Protocol-backed investment accounts are a paradigm shift
Blockchain’s version of retail investment accounts can improve yields, remove the middleman, and enable public services.
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The coming to market of “challenger banks” like N26 and Revolut, modern savings products like Goldman’s Marcus, and finance apps like M1Finance, suggests that personal finance is repositioning as generationally minded mobile applications and web apps. But blockchain’s decentralized finance version of banking and investments is not merely the next iteration of tech challengers, it is a paradigm shift.
In the near future, many interactions with blockchains will simply look like an investment account to the end user.
In the near future, many interactions with blockchains will simply look like an investment account to the end user. Activities like providing security to a public blockchain or liquidity to a financial protocol will be available in “investment account format” — just deposit any amount of dough, take some risk, and earn a return. The innovative part of this scheme is that depositing capital into the supply side of decentralized protocols is crucial for their successful operation. Just imagine if every American deposited $100 into an account for Ethereum 2.0 staking — Ethereum would have the power of an extra $32.7 billion (~1.5x current market cap) in network security, and the user can earn up to 10.3% in Ether-denominated return.
Though currently more risky, could protocols begin to stand in for traditional investment accounts over time? This past year, the market’s highest yielding savings account by Wealthfront clocked in at 2.53% APR, accepted investments as lows a $1, and lowered costs through technological automation. Similar products from Goldman Sachs, Ally, and others are popular in the market, with customers focused on higher rates of return and Millennials under increased pressure to save 40% of their paycheck. At the same time, Charles Schwab, TD Ameritrade, and other brokerages have found themselves cutting trading fees to 0 as customers in a digital world now value transaction facilitation less than advice and other services.
Imagine if every American deposited $100 into an account for Ethereum 2.0 staking — Ethereum would have the power of an extra $32.7 billion in network security, and the user can earn up to 10.3% in Ether-denominated return.
Given how quickly tech products are penetrating personal finance, traditional savings accounts seem woefully out of date. In traditional savings, the customer makes a deposit into the fractional-reserve banking system. A bank takes the capital and uses it to make proprietary investments — notably, lending — which produce a rate of return. A small fraction of the return is shared with the customer. Drawbacks of this system include that customers can neither practically opt out of fractional-reserve banking, nor mitigate the counterparty risk of the bank without invoking expensive federal regulation and insurance. Returns for customers are dictated by providers, diluted by the need for shareholder profits, and don’t go far enough to counteract the consumer’s exposure to inflation. All in all, the scope, function, and performance of the traditional savings account leaves much to be desired in our modern context.
In the protocol-backed investment account model, the customer makes a deposit into a set of public protocols whose economies provide a rate of return. In doing so, the customer can trades off the counterparty risk of an intermediary for the technical risks of interacting with protocols. Over time, these latter risks are mitigated by engineering as is routinely done with software. In some cases, like lending stablecoins, its possible to guarantee a nonnegative fiat return in exchange for the risks of that asset’s stability mechanism.
By going to protocols, customers remove the profit-seeking intermediary, and gross returns incur only the network transaction fees of interacting with blockchains. Because these deposits amount to a supply-side activity for a public network, protocol-backed accounts become both a form of ownership and governance in public goods and services. In the future, shifting the protocol allocation of an investment account may be a form of registering preferences, or voting, on public services.
In the future, shifting the protocol allocation of an investment account may be a form of registering preferences, or voting, on public services.
Participating in decentralized protocols through an investment account foreshadows how the simple, traditional concept of an account at an institution will eventually be completely rehabilitated. It will increase an individual’s financial self-sovereignty, improve consumer choice, and remove the middleman — all while helping to serve up useful public services like blockchains, domain registration, cloud storage, and even universal basic income systems down the line.
DeFi wallet products, empowered with breakthrough interoperability technologies like WalletConnect, are available for download today. You invest your digital assets in a decentralized lending protocol right now. In 2020, we should expect to see a lot more options and tools for interacting with protocol-backed investment accounts, while traditional products are likely to continue puttering along.
