Why DeFi could rebuild trust in financial services

To function effectively, society has long depended on people having faith in their institutions. Thanks to the COVID-19 pandemic and wide-ranging failures of leadership, that faith has been tested like never before.

Nowhere is the decline in trust more evident than in the financial services sector. In its 2021 Trust Barometer, Edelman found that only 53% of American respondents said they trusted those in the U.S. to “do what is right” — down 5% from its 2020 survey. You can see this in the battle between Main Street and Wall Street, which played out in January’s GameStop rally. More than just another “short squeeze,” the rally highlighted the fact that many younger investors simply don’t believe in financial institutions.

Trending away from institutional authority is also evident in the explosive growth of decentralized finance, or DeFi. By using decentralized applications on the blockchain, DeFi allows individuals to lend or borrow funds, trade coins and earn interest on savings. Their transactions are governed by smart contracts, embedded in the software; no bank, brokerage or exchange is required.

With a digital-first generation, DeFi will become the default

To illustrate how fast DeFi has taken off, examine the total value locked, or TVL, being poured into the DeFi sector. TVL is the best way of charting the success of DeFi, as smart contracts usually require a counterparty to post collateral for any transaction. As of mid-March, almost $59 billion was locked into DeFi. A year earlier, that figure stood at around $500 million.

The overall crypto market — driven by Bitcoin (BTC) — is now worth well over $1 trillion, so there’s a long way to go before DeFi becomes headline news. Though remember: It took Bitcoin nearly 10 years before institutional investors really started to buy in — and it seems that it will take half that time for DeFi to achieve similar penetration.

Why? Because younger investors — like the GameStop traders — understand the concept of digital scarcity, embracing the fact that non-physical assets have value. That’s why they’re buying up nonfungible tokens as a way to trade digital properties. The best-known example of the NFT phenomenon was the Christie’s auction in March of a digital collage by artist Beeple — purchased for almost $70 million using cryptocurrency.

What has been a trickle of crypto activity promises to become a torrent, once the bulk of Baby Boomers retire. The epochal event, now underway, represents one of the greatest transfers of wealth ever. According to “Big Four” audit firm PwC, an estimated $59 trillion in wealth will move from retiring Boomers to their digital-native beneficiaries by 2061.

It is this new generation that will be looking for ways to invest their inheritance — and choosing the systems and platforms in which to place their trust. Given the choice, Millennials and Gen Zs will always choose the investment option that’s cheaper, more accessible and available 24/7.

As DeFi takes off, expect legacy institutions to fight back

Of course, banks being banks, you can expect to see them — along with other legacy institutions — fighting hard to defend their turf. They know that to remain competitive, they’ll need to increase service hours, decrease settlement times and boost user functionality.

Already they’re starting to integrate smart contracts and other DeFi technologies into existing platforms — both to increase efficacy and to keep up with market demand for more transparency and customer privacy. In a February white paper, released by the Depository Trust & Clearing Corporation, the DTCC proposed shortening the settlement…