ING Bank DeFi Report
Netherlands-based world giant ING Bank published a report on DeFi markets, one of the main branches of the crypto money industry. Under the title of Lessons Learned From Decentralised Finance(DeFi), this report includes the bank’s analysis of DeFi, and more significantly its opinions and future perspective. It is possible to divide the report into 3 main sections. We see that the Bank determined 10 main parameters for DeFi in the first part and performed the analysis of the market through these parameters, shared a sample of the sector by conveying the operation of the Aave platform in the second part, and expressed its opinions on 10 main parameters in the last part.
In this study, it is aimed to dwell on the bank’s opinions and to interpret these opinions over the 10 parameters determined by the bank. Hence, our readers must have a basic knowledge of DeFi. We recommend our readers who do not have a basic knowledge on this subject to read our DeFi 101 writing by clicking here first.
Before proceeding to the summary of the report, it should be indicated that the bank’s opinion on DeFi is extremely positive. It can be said that ING Bank has also participated in the positive progress of the perspective of cryptocurrencies and main branches such as DeFi which was created by this sector. In both the introduction and the conclusion part of the report, the bank states that it supports the integration of the innovations brought by DeFi into the existing banking system or the cooperation of the two sectors.
Stating that there are various definitions for DeFi, the bank states that these definitions contain deficiencies, therefore it wants to put its definition as “open to public, permissionless, financial systems working on blockchain technology”. Common services provided by DeFi;
- Translation of monetary banking services
- Peer-to-peer borrowing and lending
- DEX is summarized as advanced financial services such as tokenization platforms, derivatives, and prediction markets.
Although the definitions in the second and third articles are common classifications in the market, the “translation of services” in the first article can be seen as a confusing classification. The bank exemplifies the production of stablecoins for this article. However, it can be said that the stablecoin meant here is decentralized stablecoin such as DAI, instead of currencies such as USDT or USDC, which have a centralized production system. What the bank means by this article is to lock the USD in circulation in the system and to apply it again in the form of stablecoin in accordance with the cryptocurrency market. In other words, increasing the USD supply in the cryptocurrency market by reducing the USD supply in the traditional market is a sort of transforming USD into cryptocurrency.
The main parameters specified for DeFi are as follows:
- Automation of Business Process
Under this title, it is stated that complex systems such as decentralized exchange and borrowing-lending, offered in the DeFi market, can work together through cryptocurrencies and at the same time, the biggest concern of the Bank for the DeFi sector is expressed under this article. Stating that the loans granted by DeFi platforms can be used as collateral on other platforms or used in derivative products, the Bank states that an intertwined loan cycle has occurred, and that this cycle may trigger a situation similar to the mortgage crisis in 2008.
To analyze this criticism, it will be useful to compare the lending criteria of banks with the lending criteria of DeFi platforms.
As it is known, banks give loans to their customers as a result of analyzing a series of personal data such as personal assets and past financial payment information. In case of the loans given are not based on actual accurate and consistent research, these loans are not repaid and global crises occur as in 2008.
On DeFi platforms, on the other hand, since personal information is not requested, collateral is mandatory, and since 67% of the collateral is given, the platforms protect themselves against the high volatility of cryptocurrencies. In case of sudden price movements, the remaining 33% provides the necessary time for both the platform to organize its own liquidity pools and to update the collateral amount of the borrower.
When these two loan systems are compared, we see that DeFi platforms are mostly based on mathematical criteria and generate loans solely for a certain asset. Banks, on the other hand, have systems based on repayment estimates based on human behavior, and they also cause an increase in monetary supply through loans. Because cash collateral is not always required to give a loan. Therefore, it can be said that the loan systems of DeFi platforms are much more secure and resistant to crises. However, the bank’s concerns here are not entirely unfounded. If DeFi platforms increase the rate of 67% to reach higher users, users will be able to get more loans with the same amount of collateral. This situation may cause liquidity problems for these platforms as a result of sudden changes in the prices of cryptocurrencies and a chain crisis that may occur in the loan systems, causing the bank to worry. Another factor that may cause a similar crisis in the DeFi sector is the accepted types of collateral. For instance, platforms accepting NFT assets as collateral merely due to their high popularity can lead to a crisis in the loan system as well. As a matter of fact, NFTs are digital assets with highly subjective valuations. Hence, it is extremely significant for the platforms to pay attention to the nature of the collateral they accept and the rate of collateral to avoid the bank’s concern.
