Traditional finance has conditioned us to accept a certain level of return when we invest our money. When cryptocurrency came along, especially decentralized finance (DeFi), people started to call the return a Ponzi Scheme or scam. Of course, they are referencing it against a framework of what they know.
The problem with this is, as technology advances, things change.
Consider the smartphone. If our reference is landline, we would say that what a smartphone offers is impossible. The idea of people walking around with a computer in their pockets would be absurd. Even if it worked, who would pay $600 for a phone?
As I said, things change.
When it comes to returns in cryptocurrency, there are a number of reasons why the returns are not only higher, but sustainable at these levels.
So let us take a look at them.
1. Money Coming In
There is a lot of money flowing into crypto. digital assets are likely to keep growing over the next decade and investors will not want to be left behind. That means we are going to see a massive amount of growth in regards to the money generated.
Why is this the case?
When capital is invested, it generates a return. By this we are not referring to what is paid out to those investing. Instead, we are focusing upon innovation, which provides economic output for society.
This, naturally, comes in many different forms. For example, the billions going into AI and robots is likely to send economic productivity soaring at some point. This will probably correlate to growth rates we have not seen before. What kind of return can be paid out to investors if an economy the size of the United States is moving ahead at 10% annually?
The crypto economy is very small at this time. So, unlike an oil tanker such as the United States, this economy can be multiplied rather easily.
2. Lower Costs
Do you know how much it costs to run a bank? How about a financial institution such as a brokerage firm?
It costs between $600K-$800K per year to run a bank branch. If a bank has 30 branches, this is around $20 million per year in expenses.
What does this situation look like for Bank of America and JPMorgan Chase? Keep in mind, this is only their retail banking operations.
Then we have to factor in things such as back office operations, compliance, and legal. All of this adds up to an operation that is eating into the returns these firms generate on their capital deployment.
Let us contrast that with cryptocurrency.
What is the cost to a blockchain network? The expense is minimal and is paid out of inflation. Direct cost of infrastructure is actually paid by the node operators, who seek to produce enough blocks to operate at a profit.
Also, back end operations are self contained. Where do banks store all the financial data? They have huge investments in servers. Blockchain by its nature is a network of servers storing data.
It costs an average of $1.5 million to build a bank branch. A DeFi application has costs in the thousands, with some reaching $100K. This is a huge difference in start up capital.
3. Efficiency
Blockchain doesn't know if one is in New York City or some remote town in Chile. In the digital world, geography means nothing.
If an area cannot support X number of financial institutions, some will fail. Loss always eats into returns, whether we are looking at it from the individual or the system standpoint.
Inefficient use of capital hinders returns. This is reduced outside of TradFi. Money can flow to where the return on the capital is the greatest. A regional bank does not have this luxury. Due to regulation (and cost of entry), the larger banks are also excluded.
DeFi experiences none of this. If there is an opportunity for a more efficient use of capital, reallocation is achieved simply by clicking a few buttons. This is true whether we are dealing with a different network, region, or sector. To the digital world, it all looks the same.
Again, consider the expense associated with any decision in TradFi. Even once it is made, there is compliance, licensing, construction, legal, accounting, and a host of other costs that come with it.
With an application, it could be simply changing a few lines of code and redirecting where the application pulls information from.
4. Ownership
Here is where a radical difference enters.
In 2022, Jamie Dimon made $34.5 million. For a company that size, it is a small percentage. However, what was the payouts to all the other high level executives at JPMorgan?
Over the years I stated how public digital networks are cooperatives. The users are the ones who can also benefit financially. All transactions are transparent, something that is not true for the TradFi world. Not only are financial institutions extractors, there is extraction within the firms which lower returns.
As a users, you are paying for the infrastructure that helps to generate the return, which is received by the same individual (if staking). Thus, we see the built in incentivization applied to the user base.
This creates an environment where reinvestment is constantly taking place. Individuals are consistently investing in the network because they have the proverbial "skin in the game". This is not necessarily a monetary investment although that happens also.
Instead, we are referring to activity, focus, and attention. People have a vested interest in engaging in a manner which essentially performs some tasks that are traditionally done by employees. Naturally, the expense is not there since this tends not to be paid by the network.
Again, the incentivization model comes from ownership. The line between investor and customer is blurred.
Speaking of extraction, we are removing many layers of financial intermediaries, all who take a piece of the action. This means that returns are spread over a larger number of players before the payouts to the investors even begins. This hinders returns greatly.
At every layer, a small percentage is removed, often adding up to 5% or more. This alone would double or triple many returns in the TradFi world. It is money investors never see because the financial system swallows it up.
In Conclusion
The net result is we are dealing with a completely different business structure as compared to TradFi. Our challenge is people are looking at the transmission of information through their Pony Express eyes in a world of email and text.
When it comes to returns, these factors mean that crypto is going to be offering higher yields for a long time. It is something that TradFi will struggle with. They enter implement components of FinTech in an effort to stay relevant. DeFi is all FinTech.