2019 was marked by a boom of DeFi apps and neobanks. Both form part of the wider fintech industry, and both can change the way people view and use money. But you shouldn't lump them together. In this post, I'll explain the subtle differences between decentralized finance and neobanking apps.
A very basic definition
The problem with neobanks and DeFi apps is that it's hard to define where they start and end. Fintech is a spectrum, where different types of services merge into one another. Here's a simplified definition:
A neobank is an app (mobile, web-based or desktop) that lets you manage your fiat money in the same way as banks do, but doesn't have any physical branches; everything is done online.
Service range: money transfers, loans, payments, ATM withdrawals, trading, currency conversion.
A DeFi service is an app (mobile, web-based or desktop) that lets you manage your crypto assets in a decentralized way – that is, trustlessly via smart contracts.
Apart from these two types, there's a wealth of fintech apps that can't be categorized as either DeFi or neobanks. I'll return to them at the end of the article.
Now, let's compare our two kinds of apps using various criteria. In the process, it will hopefully become clear how they are similar in many ways, yet different in others. You'll also see that there are no sharp black-and-white divisions, but rather many shades of grey.
1) Asset type
This is perhaps the most obvious difference. Neobanking services focus on transactions with fiat money – USD, euro and so forth. For instance, Monzo supports 140 fiat currencies.
At the same time, a neobank can offer cryptocurrency exposure. For example, Revolut allows its Premium clients to convert fiat into crypto and send it to others within the app, though you can't withdraw this crypto to an external wallet.
By contrast, DeFi apps are designed to manage crypto. A 100% decentralized DeFi app can’t offer any fiat services, because it's not possible to convert crypto into fiat and back using smart contracts.
However, DeFi projects need to give customers a way to deposit and withdraw fiat money if they want to achieve mass adoption. This means involving centralized organizations in the process. For example, Maker has just signed an agreement with the payment provider Simplex to create a fiat on-ramp for its stablecoin DAI.
2) Regulation and licensing
Most countries don't regulate virtual banking, so a neobanking app doesn't need to be registered as a bank. Instead, it can establish partnerships with real banks and simply act as an interface.
Still, there is a trend for larger neobanks to obtain full banking licenses. Revolut, Monzo and N26 have all gone this route.
With a license comes a full KYC and a proper account opening procedure. You'll need to fill a registration form and provide an ID photo and a selfie for the KYC. It can take over an hour for your account to get approved.
DeFi projects generally operate without any financial license. You can take out a loan or lend your crypto assets and earn an interest – all without as much as providing your email address.
So far DeFi apps are flying under the radars of the regulators, but it's not clear how long this will continue. If governments introduce obligatory registration as financial institutions for DeFi, this could endanger the whole decentralized business model. We'll just have to wait and see.
The differences in availability stem from the licensing and regulation rules.
DeFi apps are unregulated, so they are available in all countries where you can use Internet and crypto. You don't need to tell the app your name or address.
By contrast, neobanks are regulated, so they face certain restrictions on who they can and can't serve. For instance, Monzo is only available to UK residents, while Chime works solely in the US. Revolut can be used by residents of the European Economic Area (EEA), Australia, Canada, Singapore, Switzerland, and the United States. N26 supports most EU countries, plus the US.
In DeFi, the main criterion of growth is the amount of funds locked in the smart contract of each app. You can find this data on DeFi Pulse, for example. The amount is in USD equivalent, so it changes together with crypto prices.
At the time of writing, a total of $732m were locked in all DeFi apps. A year ago, in March 2019, it was just $313m. This means an increase of 133% in just one year – an impressive figure. (In mid-February 2020, when the price of Bitcoin exceeded $10,000, the value reached $978m – a 212% year-on-year increase.)
5) User numbers
Instead of the number of individual users, DeFi operates with the number of unique addresses (active wallets). This number also exploded last year. In February 2019, Maker – by far the largest DeFi app – had only 7,300 active DAI addresses. By September, there were already 66,000 addresses – a 9x growth.
