- Legacy banks cannot compete with yield rates offered through the Ethereum network and by decentralized finance applications.
- Centralized cryptocurrency exchanges stand to benefit tremendously by offering a platform for this yield.
- Beginning next year, Ethereum's staking rate will likely be used as a benchmark for global digital asset portfolio performance.
- As a result, over time, Ethereum will elevate to become a global macro force akin to the US bond market.
We are at the forefront of an explosion in innovation. The seeds for what is about to happen were first planted during the dot-com bubble at the turn of the millennium. These information-based concepts, projects, and motivations have since gestated for the past 20 years. In 2021, they are finally exploding into fruition.
The past year has seen significant growth in cryptocurrency adoption and perhaps marked the beginning of a multi-year downtrend for legacy banking. If you take China as a typical example for country-wide financial innovation, it paints a pessimistic future for the value of legacy banks. Fundamentally, this bleak outlook is due to two overarching reasons:
- Central banks are no longer necessary to protect assets.
- Central banks no longer maintain a monopoly over financial transactions.
Due to cryptography, the monopoly over protection that nation-states and banks have maintained for the past 200 years is over. When combined with decentralized networks, cryptography has the potential to change essentially every aspect of society. In short, cryptography is the innovation that renders banks unnecessary and that defunds the welfare state. This is because cryptographic assets finally give consumers a way to opt out of the government-based and location-based international economy. For the first time ever, rather than remain oppressed by outdated and parasitic regulations, individuals can simply leave by shifting their funds into the metaverse.
The internet, decentralized networks, and cryptography are collectively the first technological innovations in history that are not location-based. Thus, these location-agnostic innovations will drastically affect any conventional infrastructures that are location-based. Among all of this, legacy banking will be the first to take damage from crypto.
Currently, Ethereum (ETH-USD) maintains consensus and security through proof-of-work mining. Miners on the Ethereum network validate, aggregate, and submit transactions to the blockchain. The miners are paid through 'block-rewards' (created by minting new Eth) and by dividing a percentage of Ethereum's fee revenue in concordance to the hash power that each miner contributes to the network.
In about a year, Ethereum will shift its consensus mechanism to proof-of-stake. Proof-of-stake uses no energy intensive algorithms and aims to increase Ethereum's scalability. Rather than require specific hardware to 'mine' and participate in fee revenue, proof-of-stake simply requires participants to lock-up Ether in a deposit contract and to optionally run a validator node. Since there exists no physical barrier to participate, anyone who owns Ethereum will maintain the opportunity to stake their value and collect rewards. In fact, many exchanges already offer staking opportunities in preparation for Ethereum 2.0.
When Ethereum finally shifts to proof-of-stake, it will majorly disrupt the jurisdictional power of legacy banks and traditional financial institutions. In fact, it seems this disruption is already occurring. The heightened regulatory talk within the United States in the past few months is likely because crypto-yield has attracted so much attention that banks are already starting to feel it. Certainly, Coinbase's (COIN) recent failure to launch a cryptocurrency lend feature points to this thesis.
[Note: Coinbase tried to offer users 4% APY on their stablecoin, USCoin (USDC-USD). The interest intended to be funded through a cryptocurrency lending program. However, the SEC shut down these plans after declaring the feature to be a security. The whole situation is messy and can fill an entire story of its own. If you want to read more, I suggest you see Cointelegraph's article and Brian Armstrong's tweets.]
The RPY on staked Ethereum is estimated to be between 4% - 7% annually. Traditional banks cannot currently compete with these interest rates. Furthermore, since Ethereum is decentralized, the SEC cannot necessarily 'ban' or even effectively regulate this yield. Once Ethereum shifts to proof-of-stake and offers risk-minimized high-percentage returns, legacy banks will have no choice but to contend with these rates. To reiterate my past point, the monopoly over money held by nation-states and central banks is increasingly weakening.
Banks' Biggest Competition
Going forward, the most influential and controversial players in financial technology will continue to be centralized cryptocurrency exchanges. As we progress into an increasingly information-based economy, these exchanges will exist as battlegrounds between the enforcement of traditional regulations and the spread of decentralized innovation. Legacy banks, the SEC, payment networks - all the big players in traditional finance are already aware of this. However, it is still unclear how the future will play out.
Centralized cryptocurrency exchanges presently have the unique opportunity to exist as meeting points between retail investors and decentralized finance applications. Clearly, the demand for DeFi already exists. However, the complexity that comes with using DeFi applications has heretofore acted as a stiff barrier to entry. If cryptocurrency exchanges are eventually given the green light to offer DeFi opportunities through their smooth and efficient platforms, then I predict massive amounts of funds would shift out of legacy banks.
