Decentralized Finance and Bitcoin: Is a Bitcoin Bank Viable?

In the last 10 months, the Bitcoin price has increased nearly four-fold, going from a yearly low to a yearly high. Despite the massive opportunity for capital appreciation alone, many people lend out their Bitcoin in exchange for an interest payment. The viability of such a business model has been questioned time and time again, especially because the platforms facilitating this exchange are young and mostly uninsured.

Market Lending Your Crypto

Decentralized finance entails lending out your crypto to a borrower in exchange for an interest payment. You may be wondering why people take such a risk when Bitcoin price movements are already so fruitful. 

Most people view their Bitcoin as an investment, and since it is just lying idle, it seems to make sense to lend it out or deposit it in a savings scheme. 

The most used lending platform for Bitcoin is BlockFi, and it employs a centralized lending mechanism. Interest rates from BlockFi are attractive, but that is a result of the built-in risk of lending via the platform. 

The so-called ‘bitcoin banks’ that are in use today are mostly centralized, and hence, the risks are far greater than a decentralized, market run mechanism. Ethereum’s decentralized finance stack offers users a much better experience through browser wallet integrated lending and borrowing. 

Risks include (but are not limited to) non-payment of principal, default on interest payments, and bugs in the platform that cause incorrect data logging. When you hold an asset that offers thousands of percent gains over a 4-5 year period, why take the risk of losing that asset for a measly 4-6 percent annually?

Crypto Finance Needs to Be Decentralized 

One of the biggest problems people have with Binance’s new lending service is that they guarantee a fixed interest rate as well as an interest payment. In essence, Binance is making a guarantee to lenders on behalf of borrowers, but will not be held as a guarantor in the case of a default. 

Firstly, fixed interest rates are dangerously manipulable by the entity fixing them. They aren’t optimally revised for supply and demand in the market. Central banks learned this lesson when they tried to fix exchange rates and realized it was inefficient not to have a floating peg. 

Secondly, the centralized custody of your funds leads to many risks from the platform’s side. In most cases, these risks are actually much greater than the benefits but are easily ignored because they aren’t priced into the interest rate

To fix this, lending services on Ethereum adopted a market-based interest model that moves according to demand and supply. However, custody is currently done in a centralized manner with plans to shift the mechanism to a more distributed approach. 

Adequately Assess Risks

The conclusion you should have reached by now is that the risks of each platform are not always priced into rates. Risk of default, non-payment of principal, and other market-based factors are taken into account, but most others regarding security and custody aren’t. 

Be aware of who you are keeping your money with. Bitcoin is by itself a risky asset class; taking on an extra layer of risk may be unnecessary.