Banking Sector Stumbles Are Boon For DeFi

DeFi

The recent wave of bank closures across the US has highlighted the vulnerability of the traditional banking system, prompting crypto industry experts to advocate for decentralized financial infrastructure as a more secure and reliable alternative.

Cracks across international banking sectors are being papered over by regulators hellbent on preserving the status quo, Blockworks was told.

Rob Alcorn, CEO and co-founder of DeFi credit marketplace Clearpool, argues that while some of the closed banks had significant connections to digital assets, the primary factors contributing to their failures were monetary and prudential policy decisions that impacted liquidity and market structure.

“In the short term, there will be additional headwinds for some crypto market participants to access USD-based banking services,” he said. “But the knock-on effects will continue to have more of an impact on centralized institutions than on decentralized protocols.”

Silicon Valley Bank’s demise has all but reignited the focus on financial institutional reforms that were wound back during the presidency of Donald Trump in 2018 — namely the Dodd-Frank Act.

The act was passed by Congress in 2010 as a response to the severe economic downturn caused by the bank-induced Great Financial Crisis two years earlier.

Part of the act was to classify banks with more than $50 billion in assets as “too big to fail,” making them subject to heightened prudential standards such as stress tests, capital planning, and liquidity requirements.

This provision, in turn, gave the US Federal Reserve greater regulatory power over banks, even those it did not directly supervise.

However, the Dodd-Frank Act faced resistance from the financial industry, which viewed the regulations as excessive and aimed primarily at the largest banks.

As a result, Congress passed a law under the Trump administration that eased some of the Dodd-Frank rules for smaller and mid-tier banks, after years of political pressure.

Blame games and finger pointing

Abroad, conditions are also beginning to fracture.

Following a recent sell-off of Credit Suisse stock and credit default swaps, regulators have issued a statement affirming the bank meets the higher capital and liquidity requirements for systemically important banks.

They have also pledged to provide liquidity to the bank if necessary, a move that was largely derided during the 2008 financial crises among politically and financially motivated activists.

Proponents are now pointing fingers at digital assets as the catalyst for the failure of Signature Silvergate and Silicon Valley Bank, leading to a blame game amongst regulators, crypto enthusiasts and market participants.

Alessio Quaglini, the CEO and co-founder of Hex Trust, told Blockworks the hostility towards crypto is less relevant than the failure of the overall banking system.

“Compared to traditional finance, counterparty risk is far more transparent with decentralized finance and it’s events like these that make investors realize there is an alternative,” he said.

Bitcoin was designed for this exact moment and has performed as intended during times of fiat instability via its decentralized nature, the co-founder added.

Decentralization is a fundamental aspect of crypto finance that provides several key benefits, according to industry experts.

It’s supposed to mean there exists no central authority or single point of control that can manipulate or censor transactions.

In the ideal, decentralization is meant to create a more resilient defense against attacks while making it less vulnerable to corruption. It is often harder to implement in practice, as hacks and exploits targeting multi-sig wallets and price oracles across various protocols in recent years can attest.

Another important aspect of decentralization is its allowance for greater privacy and security.

Since there is no central database of user information or transaction history, it becomes more difficult for malicious actors to gain access to sensitive information, or so the argument goes.

Decentralization also promotes innovation and competition by allowing for a level playing field where anyone can participate and contribute to the development of the system.

Building the necessary rails

In order to fully realize the benefits of decentralization, appropriate infrastructure is essential. This includes secure and reliable networks, decentralized storage and computing resources, and user-friendly interfaces that enable people to interact with the system easily and safely.

Setting up appropriate infrastructure is useful because it helps to ensure that the system is secure, efficient, and accessible to everyone, the industry experts said.

It also helps to foster trust and confidence in the system, which is crucial for widespread adoption and acceptance.

Ultimately, building the right infrastructure is key to realizing the full potential of crypto finance and creating a more decentralized, universal and equitable financial system, they said.

Hamilton Keats, CEO, and co-founder of Krayon, also sees the recent banking crisis as a sign that the traditional financial system is weakening.

Keats points to the Federal Reserve’s decision to raise rates too quickly in an attempt to combat inflation as a key factor contributing to the crisis.

“Yes, SVB’s failure to hedge its duration risk was a catastrophic failure in risk management, but they’re not the only bank at risk, and we’re now seeing rumblings throughout the sector,” he said.

Conversely, blockchain-based payment infrastructure and decentralized monetary systems have been working effectively to build investor confidence, abstracting away from the manual interventions of the existing banking systems and providing risk visibility, Keats added.

“Whilst the effects of this recent crisis are likely to be short-term, we’ll likely see a move towards the crypto asset ecosystem over the longer term, where on-chain transparency brings trust.”