Evidently, the Ethereum network serves many unmet investor demands. In fact, this is precisely why Ethereum is so disruptive. Retail investor's hunger for yield is being satisfied by a more efficient financial ecosystem. For the first time ever, Ethereum allows normal people to partake in financial opportunities once limited to 'accredited investors'. Provided they are given the regulatory permission to host Ethereum's DeFi applications, cryptocurrency exchanges stand to achieve astounding growth. However, US regulators do not seem keen on this. Since crypto is difficult to tax, regulators are presently choosing to ignore it.
"First they ignore you, then they laugh at you, then they fight you, then you win" - Mahatma Gandhi
Ethereum Staking as a 'Risk-Free Rate'
Regardless of the state of regulation, the crypto-metaverse continues to grow. A concept I do not hear discussed enough is the idea that Ethereum's staking rewards may eventually act as a 'risk-free' (or more accurately, 'risk-minimized') rate, upon which the flow of the information economy is commanded. In this context, Ethereum's fluctuating staking rate would act as benchmark against which all other digital asset portfolios are measured. In Ethereum's digital economy, the staking rate would serve the same function as the US Treasury bond market.
To clarify, the cost of capital in the traditional economy is dependent on US Treasury bonds. How risky individuals and corporations manage capital is dependent on the risk-free yield they can alternatively receive in dollars on the bond market. Separately, in the metaverse, Ethereum's staking rate will likely be the most risk-minimized way to receive yield on digital assets. For Ethereum's staking rate to serve this purpose, two overarching factors must be true:
- Ethereum must exist as the largest and most decentralized smart-contract platform on Earth.
- Ethereum must always be solvent. The Ethereum 2.0 protocol must always be able to print more Ether to pay stakers.
My article here explains my thesis that Ethereum will continuously grow to become the most fundamental settlement layer for the Web3 transactions. If this occurs, then Ethereum will elevate to become a powerful global macro force. An important factor to note is that as Ethereum grows and matures, so too does its security. Eventually, Ethereum may expand and decentralize to such an extent that its foundational layer-1 security will maintain a level of trust akin to the faith that people currently have in US Treasury bonds.
Lastly, I believe it is the case that once Ethereum shifts to proof-of-stake and offers 4% - 7% annualized yield, the majority of retail investors will prefer to access these returns through centralized exchanges. This, combined with similar returns available on stablecoins, will likely be the most important factors that draw investors out of traditional institutions and into cryptocurrency exchanges.
The Metaverse has no FDIC insurance
My general thesis in this piece is that Ethereum's opportunities for high-interest yield will incentivize individuals to leave the legacy banking ecosystem. However, for someone to leave the legacy financial ecosystem and shift to Ethereum, they have to first change their mindset to trust code more than institutions. Due to this, it might be misguided to expect older investors to rush into crypto.
Ethereum and its decentralized finance applications do not offer insurance. If your funds are somehow lost, then you are simply out of luck. Currently, risk-aversion is the biggest drawback against using decentralized assets as investment vehicles. Many people believe regulation will inevitably alleviate this risk, however, I disagree. At the moment, it doesn't seem that nation-states want to encourage crypto. Rather, they just want to tax the gains.
To conclude, here is a summary of my most important points:
- Legacy banks no longer maintain a monopoly over financial transactions and are no longer necessary to protect assets.
- The biggest threat to the health of legacy banks are centralized cryptocurrency exchanges.
- If cryptocurrency exchanges can offer DeFi applications through their smooth platforms, the high-yield opportunities will spur momentous user growth.
- Due to low risk and high returns, Ethereum staking will be the most popular feature that retail investors want to be offered on cryptocurrency exchanges.
- It is currently unclear what US regulators plan to do about any of this.
- As the crypto-metaverse grows, Ethereum's staking rate will evolve to become a benchmark for digital asset portfolio performance.
Overall, the main idea I want to stress is that financial technology is rapidly evolving. If US regulators do not let cryptocurrency exchanges host DeFi applications, then retail investors will find another way to reach these applications. In this context, strict US crypto regulation would simply incentivize Americans to move their funds elsewhere.
It seems that legacy banks are currently faced with a 'join or die' scenario. Simply put, retail investors want high-interest yield. Correspondingly, these investors will flock to whatever applications can securely provide this yield. In terms of DeFi, the cat is already 'out of the bag', so to speak. Many tech-savvy investors are already maintaining high yield on DeFi applications such as Aave, Curve, Compound (COMP-USD), and many others. Less tech-savvy investors will absolutely shift their funds out of the jurisdiction of legacy banks if similar yield is offered through centralized cryptocurrency exchanges. Furthermore, even if US regulators ban centralized exchanges from hosting DeFi, eventually, these DeFi applications will improve to such an extent that there no longer exists a technological barrier entry. Then, once again, retail investors would be incentivized to leave their traditional banks.
Technology is gradually shifting, evolving, and connecting the global economy. Since it is an open network, Ethereum flourishes in an increasingly global world. Going forward, it will be interesting to see how traditional institutions and regulators respond to the growth of Ethereum and decentralized finance.
Disclosure: I/we have a beneficial long position in the shares of ETH-USD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.