Under this title, ING Bank underlines that DeFi platforms have open source codes (the codes are accessible to everyone), and states that the codes can be freely copied and used by other platforms since there is no regulation on this subject in the market. The bank states that the free circulation of codes can be hazardous, they can be used by malicious people for fraudulent activities, and therefore they do not lean towards open source systems. It is not possible to say the bank’s opinion on this matter exactly right or wrong. As the banking sector principles and the values on which DeFi is built and the parameters they depend on are definitely different. First of all, as stated by the Bank, fraudulent DeFi platforms can be established by copying the codes. However, such platforms are branded as unsafe by the cryptocurrency community after the codes are examined. For this reason, traditional financial institutions such as ING Bank think that the open-source codes cause security vulnerabilities, while the cryptocurrency community thinks that the open-source codes increase security. Because the open publication of the codes ensures that many factors such as who is in control of the platform, its working principles, and the synchronization of smart contracts can be seen without any mistakes. It is almost impossible for a platform whose codes have been examined to cause any fraud. Therefore, the open-source code allows the platform to exonerate itself. The reason why ING Bank does not share this mentality is that banks do not need a process such as self-exoneration. Banks are obliged to meet certain standards since they have to comply with many laws and supervisory public authorities. Similarly, bank customers also have certain guarantees and insurances legally. Hence, as long as banks fulfill their legal obligations, they do not need extra transparency and users often do not pay attention to their personal responsibilities as they are protected by law. On DeFi platforms, on the other hand, the rules operating in the entire cryptocurrency market are valid. Users are responsible for everything from which platform they choose to the actions they perform, and there is no protective authority or regulation. In order for the users to know and manage their own responsibilities, it is indispensable for the codes to be open to everyone. Consequently; it can be said that the bank evaluates the code sharing, which is essential for DeFi, as a luxury by evaluating it from its own perspective.
Under this title, it is stated that the bank accepts the definition for decentralization as “updating the distributed ledger technology (DLT) by multiple parties establishing a consensus (reaching consensus)’’. While the Bank states that whether decentralized systems offer an optimal solution compared to centralized systems is a controversial issue, it claims that decentralized systems can jeopardize stabilization, cause inequalities, and reduce effectiveness.
It is possible to compare the two systems superficially over a few parameters. Firstly, when we consider the management of both systems, decentralized systems are more democratic as they are managed by the voting system by the miners and ensure the participation of much more people. The criticism of the bank here may be POS and similar systems, however, users who do not have sufficient capital can become partners with existing miners. Nevertheless, it can be said that decentralized practices are more advantageous in terms of equality since more people have a voice on the system compared to the management of centralized systems through boards of directors. Moreover, miners are unlikely to use the financial power they gain to conduct fraudulent transactions on the network. Because in such cases, since all transactions on the blockchain are open to the public, fraudulent transactions can be detected and if the mining group performing the transaction has the majority of the network, malicious miners can be excluded from the new chain to be created with a hard fork. Thus, decentralized systems are highly competitive not only in a democratic sense but also in terms of security.
We are of the opinion that the Bank is right regarding the decrease in effectiveness. As the security measures of decentralized systems increase, their capacity for fast processing decreases. This problem, which is chronic for blockchain networks, has been tried to be overcome by blockchain solutions such as Ethereum, Solana, Algorand, Avax. However, such platforms need time to prove that they have BTC-like security. Therefore, in terms of effectiveness, centralized systems can be considered as applications that are much faster and easier to use.
On the stabilization issue, the criticism of the bank should be justified. It is an undeniable fact that the bitcoin price has extremely high volatility. This situation is tried to be resolved through stable cryptocurrencies. In this way, the integration of fiat currencies we use in daily life with cryptocurrency platforms can be achieved. Looking at the current progress of the market, it is seen that Bitcoin is classified as Digital Gold, not a payment instrument, and stable cryptocurrencies and CBDC projects become prominent in stabilization.
The main argument in this article is that prejudicial individuals and institutions can easily integrate into the DeFi market. DeFi platforms, as is known, can solely be used by integrating an online blockchain wallet. Platforms do not request any personal information or documents. ING Bank refers that this situation poses various risks and that countries, individuals, or institutions that are seen as prejudicial in the traditional financial system can easily access banking services through these platforms. It can be said that under this article, the Bank alludes to countries such as Iran, Venezuela, North Korea, which are subjected to severe sanctions in the global financial network, and individuals or institutions that directly carry out the financial operations of terrorism or any criminal institution. How right it is for countries to be completely restricted from the global financial system is an opinion that can vary from person to person. However, actions that will help criminal institutions and terrorism should assuredly be restricted from all systems. The Bank’s criticisms in this matter can be justified. Nevertheless, the point to note here is that this matter is not specific to DeFi platforms and the cryptocurrency market. It is known that almost every 2–3 years, global giant banks such as HSBC and Deutsche Bank were sentenced to serious penalties for gigantic money laundering crimes. Hence, it should be said that this concern stated by the bank applies to both traditional finance and DeFi platforms and the cryptocurrency market.
