The disparity between rising interest rates (at the time of writing, mortgage rates were over 7.4%) and interest rates paid out by major banks (the current typical savings account rate is .18%) has infuriated many customers.
And for good reason: customers put their money into savings thinking they’re making a sound financial move, while it’s actually being loaned out at hundreds of times the rates they’re receiving back. As lending rates soar, barely anything trickles down to them.
DeFi savings accounts were created in an attempt to return value to the customer. While we’re not going to advocate for any particular type of account, this post will look at where DeFi accounts come from and where, ideally, they’re heading.
Decentralized finance (DeFi) was effectively launched on the Ethereum blockchain in 2016 through the implementation of smart contracts. At the most elementary level, a smart contract is a program that runs on a blockchain (and is deployed through a decentralized application, or dApp).
While that might sound confusing, computer scientist and cryptographer Nick Szabo came up with an ideal metaphor for understanding the mechanism by which smart contracts work: a vending machine.
Money + snack selection = snack dispensed
Not exactly what you’d think of when contemplating the future of money, but fitting nonetheless. By allowing you to enter a snack-specific “code,” vending machines cut out the middleman—in this case, a store clerk. The rules of the transaction are programmed into the machine itself. Provided you deposit the right amount of money and press the button corresponding to your snack, the transaction is frictionless.
We might be used to these transactions when it comes to snacks, but things change when dealing with real estate agreements, concert tickets, or even loaning out money. That’s why the vending machine metaphor is elegant: it’s simple. Exchange one form of value for another. The aforementioned examples appear more complex thanks to an industry of middlemen associated with their contracts. DeFi advocates believe the future involves fewer middlemen and, therefore, more value returned to consumers and creators.
Provided you can write code in a smart contract language and create the frontend user interface as a dApp for people to engage with (or hire a coder to do it for you), anyone can create and deploy a smart contract. Then, once live, anyone can agree to its terms (if they’re so inclined).
Potential uses for such contracts are limited only by the imagination: musicians offer NFTs or exclusive remixes; artists sell paintings to hang in metaverse offices; real estate companies crowdfund investment properties with low barriers to entry. Smart contracts are redefining how finances and information flow through societies.
The rules and methods of transacting are evolving, as they always have. The concepts of money and currency have always been fluid, changing as new technologies become available to societies. DeFi contracts are simply the next step in a very long process.
While dApps are now utilized in a variety of industries—energy, security, storage, and identity, among others—it makes sense that finance would be involved given the role currencies play in virtually every blockchain transaction. DeFi is helping shape the future of digital transactions, affording everyone the opportunity to write their own rules around the exchange of goods and services. As this happens, decentralized savings accounts are becoming an important component of new financial services writ large.
A big difference between DeFi and traditional banking services is the yield these platforms offer consumers in return for storing money in their accounts. DeFi savings accounts harken back to a bygone era in banking when mortgage rates and savings interest rates moved together. In 1984, for example, the typical certificate of deposit (CD) rate on a savings account at major banks peaked at 11.77%—a far cry from today’s .18%.
With DeFi savings accounts, money is deposited into a cryptocurrency lending pool with typically higher investment returns. This matters, as the best terms on traditional savings accounts often come from fixed-term accounts; the current average rate on a five-year CD is .74%. While safer than stocks, you’re locked into a low rate for five years. Your ability to move your money through DeFi accounts is generally not hampered by such long-term lockups.
Beyond savings accounts, DeFi protocols are allowing users to engage with a number of financial services, including lending, trading, liquidity mining, yield farming, and asset management. As these protocols continue to grow and gain more user adoption, consumers will be able to monitor and manage their entire financial life through a single interface.
While DeFi accounts are currently not FDIC-insured, stablecoin lending platforms safeguard the money circulating in their pools in other ways. For example, the stablecoin, USDC, has always been backed by the equivalent value of U.S. dollar-denominated assets; USDC reserves are kept in the management and custody of leading US financial institutions, including BlackRock and Bank of New York Mellon; and the USDC reserve is held entirely in cash and short-dated US government obligations, consisting of US Treasuries with maturities of three months or less.
As with any new technology, DeFi savings accounts will continue to evolve as more people embrace the future of the financial industry. Better products and services will further incentivize businesses to compete for customers, who are now being given the tools they need to write and play by—and profit from—the terms they decide on.
That is, they’re finally taking back control of their money.