DeFi is eating traditional finance?

Dear bankless community:

Software is eating the world.

This article written by Marc Andreessen in 2011 describes how software-side companies have replaced traditional companies and revolutionized the industry.

Amazon has replaced consumer sales, Spotify has replaced music, and LinkedIn has replaced hiring-all of which are intended to replace existing companies that have not built an Internet-native business.

why? Software-side companies are faster, cheaper, and more convenient for users. In Marc’s view, it is only a matter of time before each industry is replaced by software.

But this is not true for the financial industry.

Our financial system is still built on ancient infrastructure. Jim Bianco pointed this out in a podcast…Since the telegraph era in 1871, wire transfers have not become faster and cheaper! ? (please see Jim’s evaluation of our current banking infrastructure).

What about fintech? At present, what Fintech has done is just to improve the user experience of the existing system.

But DeFi changed everything…

Compare the funds transfer network of PayPal and Ethereum.


The above is a comparison between Paypal and Ethereum…Cryptocurrencies are becoming faster, cheaper and better. (See Dmitriy Berenzon’s twitter thread, which inspired this article)

Or take the lending platform as an example. MakerDAO has been profitable after 6 years of operation, while LendingClub is still recording losses after 15 years of operation.


The above is Dmitriy Berenzon’s comparison between LendingClub and Maker.

DeFi makes the software economics of financial services possible. 

Faster. The cost is lower. better. financial.

Here is Dmitriy’s explanation of why DeFi is devouring finance, and some clues that inspired it.



DeFi eats up the financial system. 

DeFi: Cloud Financial Services

Although software has been eating the world in the past few decades, it has done a relatively ordinary job in disrupting financial services.

Due to entrenched incumbents, high switching costs, and regulatory issues, the industry’s innovation is mainly around channels (such as your favorite mobile banking app). This has brought a very good change to the user experience, but the underlying value chain and cost structure are still largely based on the system developed in the 1970s.

DeFi applications are rebuilding financial services from the foundation, replacing humans with machines, replacing paperwork with codes, and replacing legal execution with crypto execution. Therefore, their operating costs are several orders of magnitude lower than their counterparts.

Interestingly, this evolution of financial services is similar to the evolution of the software industry ; as software evolves from a single infrastructure and applications to microservices in the cloud, cost efficiency has been achieved and new business models have been invented.

In this article, I will outline the evolution of the software industry, compare it to financial services, and discuss how these changes have led to fundamental improvements in the latter’s economy and profitability.


Traditional financial services are like software before the establishment of the Internet

Before the advent of the Internet, software vendors had high fixed costs and thresholds. In the 1960s, when the purchase cost of computers was too high, vertically integrated vendors would invest a lot of money to develop and distribute software through their private networks.

For example, Computer Sciences Corporation spent US$100 million (worth about US$900 million today) to develop “Infonet”, a mainframe network that provides (via telephone communication lines!) computer power and software such as brokerage services and hotel reservations .

1625295740499116Traditional finance also has similar dynamics. Due to high barriers to entry and economies of scale, vertically integrated banks ultimately provide most of the core banking services, such as accepting deposits, lending, transferring funds, issuing debt, establishing clearing houses, and, in the case of a central bank, managing money supply. These services are costly and involve physical presence, manual and paper-based processes, and complex and isolated infrastructure.

Fintech is like software supported by the Internet

Since the 1990s, the Internet has facilitated a new software delivery model; software no longer exists in independent instances on people’s computers, but in the cloud and delivered remotely.

This, in turn, led to the rise of software as a service (SaaS), which is an innovation in business models where software is licensed on a subscription basis. Compared with local methods, SaaS provides users with many advantages, such as browser-based accessibility, automatic updates, and lower total cost of ownership.

Fintech and Internet software have similarities. Both use emerging technologies to innovate products and business models. Chime uses online channels to expand coverage and reduce physical expenses for retail banks. Robinhood has adopted a business model that replaces commissions, namely “payment for order flow” to provide “free” retail transactions. Transferwise circumvented the correspondent banking system and created a two-sided market to make net payments for people who send money in opposite directions around the world.