Apart from country and crime revenues, there are many people who are blacklisted by banks for various reasons. DeFi platforms actually offer a free banking service to both these people and anyone who wants to protect their personal information. Any regulation that will prevent malicious users who want to benefit from this service will be welcomed by the cryptocurrency community warmly, provided that personal data are protected.
In the article on flexibility, we mentioned the concerns the Bank has due to security vulnerabilities that open source systems may cause. Under this article, a similar issue is evaluated this time from a positive point of view.
It is sort of a challenge to have codes available to everyone. Software developers who can build a better platform on the same code base can move ahead of existing platforms. This situation also prevents each platform from making efforts to solve similar problems over and over again, as it enables the solution methods brought to the problems in the sector to be used by everyone. With a similar view, under this article, the Bank mentions that each platform requires that new platforms to be established have higher standards and that the sector has a dynamic that moves forward by itself. More importantly, ING Bank also states that financial institutions with an existing centralized system may consider using open-source software due to the fast problem solving and innovative features mentioned above.
Under this title, ING Bank discusses DeFi platforms under two separate criteria as technical and functional interoperability. The functional part is the interoperability of DeFi platforms and their assets with their own type. To put it another way, the various DeFi platforms established on the Ethereum network provide seamless token transfer between each other and the synchronization of smart contracts can be shown as an example in this area. The Bank states that DeFi platforms do not have any functional problems and that they can operate exceedingly effectively and in an integrated manner. However, it is mentioned that both the traditional finance sector and DeFi platforms have similar problems in terms of technical interoperability. With the definition of technical interoperability, the bank refers that different platforms in different blockchain networks can work with each other. The transfer of data between blockchain networks with each other can be achieved with bridge applications established recently. Notwithstanding, as stated by the Bank, it does not seem possible to say that there are effective and seamless processes. These processes have to reduce their costs and be available for use by everyone. Based on the technical and functional features described above, while ING Bank indicates that cryptocurrencies have an obvious advantage in money transfers, it underlines that a product offered by DeFi platforms is also not more effective than a bank in terms of transferring to another platform.
In this article, ING Bank indicates that since DeFi platforms are systems that operate entirely on the Internet, they are not subject to the physical limitations that centralized structures are exposed to and that they are very advantageous in this regard. However, many disadvantages provided by this situation are mentioned as well. Although ING Bank states that DeFi platforms and traditional financial institutions should work together, it remarks that centralized institutions cannot work merely with the integration of the wallet as in the current DeFi system. These institutions definitely need customer information due to the laws they are affiliated with. The bank states that this situation is one of the biggest obstacles in the integration of DeFi platforms. Furthermore, it is mentioned that even if DeFi platforms are subject to a possible KYC-AML regulation due to the fact that they are not located within the borders of any country and extra difficulties will occur owing to the necessity of creating international laws. The Bank states that another significant problem in the integration of DeFi platforms is the requirement of traditional financial institutions with centralized systems to preserve their assets in the country where they are located. Since assets locked to Defi platforms are stored on a decentralized platform, this requirement may be seen as a more serious problem than the KYC-AML process as well.
Because of all these reasons, ING Bank states that centralized institutions should definitely benefit from DeFi technology, however perhaps they should create similar platforms on a centralized blockchain network under their own control.
The subject of this article is determined as transparency. The bank states that DeFi platforms built on the blockchain are in an extremely advantageous position by virtue of the transparency feature of the blockchain. Besides, it is also underlined that the transactions and smart contracts on the platform are open to everyone, which may be beneficial in terms of detecting a possible financial crisis in advance.
The bank’s criticism on this issue is not the kind of that the cryptocurrency community was used to hearing before. The Bank states that the fact that the transactions are open for everyone can be seen as a violation in terms of “confidentiality of personal data”. Having only a wallet number instead of any name or information in transactions seems to not provide sufficient confidentiality for the bank. It is not possible to make a transparent comment on this criticism of the bank, since the subject is considered subjective. However, currently, the level of confidentiality offered by the blockchain is considered sufficient by the market, both to ensure the accuracy of transactions and to create observable transparency. Considering that centralized systems are in trouble with much more serious data leaks regarding personal data violation, it seems unlikely that cryptocurrency users will have made such a complaint about the blockchain, at least in the near future.
