The accelerating development of finance in the world today, has led to the appearance of decentralized finance (DeFi) which is beginning to put traditional banking systems to a tough test. This tension is felt nowhere more than in the UK, cradle of some of the world’s most influential financial institutions.
In this disruption, Ethereum is at the heart of it all — it provides the infrastructure behind many DeFi applications. The result is that UK banks are now forced to adapt to survive as the days of centralized financial services are fast becoming a thing of the past.
Ethereum is not just a cryptocurrency; it is a decentralized and open source blockchain system for developers to write smart contracts and dApps. Whereas Bitcoin is a digital currency, the blockchain of Ethereum is very customizable, and it will be used in DeFi projects, tokenisation and more. This versatility has turned Ethereum into a blockchain that is the natural choice for a wide variety of DeFi projects, with services such as lending, borrowing and trading without intermediaries like banks. As these services grow in popularity, UK financial institutions are beginning to sit up and take notice.
The Rise of DeFi: A New Era for Finance
DeFi, in its simplest definition, is a movement towards an open, decentralized and blockchain based financial system with no central authority. Defi applications are doing away with the need for intermediaries, reducing costs, and providing faster, more transparent services through smart contracts: self executing contracts with the terms of the agreement written into code.
For both challenge and opportunity, this is good news for the UK’s financial powerhouses. DeFi protocols are challenging the traditional model of banking, where institutions stand as trusted intermediaries in the management of assets and in their transactions. In the DeFi ecosystem, services that involve borrowing, lending, trading and asset management are all carried out on decentralized networks without any cost or time. The advantages are driving increasing number of users and institutions to decentralized platforms, therefore it is necessary for traditional banks to adapt.
Ethereum and DeFi – UK Banks’ Response
Yet, UK banks have been slow to fully embrace DeFi with the landscape slowly changing as they begin to realize the power of blockchain technology, notably Ethereum. Among the UK’s biggest financial institutions, Barclays, HSBC and Lloyds are starting to mull the ways they can integrate blockchain technology into their business with a view to making it more efficient and less costly.
For example, Barclays has been exploring blockchain applications for a number of years. One of the first UK banks to patent blockchain-based solutions, it has also participated in pilot programs to use blockchain for trade finance and international payments. While Barclays hasn’t fully embraced DeFi, its research into blockchain technology paves the way for a shift into the future.
Just as HSBC is experimenting with blockchain in several areas. Last year, the bank rolled out its ‘FX Everywhere’ platform, which uses blockchain tech to process millions of transactions a year, slashing expenses and enhancing efficiency. This is not strictly DeFi but it shows HSBC is willing to experiment with decentralised technologies. The bank is probably going to keep on playing with Ethereum based solutions in search for ways to fit it to the needs of the new wave of so called decentralized finance.
Another large UK financial institution that has been more conservative in its approach, but interested in the space, in particular in the context of digital currencies, is Lloyds. Lloyds hasn’t yet announced any big blockchain initiatives, but sources say it is exploring digital currency solutions and could be heading toward Ethereum-based DeFi solutions.
UK Adoption of Ethereum and DeFi: The Role of Regulation
Regulation is one of the biggest hurdles to wider adoption of DeFi in the UK banking sector. DeFi runs in a highly unregulated space that makes the work of traditional financial institutions that are regulated heavily by financial regulations almost impossible. While the UK’s Financial Conduct Authority (FCA) has been cautiously optimistic about the potential of blockchain technology, it has also been keen to temper this enthusiasm with warnings around decentralized finance risks, including around security, fraud and money laundering.
However, UK regulators have been quick to think about how to incorporate blockchain and cryptocurrencies into the financial system. The FCA has started ‘regulatory sandboxes’, which allow companies to run blockchain based financial products in a controlled environment, in a safe space for experimentation, without the full weight of regulation.
How quickly and fully UK banks will embrace DeFi use cases on Ethereum will depend upon regulation, which will evolve. On the one hand, the potential benefits they offer are significant: lower costs, faster transactions, and greater accessibility. But traditional financial institutions would also need to work out how they can conduct business under this new environment without breaking the rules.
Looking Ahead: Ethereum in the Future of UK Banking
It’s early days for the relationship between UK banks and Ethereum, but the potential for collaboration is huge. Now with upgrades like Ethereum 2.0, which improves scalability and security, Ethereum is likely to grow, and UK banks will be more inclined to experiment using decentralized finance solutions within their services.
A hybrid model between traditional financial institutions and those built on Ethereum, such as decentralized platforms, maybe the future of banking in the UK. Of course, for UK banks, changes will need to take place to adapt to this new future and, for the most part, this will involve a combination of innovation, regulatory compliance, and an open mind to the future of money.
Whether they embrace DeFi as partners or competitors remains to be seen, but one thing is clear: We can’t have UK banks ignore that Ethereum is already shaping the future of financial services.