Expert principal at BCG Platinion in Amsterdam Igor Mikhalev elaborated. “By removing the intermediary and automating many functions, DeFi can provide lower costs, higher degrees of security and privacy, resist censorship, increase accessibility and promote a decision-making democracy.”

All of a sudden, loans, deposits, savings and investments become a reality for thousands who cannot satisfy mainstream financial conditions. And many have realised this. DeFI platforms are coming up in droves, and are finding solutions that enable financial accessibility. Trudging along below the $2 billion mark till last year, the value of DeFi assets has surged to nearly $10 billion since the start of this year.

Naturally, there are those who doubt the potential of DeFi. Experts point to nearly $2 billion that the world of financial services has channeled into blockchain without returns of any significance – barring unstable Bitcoin investments. There are few reasons to believe that the blockchain technology could generate any real value for other players, given the high costs associated with its implementation.

Add to this the fact that DeFi remains an immature market, with poor security protocols, regulatory ambiguity a distinct lack of liquidity. Further evidence of immaturity is that most of DeFi tends to revolve around a single network – Ethereum. All these factors explain the apprehension around DeFi – termed by the researchers as “growing pains.”

DeFi's disruptive value in the payments landscape

DeFi's disruptive potential

That being said, BCG Platinon and note how DeFi could be tremendously disruptive if it can navigate these growing pains. In fact, the new paradigm could hit centralised finance where it hurts the most – payments and lending.

By this point, most consumers around Europe and other developed markets have come to take contactless payments, mobile wallets and money transfers for granted. By contrast, in the developing world, many countries are still struggling with financial inclusivity. Millions of financially eligible people are yet to have a bank account, let alone digital payments infrastructure.

Cryptocurrency famously offers financial inclusivity by facilitating anonymous transactions from one part of the world to another. Even in the developed world, some transactions can take up to three days to get regulatory and procedural clearance, while most transactions are subject to a transfer fee. DeFi is built with the intention of eliminating these intermediary charges and speeding up the process.

Then there is DeFi’s disruptive potential in the lending landscape, where it can add value for lenders and borrowers alike. For borrowers, the appeal lies in the absence of credit checks and ‘know-your-customer’ practices, as well as in low, personalised and flexible interest rates.

DeFi's disruptive value in the lending space

For lenders, there is a chance to retain a bigger share of the interest. Mikhalev explained: The value extracted by banks in traditional lending significantly outpaces the level seen in DeFi lending protocols. The main reason for this is that banks incur significant labour costs for its operations and they are able to extract higher economic rents due to their central position, while decentralised lending protocols have minimal ongoing costs, with the only cost being to compensate governance token holders for carrying out their functions.”

It is no secret that Europe’s banking sector has been under pressure in recent years. Regulatory changes, low interest rates and the tendency to save are putting a squeeze on earnings. As a range of smaller tech-based players look to pounce on this vulnerability, DeFi might just find its foot in the door of mainstream financial services.