Why building directly on Ethereum and DeFi protocols is stronger than the alternative

The downfall of CeFi platforms has proven financial institutions must build on Ethereum and DeFi protocols directly, not through excessive intermediation.

The failures and setbacks of some prominent centralized finance (CeFi) platforms like FTX last year pose a critical question for financial institutions eager to adopt blockchain technology: why not build on DeFi (decentralized finance) protocols and robust blockchains like Ethereum directly?

As our CEO and Founder, Joseph Lubin has expressed, we need right-size intermediation. I believe there is a space for established financial institutions to innovate in web3, but this needs to be done by accessing the power of DeFi protocols on Ethereum directly.

In my conversations with incumbent financial institutions with deep experience in self-custody and payments, I frequently hear that as they develop web3 offerings, they’ve chosen to work with what I refer to as a Crypto FI.

Crypto FI means crypto-financial-institution. The term refers to when a bank works with another financial institution that has web3 capabilities in order to access Ethereum and DeFi as a blackbox product and not directly via their own node or a node as a service provider like Infura.

And while some Crypto FI solutions may give their customers a relatively faster go-to-market, it’s fundamentally no different than working with a custodian or correspondent bank. The only difference is that instead of stocks, bonds, or other currencies, it’s crypto and digital assets.

I've found this surprising as it amounts to layering on additional financial institutions versus the ease and security of using Ethereum and DeFi directly with Infura.

The benefits of accessing DeFi directly with Infura for financial institutions

Ethereum already does settlement successfully and has trustworthy lending markets and exchanges. Ethereum also has standards developers must adhere to, as well as composability to infinitely scale applications.

I've told financial institutions entering web3 that by using crypto-native software partners like Infura to leverage blockchain innovations and not a Crypto FI has several benefits:

1. Margin compression: Solutions banks offer will be as costly as the intermediary or intermediaries between them and the protocols they are using to build financial products. Margins are compressed by the rent seeking of these intermediaries, whereas when using Ethereum directly they’re limited to the cost of gas only.
   
2. More product flexibility: Solutions banks offer will be limited to what their intermediary can offer. Ethereum has infinite composability and interoperability on its own.
   
3. Less counterparty risk: Solutions banks offer are exposed to significant financial, reputational, and compliance risk, because they’re dependent on third party crypto-custodians and correspondents like FTX. Major DeFi protocols that are fully decentralized do not present such risks as they execute logic according to smart contracts.
   
4. No restrictions for non-financial apps: Solutions banks offer, when dependent on a Crypto FI can foreclose activities such as DAO voting, NFT as PFP, pay-with-asset, and staking. No such restrictions exist when using Ethereum directly.

What 2022 taught us about the strength of DeFi

The core lesson of 2022 is that incumbent financial institutions build on Ethereum and DeFi protocols directly, not through excessive financial intermediation.

My colleague Lex Sokolin, Head Economist at ConsenSys, has written extensively that the primary purpose of using Ethereum and DeFi protocols is to transform the manufacturing of financial services  — not just their distribution.

For example, there’s no reason that banks, with their existing key management services and the ConsenSys product suite that includes Infura infrastructure, couldn't readily create a stablecoin settlement system. This would free them from the burden of prefunding nostro accounts with each other and free up trillions of dollars of liquidity locked up in legacy procedures.

JP Morgan accessing DeFi directly and securely with Infura

An example of a major bank using DeFi directly with Infura happened in November of last year.

JP Morgan, in collaboration with the Monetary Authority of Singapore, DBS Bank, and SBI Holdings, did a live SGD-JPY cross-currency transaction on Polygon and AAVE, two protocols that have remained resilient since their inception. Infura's suite of high availability APIs was used to enable the transaction.

Are you ready to take advantage of DeFi directly on your terms without the risk and drawbacks of layering in additional financial intermediaries?

Contact us at Infura today to learn more.