DeFi and Cryptocurrencies In Modern Economy
A detailed dive into how cryptocurrency and DeFi are impacting the global economy, reducing global inequality, and supporting traditional financial institutions
Long gone are the days when we used to discuss whether cryptocurrency could be a valuable alternative to fiat currency. It is now obvious that it can. However, it is also apparent that fiat currency is here to stay, at the very least for a few more decades. That said, the influence of cryptocurrency on the global economy is being felt with each passing day. As digital coins achieve widespread acceptance across the globe, their influence is only going to increase.
Here, we’ll cover both how crypto has affected the global economy so far and theorize how it could further push us beyond the limits of fiat currency in the future. The focus here is on how the technology can change the way our financial systems operate while simultaneously removing a lot of issues that currently plague a fiat-based global trade system.
There are two sections in this article. The first deals with how cryptocurrency has been an equalizing force in the global economy and offers developing countries a chance. The second deals with its utility in the developed world and traditional finance.
Note: While the underlying technology behind cryptocurrency (blockchain) has numerous applications of its own (e.g., NFTs), the focus here is only on cryptocurrency. As such, I will speak only to the monetary utility of the digital coins and not all the other benefits that blockchain technology embodies.
Cryptocurrency: The Great Equalizer
Cryptocurrency was created by a mysterious figure who preferred to remain anonymous, even though they could have soaked in the fame and celebrity that would have come with the invention of one of the most significant financial revolutions in history. The mysterious identity of Satoshi Nakamoto perfectly encapsulates the premise behind cryptocurrency: It is meant to be greater than any individual, party, government, or coalition.
Pretty much every cryptocurrency has built-in safeguards to prevent abuse and ensure that the currency’s integrity is protected. This is precisely why it is preferred by those that embody an innate distrust of the government, the central banks, and mainstream financial institutions.
While I won’t say that I embody that same distrust, I would like to cite a few examples of how cryptocurrency can potentially eradicate economic inequality in the world.
The Dawn of the Second World
Developing countries (previously alluded to condescendingly as third-world countries) have historically had trouble with financial stability. Whether due to government mismanagement or the lack of viable economic opportunities, developing countries have been the victim of the vast majority of currency failures. Even in 2020, the countries that defaulted on sovereign debt were all developing.
For such countries, cryptocurrency represents a way out. While there are inherent issues with volatility, cryptocurrencies, on the whole, are much more stable than certain currencies. It is not difficult to imagine people in certain countries having more faith in Bitcoin than in their native fiat currency. Cryptocurrency may be exactly what is needed to extinguish the notion of third-world countries altogether.
Venezuela: A Perfect Example?
While fears of hyperinflation are only on the fringes in the US, there is no country in recent times that better encapsulates how crypto could be beneficial than Venezuela.
Having long suffered from hyperinflation, the government has been looking for ways to utilize cryptocurrency to stabilize its economy. Although it launched a Petroleum-backed currency called Petro in 2018, it has been marred in controversy, with the government being accused of using the coin as a political weapon.
It is evident that no crypto revolution is going to be government-backed. The fundamental reason behind the creation of currency is to avoid excessive government intervention into the financial system and currency in the first place. That said, mainstream coins such as Bitcoin and Ethereum have been surging in popularity in recent years, with Venezuelans using them to combat inflation, send remittances, and even transact locally. Coins tethered to a specific currency (mainly the USD) are also seeing an increase in use, once again to achieve some form of stability in a rapidly disintegrating economy.
Venezuela is not the only country whose population has been using crypto to fight inflation. Argentina is another example, with even the Argentinian president citing crypto as a means to combat inflation and calling it a ‘hard currency’ in the process. However, fighting inflation is not the only reason people in developing countries
Cryptocurrency is a total revolution for countries that do not have robust financial institutions that can quickly and cheaply transact with foreign nations. For the first time in history, anyone can send money anywhere in the world in a matter of minutes.
Local transactions are extremely cheap almost everywhere in the world. However, the same cannot be said for transactions where the money is sent in one currency and received in another. Back in 2018, it was estimated that transaction costs and exchange-rate margins for remittance payments could be up to 7% of the amount sent.
Transacting through a cryptocurrency, on the other hand, costs a lot less. While the fee can vary depending on the coin used and various other factors, sending crypto for fees less than 1% of the total transaction is possible. This is, of course, a lifesaver for countries such as El Salvador, which adopted Bitcoin as legal tender back in September. As a country that receives billions of USD every year in remittances, the advantages of using Bitcoin are obvious.
Financial institutions are also springing up to provide additional services to crypto users. DafriBank, for example, is an African bank that primarily aims to serve customers with international banking requirements.
Cryptocurrency: A Powerful Tool in the World of Finance
The idea of a currency that can be easily transferred and is used by everyone in the world is not new. In fact, PayPal’s initial aim was to create ‘the new world currency,’ according to the company’s first COO David Sacks. This is also discussed in Peter Thiel’s (one of the founders of PayPal) book ‘Zero to One’, where Thiel mentioned the lack of a technological breakthrough as one of the key reasons the company had to pivot to becoming a payment provider.
