Today’s financial system doesn’t work for everybody. Interest rates in Europe are extremely low or even negative.
Just look at the interest rates on savings accounts with some of the most popular banks in Europe:
If you want a higher return than this, banks make you lock your money for 12 months or longer. You might be restricted to a maximum deposit amount. Many banks also have a negative interest rate on balances over 100,000 euros – charging you to leave your money with them.
Importantly, these rates are also far behind price inflation. This is a big problem, because as a result saving money means losing purchasing power.
Let’s look at how interest works to understand why this is happening.
How do interest rates work?
Interest is fundamentally related to lending and borrowing rates. In principle, it should benefit lenders: you lend $1,000, you get $1,100 back.
When you put money in a bank savings account, your bank uses the money in your account as a reserve when issuing loans. Your bank earns interest on these loans and shares some with you. This is where the interest on your savings comes from.
However, we’ve all seen the headlines. Stories about low or negative interest rates have been all over the news during the last couple of years.
And low interest on loans means low interest on savings accounts.
Why is interest on loans so low? The simple answer is that governments don’t want people saving money. Central banks force these low rates on high-street banks. This is the result of a well-known theory in economics: “The paradox of thrift”.
The paradox of thrift: Why interest rates are so low
The thinking behind this paradox informs a great deal of modern monetary policy. One person’s expenditure is another person’s income. So, the more people save, the less money is circulating in the economy. Aggregate incomes fall, and the economy slows down. This is bad when the economy isn’t doing well.
As a result, in times of economic downturn, governments slash interest rates to encourage spending. Low interest rates encourage cheap borrowing and discourage saving. The goal here is to stimulate the economy by keeping as much money circulating as possible.
Look at what happened to interest rates after the 2008 financial crash. They fell and never recovered:
If this wasn’t bad enough, the outbreak of the coronavirus pandemic has created ongoing strained conditions. This will only prolong the period of economic crisis and low-interest policies.
These measures may be necessary in the short-term to avoid disaster, but they end up hurting regular people.
Low interest rates increase wealth inequality
A study by the Dutch central bank examined the effects of low interest rates on wealth inequality. These policies make it easier for wealthier people to control a larger proportion of assets.
Wealthy people essentially profit from cheap borrowing because they store and grow wealth in investments, not savings accounts. They use their existing assets as collateral on cheap loans, allowing them to acquire even more assets, like real estate, which increase in value over time. Increased investing with cheap loans also has the effect of inflating share prices, further benefiting wealthier people who already own these assets.
By contrast, regular people have a harder time with low interest rates, because they cannot save. It is harder for regular people to put aside money and grow their wealth, since low interest rates reduce the power of savings accounts. And since regular people do not already own significant assets, they can’t take advantage of cheap loans because they lack the appropriate collateral.
When interest rates are lower than price inflation, saving money actually reduces purchasing power. So this dynamic allows the wealthier to get wealthier, and the poor to get poorer.
Blockchain: A new, inclusive financial system
If regular people are to earn high interest rates under the current conditions, they need access to alternative opportunities.
One possibility is a decentralized system of digital money based on blockchain technology. Without central banks controlling interest rates, many new opportunities arise for borrowing and lending markets.
All previous systems for making money digital relied on trusted parties. This is because moving things around digitally actually duplicates them. If you send a photo to a friend from your phone, your friend ends up with a copy of the photo on their phone, in addition to the original that exists on your phone.
There’s no way this could work with money, since coins would be duplicated and spent twice.
This is why trusted third parties were always involved until Bitcoin solved the “double-spending” problem by using a structure called a “blockchain”.
Blockchain works by replacing one trusted copy of a database with multiple copies on a network of computers. Every computer in a network keeps track of assets, not one person. The whole network has to agree on where assets have been moved to and update all copies of the database in the same way.
This system makes it impossible to undo a transaction or spend the same coin twice – but it also removes any middlemen from the process.
Decentralized finance (DeFi) and crypto savings
Blockchain isn’t just about creating digital currencies. It’s also about programmable money.
Smart contracts on chains such as Ethereum are like computer programs that run on the blockchain. They execute transfers when particular conditions are met. This allows us to recreate traditional financial instruments in a decentralized form: “decentralized finance”, or “DeFi” for short.
DeFi lets us recreate the entire financial system on the blockchain without middlemen. You can do anything done in traditional finance, like lend, borrow – and more. However, DeFi’s assets and protocols are independent of government policies. Bitcoin is programmed so as to have a fixed supply, and so is immune to inflation. Similarly, borrowing and lending markets aren’t controlled by central banks setting interest rates. These rates are instead just set by demand for assets.
What’s more, no middlemen means lower barriers to entry. Anyone with a digital wallet can participate in DeFi – and there are no lengthy bureaucratic processes when, for example, taking out a loan.
How do DeFi savings compare to traditional finance?