9.Automation of Business Process
In this title, which was opened to indicate that transactions are carried out automatically without the need for any centralized authority due to smart contracts, some concerns of the bank bring useful discussion topics as well. The bank states that users do not need to rely on a centralized institution to carry out their transactions, yet still have to rely on software developers coding smart contracts. While it is expressed that there is no mechanism to protect users from the security vulnerability that will occur if smart contracts do not function as planned, it is explained that an insurance system that will protect users against possible security vulnerabilities will also increase the cost of transactions. Hence, the main point that the bank questioned is, if DeFi platforms are subject to the insurance system, the cost increase that will occur is whether they will still be able to maintain their appeal compared to centralized institutions that provide a certain insurance and reversible transaction service to their users.
The concern of by the bank leads us to the same problem once again. While all the responsibility is on the user in the cryptocurrency market, centralized platforms have mechanisms and laws to ease this burden. The entire cryptocurrency community is not consisting of software developers. Therefore, it is not possible to expect anyone to analyze smart contracts by reading code. For this reason, it is significant that people using the DeFi platform use platforms that have already been examined by the community and are above a certain level of reliability. Otherwise, as the bank states, problems that may occur in smart contracts may cause users to encounter financial losses.
Lastly in this article, the Bank dwells on the approval and irreversible processing of transactions on the blockchain with consensus and states that this situation negatively affects the flexibility of the platform, as it will make it difficult to perform trial-error and testing on DeFi platforms.
For the blockchain to function securely, the inability to recover transactions seems indispensable, at least for the time being. Hence, the criticism of the bank on this issue is justified, and the fact that platforms using the Ethereum network are also exposed to extra costs due to the transaction fees of the network causes the flexibility of the bank to decrease even more.
Apart from the 10 articles mentioned above, the Bank also has essential implications for digital assets. The bank has two separate classifications as ‘’digital token’’ (currency) and ‘’digital asset’’. The bank states that digital tokens are cryptocurrencies that are currently in use and are completely digital, while digital assets are assets that have a physical asset and are represented in digital form. Underlining that DeFi platforms do not have any problems with digital token transactions, the bank states that digital assets still need the approval of a centralized institution to be matched with the physical asset they represent. It is stated that it is significant to work together with centralized institutions and DeFi platforms to solve the problem here.
The best example of this opinion of the bank may be the real estate sector. For instance, the residential mortgage lending method is quite suitable for DeFi platforms that provide loans with collateral. However, as stated by the Bank, legal processes must be appropriate in order for the residence to be mortgaged. Herein, it is revealed that not only DeFi platforms but the entire cryptocurrency market need certain legal approvals and the need to work with centralized institutions. As a current example; it can also be shown that cryptocurrency exchanges offer stock trading services on their own platforms through cryptocurrencies representing stocks. Even the representation of stocks, which cannot be considered as a full physical asset through synthetic cryptocurrencies, for instance, has entered the radar of regulators in Germany. Therefore, it can be said that certain legal approvals must be obtained, as stated by the Bank, in order to represent digital assets on cryptocurrency platforms.
Another significant criticism of the Bank is that the responsibility for the damage caused by smart contracts is not undertaken by the person or the platform since the software developers are generally anonymous. Due to this situation and various concerns mentioned above, it is stated that it is difficult for people particularly who will carry out large-scale transactions to choose DeFi platforms as there are no mechanisms to minimize or manage their risks, and even all risks are not transparent. Here again, the basic functioning problem arises in the cryptocurrency market, due to the fact that users are responsible for all their transactions. However, these risks can still become manageable with new updates to DeFi platforms. For instance, the latest update of the Uniswap platform includes significant mechanisms for liquidity providers to manage their risks.
The Bank also states that DeFi platforms are still more complex than centralized systems, and therefore users who prefer centralized systems are not expected to switch to DeFi platforms entirely. It is also underlined that although DeFi platforms are more efficient in many areas, users may continue to prefer centralized systems despite lower efficiency, due to the higher ease of use in centralized platforms.
While the general opinion of the Bank about DeFi is certainly not negative, it is based on the constructive criticism of these platforms about what to develop. As stated many times in the study, the Bank has the opinion that working together with DeFi platforms and centralized institutions will bring the optimal solution.
Some of the bank’s concerns are likely to be resolved in the future, however, it should be noted that some have serious disagreements with the cryptocurrency community. For instance, it can be said that DeFi platforms integrate AML — KYC processes, which is a difficult change to realize as it will limit the financial confidentiality and the freedom provided by this confidentiality, which is one of the most essential features of cryptocurrencies. Hence, it seems more likely that centralized institutions will create their own centralized DeFi-like platforms and that these platforms interact with DeFi platforms. In this way, it will be easier for the bank to fulfill its legal obligations.
Click here to access the original text of the report.
Written By: Berkay Aybey
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