All these companies are valuable, but Chime still depends on Visa (started in 1958), Robinhood still depends on DTCC (started in 1973), and Transferwise has not replaced ACH (started in 1972) or SWIFT (started in 1973). year).

DeFi is like cloud software

“Modern Cloud” began with the release of Amazon Web Services (AWS) in 2006, and many applications were migrated in the following ten years.

Nevertheless, most of them are still “cloud-enabled” rather than “cloud” applications, which means that they are likely to still have monolithic and dependent modules that cannot be upgraded individually without changing the entire application .

On the other hand, cloud applications are structured from the ground up in order to run in public clouds like AWS. They take advantage of resource pools, rapid resilience, and on-demand services. They are also built on a microservice architecture and are designed as independent modules to serve specific purposes. Today, many applications are also running on a serverless architecture, which allows developers to purchase back-end services on a “pay-as-you-go” basis. These design patterns can also be used in tandem to form the so-called serverless microservices.

The crypto network realizes serverless financial microservices. This is possible because the crypto network itself is a business model innovation; it replaces the supplier to provide infrastructure and services in a contractual manner in order to obtain dollar-based compensation; it is provided by a distributed network composed of “nodes” (ie computers) These functions to earn protocol tokens, in fact, become part of the owner of the network.

Don’t confuse this with the logic of “Blockchain is not Bitcoin”-protocol tokens are necessary to incentivize “third-party vendors”.

1625295740508912Source: Chris McCann

Because of this, DeFi realizes many benefits that financial services do not have from the software and SaaS economy. Specifically, solitary transaction processing and banking systems are replaced by global blockchains and related smart contracts and node infrastructures, which can save a lot of costs. In addition, applications benefit from instant interoperability and single sign-on (user’s public/private keys) after deployment.

This reduces the need for multiple market infrastructure vendors to build effective identical systems (for example, there are approximately 100 ACH systems around the world), as well as applications to build and maintain their own back-end infrastructure.

This proposition is more attractive to application developers because it is not that they pay for the use of the “financial cloud”, but the user pays “gas” to the miner/verifier in the form of each interaction. In other words, transaction, service, and infrastructure costs are all tied into a single gas fee.



Example of serverless architecture. Source: Badri Janakiraman. Badri Janakiraman

In addition, external service providers often perform core functions of the application, such as liquidators on Compound and liquidity providers on Uniswap. In addition, once the smart contract is deployed, there is no additional maintenance cost for the service, so the marginal cost of acquiring an additional user for the application is zero.

This cost structure enables the DeFi protocol to achieve cash flow even under high churn rates and low revenues.

Compare companies and agreements

Nothing is completely equal, but let’s use a set of three most closely related examples of income statements to make the best comparison: Deutsche Bank, Lending Club, and MakerDAO.


Source: Deutsche Bank

In 2020, Deutsche Bank’s infrastructure, real estate, and operating-related expenses are worth US$8 billion, accounting for 64% of its overall operating expenses. For such a large structured organization with decades of technical debt, this cost structure is predictable, but we can do better. 


Figures are in thousands; source: Lending Club, MakerDAO

In 2020, Lending Club’s operating expenses may exceed 50% due to personnel and hardware, software and maintenance costs. If the company has a more streamlined cost structure, it is likely to be profitable. 

Although most of MakerDAO’s operating expenses are due to head fees, it accounts for a small percentage of the overall net income, resulting in a profit margin of 99%, compared to -60% for Lending Club. It should be noted that these are not the “full” costs of MakerDAO, and these costs will increase as the additional costs of the foundation (such as Oracle operations and token-based compensation) are transferred to the DAO.

Look to the future


DeFi devours the financial system. Photo: Logan Craig

In the next ten years, the DeFi protocol will be used as a “financial microservice” for traditional financial institutions and traditional financial technology companies. These institutions will use DeFi as their back-end infrastructure and will effectively become a distribution channel for various customers, demographics and geographies.

Although the DeFi agreement may add additional costs to enable them to further integrate with the fiat currency economy, it will still be more efficient than the current market structure and business model. 

I am very happy to see a series of booming DeFi applications, which will serve as new infrastructure to provide various financial applications for people all over the world.

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