At the same time, the number of active Ethereum wallets that interacted with DeFi apps rose by over 500% in 2019 to reach 19,000, according to DappRadar. But in absolute terms the numbers aren't so impressive: no more than 1000 daily unique addresses.
When we look at neobanks, the number of users is estimated through the number of downloads. The growth rate here isn’t quite as impressive as with DeFi, but the absolute numbers are far greater. According to Accenture, neobanks' user base grew by 150% in 2019, from 7.7 million to almost 20 million. It's 1000 times more than the number of wallets interacting with DeFi services.
Neobanking apps are known for their crisp minimalist design and great UX. They are also mobile-first, meaning that the mobile version always takes priority. Some, like Revolut, can seem complex at first sight, because there are so many different services. But the overall UI/UX quality is high. Neobanks clearly allocated big budgets for design and testing.
By comparison, many DeFi apps look and feel unpolished and not too user-friendly. Few of them have native mobile apps, and there aren't enough tutorials and beginner guides. Considering how complex the process of lending, trading or transfers can be on DeFi platforms, this can scare off some potential users.
Monzo clearly looks like a 'real' app, designed to be intuitive and pleasant to use. Maker has a bare interface with many confusing terms that aren't properly explained. Clearly, it's aimed at experienced crypto users.
7) Payments and cards
Most people use neobanks as an easier, faster, cheaper way to pay, especially internationally. You can pay abroad and send money overseas at the interbank rate, without paying a conversion fee. You can both link your neobanking app to Google Pay or Apple Pay or use the neobank's prepaid card.
Meanwhile, the DeFi industry is still working on ways to make crypto transactions faster and cheaper. As long as a single Bitcoin transaction takes up to an hour to complete, crypto won't be able to compete with fiat as a universal means of payment. Examples of projects include Lightning Network (BTC, instant), xDai (ETH and DAI, under 5 seconds) and Connext (ETH, instant).
There are also DeFi-friendly interfaces and wallets that allow users to integrate different DeFi apps in a single dashboard with a better design. Essentially they try to imitate the stylish look and good UX of neobanks but for DeFi protocols (Compound, Maker, etc.). In this category, we can name Zerion, Argent and DeFiSaver.
8) Borrowing money
Crypto lending is the most popular DeFi service, while it still plays a minor role in the neobanking business. Usually you borrow from other users (P2P lending), who get most of the interest you pay. DeFi loans are always in crypto, and you need to provide collateral in a different crypto asset. The collateral is always larger than the loan itself. But you don't need to provide any personal or financial information, and the loan is instant and automatic.
With neobanks like Revolut or Monzo, you can get a fiat loan on the same day, though it's not instant. The procedure is easier than with a regular bank: the neobank will review your profile and credit history and perhaps ask you to provide an income statement. APRs range from 3.5% to 20%.
9) Earning an interest
In DeFi, lending is just the other side of borrowing: users lend to each other to earn an interest. Interest rates can be very attractive: for example, you can earn 8.5% when lending DAI on dYdX.
Since you don't know who you are lending to, your funds are protected by a large collateral. If the borrower doesn't repay, or if the price of the asset falls, you can liquidate (sell) the collateral to get your money back.
Some neobanks also offer saving accounts that pay interest. You can earn 1.35% with Revolut, 1.30% with Monzo, and 1.10% with Chime.
Neobanks and DeFi apps both tackle the same problem: helping users manage their money independently, without going to a bank or doing paperwork. The main difference is that neobanks target fiat users, while DeFi services are aimed at crypto holders. But gradually neobanks are adding cryptocurrencies to their services, while DeFi platforms are starting to integrate fiat support.
Apart from the fiat/crypto divide, the range of services offered by the two types of apps is similar. You can send, borrow and lend money, pay for purchases, and trade assets. Does this mean that eventually the two will come together?
Will we see unified crypto/fiat neobanks that allow you to pay in hundreds of digital and fiat currencies, freely convert them into each other, or buy tokenized securities? Perhaps this is the best route for fintech to follow - a very exciting possibility indeed.