In the last years, public trust in traditional banking systems has been greatly diminished. People are looking for alternative systems that can fully control their deposits and investments. The world of crypto where you do not need to trust anybody because you can verify and where no third party is needed to give you permission guarantees this to them. Therefore, the decentralized banking system is no longer a fantasy but a reality that is recognized and it is gaining popularity.
Why the decentralization of the banking system is the future?
The loss of trust in banks started mainly due to the beginning of the 2008 financial crisis, large-scale bank fraud on a global scale, and poor management of top management. The intrinsic nature of decentralized banks ensures that participants can escape financial crises or fraud crises with great probability and will not lose their digital assets because of non-transparent transactions and poor management of top officials.
What is a Decentralized Bank?
In July 2018, Binance announced the investment in Founders Bank. Founders Bank will be the world’s first decentralized and community-owned bank. Once an EU bank license is obtained, the bank will allow all market participants to become their co-founders adopting a blockchain governance model. This will increase transaction transparency which is the biggest advantage of decentralized banks. The decentralized bank philosophy is to verify and not trust while removing the role of intermediaries.
Intermediaries are replaced by smart contracts and peer-to-peer operations, allowing direct transactions between lenders and borrowers. People anywhere in the world can be a node in the banking system, something that traditional systems can’t do. A person only needs a mobile phone or a computer to access the Internet and can access decentralized banks from anywhere for 24 hours a day and 7 days a week.
“We are not only excited to be one of the first investors of this inclusive community for this pioneering initiative, but also look forward to exploring the full range of its banking services. We continue to be delighted by the vibrant blockchain opportunities in Malta, and look forward to launching more partnerships in the region.” — said Changpeng Zhao, Founder & CEO at Binance.
Decentralized Banks Vs Traditional Banks
Unlike decentralized banks, traditional banks cannot operate without intermediaries. Also, its operation is based on trust. This is where it is based on their relationship with their customers, who just have to trust the bank without a say in their governance or lending. In addition, traditional banks do not provide financial freedom and they do not have the appropriate technology to ensure the democratization of their financial systems.
This is the main difference between a decentralized bank and a traditional bank.
Lending and Borrowing
In the traditional banking system, the intermediary decides whether to lend money to someone. The fund owner has no right to decide. Neither the bank tells them how do they use the funds. The whole process is non-transparent. Traditional banking also is more geographically limited because not anyone from any location can borrow money from the bank. Moreover, if an individual’s financial situation is not good, the bank will not lend him money.
Decentralized banks can provide lending services like traditional banks. However, it does not need to have a physical office but is simply is a computer interface that can be accessed via the internet from anywhere in the world. No Intermediary needed and no bank management officials need to approve the loan. A good example the decentralized finance is DeFi.
Blockchain Technology is The Key in Decentralized Banking
Blockchain technology is a distributed, decentralized ledger that records all transactions. The lender does not have to rely on the intermediary to check whether the borrowed digital asset has reached the expected borrower. Distributed ledgers are non-tamperable, so no one can change them. Traditional banking systems do not have this technology. As a result, fund owners are always uninformed of bank borrowers, and sometimes, some bank executives modify data to deceive investors and regulators.
Smart Contracts Governance In The Decentralized Banking System
Smart contracts are self-executing contracts with terms and conditional protocols written in lines of code that exist in the decentralized blockchain network. Ethereum is the first blockchain-based on smart contracts.
In the decentralized banking system, they enforce the obligations of the participants, ensure credible transactions, and eliminate the need for intermediaries, and also ensure that the transaction process is conflict-free and accurate. In addition, smart contracts enable cross-border transactions.
The traditional banking system does not have a smart contract, and it is the obligation of the intermediary to supervise the transaction process and execute the borrower and the lender.
In short, with the rapid expansion of the cryptocurrency market, more decentralized banks are expected to emerge in the future.