When it comes to the problem of low interest rates, the most promising function of DeFi is savings, or “earnings” as they are more properly called, to differentiate them from bank savings accounts.
The main idea behind generating interest is the same for both DeFi and traditional finance. It’s generated by borrowing and lending activities. However, there are a lot of other important differences.
With DeFi, interest rates are set by the market, which can offer a higher return than traditional savings accounts. Rates are set by demand for an asset, not by a central bank. As a result, blockchain savings can offer impressive returns, sometimes up to 10% or even more.
DeFi also has low barriers to entry: anyone with a wallet can participate. It is easier to take out a loan, so long as you have collateral of some kind.
However, traditional finance offers more protections for customers. With blockchain, you are always in control of your funds, responsible for your actions and bear all the risk yourself.
How do high-interest savings on the blockchain work?
Interest is generated by lending money, and blockchain-based protocols let you do so at higher rates than central banks. But what are you lending, and who is borrowing, when you use blockchain-based savings?
Essentially, users are lending out their own crypto assets to traders, who want to use them to take positions in the market.
Say you have 100 ETH and believe the price will go up tomorrow. You want to buy more ETH to maximize your gains. However, you don’t want to sell your other crypto, like Bitcoin, just to take a larger ETH position. Your bank can’t help you – they won’t give you a loan that quickly, and you can’t use your ETH or BTC as collateral.
The solution is a decentralized crypto loan. Here, you can use your 100 ETH as collateral to borrow USDC – a form of digital dollar – and buy additional ETH with it. Protocols like Aave and Anchor will let you post ETH as collateral in exchange for a loan of USDC or a similar coin.
So, on one side of each transaction is a borrower – probably a trader – who pays interest to a lender – someone who has spare assets and wants to earn interest on them.
DeFi and crypto savings: The essentials
If you’re new to DeFi and crypto savings, the key points to remember are:
- The most popular assets to borrow are “stablecoins”. These are pegged to national currencies, like USDC, a regulated dollar stablecoin. These coins are lower volatility than assets like ETH and BTC.
- DeFi loans need to be overcollateralized. This protects lenders, since positions are liquidated automatically if it seems a borrower cannot pay back.
- Interest rates go up when more people borrow particular assets. If lots of people borrow USDC to purchase extra ETH, then the annual yield on USDC increases. Interest rates go up, allowing for higher yields than bank savings accounts.
It’s also important for customers to be aware of the risks of DeFi. Users can gain higher returns, but they need to be informed and responsible:
- Most EU bank accounts are insured up to 100,000 euros – this isn’t available with current blockchain solutions.
- If you lose the keys to your blockchain account, or an exploitation is found, then you could lose all access to your funds.
- There are also potential risks with the underlying assets. “Stablecoins” may lose their peg to national currencies for a number of reasons.
- The most popular stablecoins are all pegged to the dollar. This also means that users outside of the US face an exchange rate risk when purchasing these to lend out on the blockchain.
However, the main problem with DeFi right now is not these risks, but its lack of accessibility to normal users.
There are no user-friendly gateways to DeFi
If a user wants to earn high interest rates on a stablecoin with DeFi, this is what they currently have to do:
- Purchase USDC or ETH from Binance or a similar platform
- Add Metamask or a similar wallet to their browser extensions and create a crypto wallet
- Send USDC and ETH from Binance to the browser wallet
- Connect the browser wallet and deposit USDC to Aave or another protocol to start earning.
These current gateways are multi-platform with a poor user experience – there’s no simple instruction manual. Don’t forget that each Ethereum transaction also incurs a high cost in network fees.
People need simple tools to access these high-yield opportunities.
The future of high-interest crypto savings
If regular people are to take advantage of the opportunities offered by earnings on the blockchain, they need straightforward apps that do the heavy lifting for them.
The user experience of DeFi earnings has to be like a traditional savings account. Users need to be able to deposit cash directly without purchasing crypto or stablecoins. We also need to reduce expensive blockchain fees or remove the need for blockchain knowledge entirely.
This is exactly what Nash is offering with our earnings product.
In just a few taps, you can go from cash in your bank account to high-yield crypto earnings. This is the opposite of the complex, expensive multi-platform process described above.
Our goal is to make DeFi simple, safe and easily accessible for everyone.
Changing the nature of finance
Nash believes that we’ll see an increasing integration between traditional and decentralized finance. The traditional sector will fight to remain competitive with products like those offering high-interest earnings.
The traditional financial industry is worth over $20T. DeFi today is a relatively small industry, worth $150B – but growing exponentially.
We see DeFi eventually replacing traditional finance.
This will be good for everyone who is affected by low interest rates. People will have more choices available. DeFi will be the new, smart way to grow your wealth.
Consider the huge jump from the Internet, Web 1.0, to social networks, Web 2.0 – a genuine revolution in both technology and society. DeFi represents Web 3.0 and is still just getting started.
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