While we are far away from a time when crypto is the world’s currency (if we ever get there at all), crypto has begun to supplement traditional banking and finance, with new projects springing up every week. Earlier in October, the first Bitcoin ETF was launched. Although it trades Bitcoin futures instead of holding the actual asset, it’s a huge step forward for cryptocurrency.
Let’s go through a few ways crypto can impact the modern financial landscape.
A New Store of Value
One of the fundamental tenets behind the rise of cryptocurrency has been the distrust placed in central banks and their money printing policies. At one point in 2020, around 20% of all the US Dollars in existence had been printed that year. And while initial fears of inflation seemed to be unfounded, we are now beginning to see high inflation, with more and more analysts predicting that inflation is here to stay.
Traditionally, gold has been considered the most stable store of value. Peter Schiff, one of the foremost critics of crypto, cites the fact that gold has been used as a currency for over five millenniums and has numerous real-world applications due to its conductive and thermal properties.
While I partially agree with Schiff’s statement that gold is a stable store of value, I must disagree with his critique of cryptocurrency. Not only are there numerous currencies that are used to power applications on their blockchain, but the fundamental value of cryptocurrencies is found in their anonymity, ease of access, and the ease through which they can be transacted.
More importantly, while gold may be a store of value, it is almost impossible to imagine that we will ever use gold coins for trade once again. Crypto, on the other hand, is seeing an ever-increasing use in business every day. When Schiff says, ‘Bitcoin is never going to be money’, he is wrong because it already is.
A New Way of Personal Finance
Cryptocurrency not only offers new ways of using money, but it also supplements personal finance by making it way more versatile than it ever has been.
Firms out there are now offering crypto-based credit cards. Most of these cards have no additional fees for foreign transactions. Numerous exchanges now offer banking services, allowing people to earn interest on the crypto they hold in their exchange wallets. The same crypto can also be used as collateral for a loan, legitimizing it as a financial asset.
You may be wondering how this relates to the global economy. Well, holding cryptocurrencies and related assets can be a great way to manage your finances during a financial crisis. With increasing pressure on the US Dollar, cryptocurrencies are a viable asset for people in developing nations and those living in regions with robust financial systems. Bitcoin and other currencies can simultaneously be a financial asset, a medium of exchange (money), and a hedge against local currencies across the world.
Security, Anonymity, and Transparency
It may sound strange that cryptocurrency can be both anonymous and transparent at the same time. However, it is possible thanks to the blockchain technology used to power cryptocurrencies.
Your wallet is not linked with anything, and there is no way for anyone to know that any coins are yours unless you disclose it yourself. At the same time, every transaction is recorded in the digital ledger, ensuring transparency and weeding out any chance of fraud. Since a transaction requires multiple confirmations (the number of confirmations changes depending on the currency), it is fundamentally impossible to have two copies of the same coin.
Perhaps the most significant advantage of crypto is its security. For the first time in history, you can travel anywhere in the world and carry your “cash” with you on your phone. Even if your phone is stolen, your encrypted wallet cannot be entered without your private key. In case you need to exchange your crypto for fiat currency, there are numerous services out there that can help you do it in less than 5 minutes.
DeFi and the Global Economy
Decentralized Finance, which is finance based on decentralized assets such as cryptocurrency, has picked up steam in recent years. A total of around $275 million of crypto collateral was locked in the DeFi economy in early 2019. By February 2020, the number had increased to $1 billion, and it eventually hit $14 billion in February 2021. The number now? Well, it’s a staggering $170 billion according to data from Chainalysis. That’s a 12x increase in less than 9 months.
Perhaps the biggest revolution in DeFi has been the advent of smart contracts. Smart contracts are automated contracts that execute once specific clauses have been met. These contracts usually make use of Uniswap, a decentralized and non-custodial crypto exchange. However, there are numerous other applications for smart contracts too. For example, Dai is a cryptocurrency that uses smart contracts to keep its value as close to the US Dollar as possible. Dai is now used by over 400 applications worldwide and is as unbiased of a currency as you can get. It facilitates decentralized financing, borrowing, and lending of cryptocurrencies. Over $75 million of debt has been issued using the currency across the world so far.
Envisioning the World Ahead
As cryptocurrency continues to gain a foothold in the developing world, we should see many problems traditionally associated with the financial systems fade away. While I expect to see local start-ups capitalize on the crypto boom in these countries, the best thing is that cryptocurrency sees no borders. As long as local governments do not ban the major exchanges, anybody with an internet connection could make use of mainstream platforms such as Binance and Coinbase.
Over time, cryptocurrency can play a pivotal role in reducing the wealth gap between the developed and the developing world. Whether it helps people invest their cash in foreign assets or protects hard-earned wages from inflation, it will open up new opportunities in places where people have previously struggled to thrive because they can barely survive.
Cryptocurrencies will also continue to supplement the traditional financial and banking systems currently in place. While I do not think that the world will be primarily transacting in cryptocurrency anytime soon, I do believe that its role within our financial systems will become more significant as time goes by. Its security, anonymity, and transparency, coupled with its utility as a financial asset and a store of value, will make it quintessential to survive the turbulent times ahead, regardless of whether you live in the US, Africa, or under a rock.