An understanding of what is a Decentralized Bank and How is it Different From Traditional Banks?
The recent years have seen the erosion of public trust in the traditional banking system. People are seeking an alternative, a system that gives them complete control over their deposits and investments. The trustless, decentralized universe of digital currencies promises them that. And, therefore, a decentralized banking system is no longer a farfetched idea but is gaining mainstream acceptance. Even the conventional financial system purists are now talking about it.
Why Decentralised banks are the future?
The collapse of confidence in the banks is primarily due to the financial crisis of 2008, banking scams across the world, and mismanagement by the top executives. The inherent qualities of a decentralized bank ensure that its participants are unlikely to become a victim of a financial crisis or scams and lose their digital-assets due to opaque transactions and mismanagement by the top executives.
What is a Decentralized Bank?
In July of 2018, popular crypto exchange Binance announced its investment in Founders Bank, which is set to become the world’s first decentralized and community-owned bank. Once it obtains its European Union banking license, the bank will allow all market participants to become its co-founders and adopt a blockchain governance model. There will be greater transparency as a result of that. Greater transparency is one of the strongest points of a decentralized bank, which operates on the concept called trustlessness. It also cuts out the role of the intermediaries.
The middlemen are replaced by smart contracts and peer-to-peer service, which enable the direct transaction between the lenders and borrowers. Anyone from any location in the world can become a part of this banking system, which is not possible with the traditional banks. A person just needs a cell phone or a desktop and an internet connection to access the decentralized bank from anywhere in the world.
The decentralized bank primarily enables the lending of the cryptocurrencies (and not fiat currencies) whose underlying technology is blockchain.
How Decentralized Bank Differs From Traditional Banks?
Unlike a decentralized bank, the traditional banks cannot function without intermediaries. Also, trust is the key to its operation. It is at the heart of the relationship that they have with their clients, who have no say in its governance or its lending process. Moreover, traditional banks offer no financial freedom, and they have no technology in place that ensures the democratization of their financial systems.
Here are major differences between a decentralized bank and a traditional bank.
In the traditional banking system, the intermediaries decide whether to lend someone the money or not. The fund-owners have no authority to decide that. Neither the bank informs them how they are using their funds. Its transaction process is opaque, and there is too much paperwork. There is also a geographical limitation to banking. Not anyone from any location in the world can borrow money from the traditional bank. Also, they cannot borrow from the bank if they don’t have a good financial record.
The decentralized bank, too, offers lending services like the traditional bank. It, however, does not have a building. It is in the form of a computer interface that can be accessed via the internet from anywhere. It also does not have decision-making meetings chaired by the top management or intermediaries who approve or disapprove a loan request.
People are particularly skeptical about the people running the existing banks. The decentralized bank has no place for them. It has smart contracts and peer-to-peer (P2P) systems that facilitate direct lending between two strangers. The process is fast — as there is no one scrutinizes financial history — automated, and the transaction fees are zero or very minimal. The traditional bank usually charges a hefty transaction fee.
Blockchain Technology playing the pivotal role
The blockchain technology is the distributed, decentralized ledger that records all the transactions. It keeps track of all transactions publicly and transparently. A lender does not have to depend on the intermediaries, to check if the loaned digital-asset has reached the intended participant. The ledger is immutable so no one can make changes to it. The traditional bank’s systems have no such technology. So, the fund-owners are always in the dark about the bank’s borrowers, and there are times, some bank executives alter data to hoodwink the investors and regulators.
Smart contracts are self-executing contracts. They feature the terms and conditions agreement written into lines of code, which exist on the decentralized blockchain network. And, in the decentralized banking system, they enforce the obligations of the participants, ensure credible transactions, and eliminate the need for middlemen. They also keep the transaction process conflict-free and accurate. Moreover, smart contracts enable cross-border transactions. The traditional banking system has no smart contracts, and it is the middlemen who oversee the transaction process and enforce obligations of the borrower and the lender.
With the cryptocurrencies market rapidly expanding, it is expected that more decentralized banks would come up in the future.