How COVID19 has sped up the growth of decentralized finance (Defi)
The world is in a health and economic crisis right now due to the spread of the coronavirus. While some countries have started to open up, some have been forced to close back again due to the 2nd wave of increased cases, ie India and possibly the US now. This lack of economic activity has caused many companies to fail. The response by the Fed has been to loan money to these struggling companies and effectively bail them out. What initially started out as short term loans has eventually got longer and longer as short term interest rates have effectively reached 0. The companies still struggle to survive and are unable to pay back the loans hence require longer-term loans. Lowering the long term interest rates of government loans is known as quantitative easing or QE.
When an economy is in trouble and needs money to keep the system running, there are a few ways to get this money. You can borrow the money from your past, aka tap into your reserves, borrow from the present, aka cut back on consumption or borrow from the future, aka increase government debt. What many countries are doing with QE and other fiscal policies is to borrow from the future, and continue kicking the bucket down the road.
What is so bad about QE? Why can't we just do it infinitely since it seems to solve the problem?
A case study of infinite QE is Japan. Japan has the largest debt to GDP ratio in the world at 254% in 2017. It owns 80% of its own county's stocks and 40% of its own country's debt because it has been buying up so much of the country's debt. The US, on the other hand, has a debt to GDP ratio of 105%, but what is alarming is that it is growing at an exponential rate and is projected to reach 150% by 2050. Debt to GDP ratio of 100% means that a country has to work for an entire year and consume nothing to pay back all the debt that is owed.
Japan's economy has been in decline for the past 30 years, its peak was in 1989 where the Nikkei 225 index was at 40k, today the index is at 22k. The reason for this is that as the government starts propping the economy up and not allowing bad companies to fail, the result is that the economy is filled with bad companies and there is no real innovation and growth. Good companies start to leave as well when they realize the economy is going downhill, and the government needs to pump even more money into the economy which exacerbates the problem.
What is Decentralized Finance and how does it solve this problem?
Decentralized Finance or defi, provides savers with an alternate way to grow their wealth with higher interest rates on the platform of their choice. This is done by lending out cryptocurrency on Ethereum-based platforms such as MakerDAO or Compound.
The result of QE is that interest rates for banks are kept at 0%, while inflation is at 2-3%. This means that savers are paying the penalty for the corporates who have become too big to fail. The value of their savings if kept in a bank account is being eroded year after year.
Defi lending for stable coins like the USDC can be as high as 12% on platforms like NUO or as low as 0.15% on Coinbase according to defirate https://defirate.com/lend/ While there are risks such as smart contract risks where bugs could be present in the smart contracts and large volatility of crypto prices, the defi space has provided an alternative avenue for savers who do not want to pay for the irresponsible behaviour of corporates.
The US is the world's reserve currency yet having printed $3 trillion US dollars in the space of 4 months from Feb to June this year, bringing the overall currency in circulation from $4 trillion to $7 trillion, is a huge warning sign for many countries. Many people have turned to defi as a way to hedge against all this money printing as total value locked in defi has almost doubled from $900 million to $1.6 billion over the same time period.
@Reiko great one, you are absolutely right and there is no way DeFi will or can be stopped, there are more and more new platforms evolve like Nash or Celsium Network, Switcheo is also joining this revolution very soon. We will see this financial transformation, it will happen soon