In 2021, 6% of U.S. adults were what is known as unbanked, meaning they did not have a checking, savings, or money market account.[1] This population of unbanked individuals were significantly more likely to have low income; 79% of all unbanked adults had income below $25,000, and 91% had income below $50,000.[2] Unsurprisingly, the most cited reason for not having a bank account was related to lofty bank account fees and their unpredictability, or not having enough money to meet minimum balance requirements.[3] Distrust of banks came in second, followed by a lack of privacy.[4]

Proponents of decentralized finance (DeFi) believe the new financial paradigm offers a solution to the nation’s unbanked population. DeFi was created as an alternative to traditional financial services.[5] DeFi allows people to undertake transactions like lending and borrowing, earning interest, buying insurance, trading assets and derivatives, and more via a decentralized blockchain network.[6] Some of DeFi’s purported advantages compared to traditional finance are as follows: People can custody their own funds in secure digital wallets, steep fees levied by banks and other financial institutions are eliminated, anyone with internet access can use financial services without securing approval from a central authority, and funds can be transferred in near real-time.[7]

While DeFi may address two of the three most-cited reasons for not having a bank account, distrust of banks and lack of privacy, it does not get to the root of the problem: timing. To demonstrate, if you get your paycheck by direct deposit, your bank must make the funds available on the next business day after the business day on which they receive the deposit.[8] Therefore, if a deposit is received by your bank on a Friday, you may not be able to access that money until Monday or Tuesday, if that Monday is a federal holiday. Now, say your recurring utility bill was scheduled for that Friday. If your current balance is not enough to cover the bill, your bank may charge you an overdraft fee.

Most people finding themselves in a short-term, cash-strapped situation would simply use a credit card. However, people who overdraft their account frequently have a credit score that is significantly below the average credit score[9] and thus struggle to obtain a credit card. For these people, the next-best alternative may be a payday loan, or some other kind of alternative financial service. Payday loans, like overdraft fees, are a form of small-dollar, short-term consumer credit, and come with their own fees.[10]

Banks and payday lenders have fee policies and are subject to government regulation. Thus, consumers can figure out what they will be charged when they overdraft or borrow, and plan accordingly. By contrast, the fees incurred by consumers transacting on the blockchain vary based on network traffic: The more transactions taking place on the network, the higher the fees.[11] This is due to the capacity constraints present on the Bitcoin and Ethereum networks that create bottlenecks on high-traffic days.[12] Those who are not able to time their transactions during slower periods may have to offer a higher fee to get around these bottlenecks and have their transactions processed. DeFi runs primarily on Ethereum[13] and is therefore subject to such capacity constraints. Rather than eliminating steep fees and transferring funds in near real-time, transacting on the blockchain only appears to offer more of the unpredictability that many of those who have chosen to be unbanked seek to avoid.

Perhaps the greatest benefit DeFi will provide to the nation’s unbanked population will come from the pressure it has placed on the traditional financial system to reform. In 2019, the Fed announced that they were developing their own around-the-clock, real-time payment and settlement system, called The FedNow Service (FedNow).[14] FedNow will be available to all depository institutions in the United States and will support faster payments by providing interbank clearing and settlement that allows funds to be transferred from one account to another in near real-time, 24/7/365.[15] Depository institutions and their service providers will be able to build on this capability to offer additional valuable services to their customers.[16] The Fed hopes to launch FedNow sometime between May and July of this year.[17]

 

[1] Bd. of Governors of the Fed. Rsrv. Sys., Economic Well-Being of U.S. Households in 2021 43 (2022), https://www.federalreserve.gov/publications/files/2021-report-economic-well-being-us-households-202205.pdf.

[2] Id.

[3] Fed. Deposit Ins. Corp., FDIC National Survey of Unbanked and Underbanked Households 2 (2022), https://www.fdic.gov/analysis/household-survey/2021report.pdf.

[4] Id.

[5] What is DeFi (decentralized finance)?, Cointelegraph, https://cointelegraph.com/defi-101/defi-acomprehensive-guide-to-decentralized-finance (last visited Mar. 31, 2023).

[6] Banking the unbanked: How DeFi can help the low-income population, Cointelegraph, https://cointelegraph.com/learn/banking-the-unbanked-how-defi-can-help-the-low-income-population (last visited Mar. 31, 2023).

[7] Id.

[8] I get my paycheck by direct deposit. When can I withdraw the funds?, Consumer Fin. Prot. Bureau, https://www.consumerfinance.gov/ask-cfpb/i-get-my-paycheck-by-direct-deposit-when-can-i-withdraw-the-funds-en-1025/ (last visited Mar. 31, 2023).

[9] The End of Overdraft Fees? Examining the Movement to Eliminate the Fees Costing Consumers Billions: Hybrid Hearing Before the Subcomm. on Consumer Prot. & Fin. Insts. of the H. Comm. on Fin. Servs., 117th Cong. 2 (2022) (statement of Todd Zywicki, Professor of Law, Antonin Scalia Law School).

[10] Consumer Fin. Prot. Bureau, Market Snapshot: Consumer Use of State Payday Loan Extended Payment Plans 2 (2022), https://files.consumerfinance.gov/f/documents/cfpb_market-snapshot-payday-loan-extended-payment-plan_report_2022-04.pdf.

[11] Paul Vigna, Crypto and Its Many Fees: What to Know About the Hidden Costs of Digital Currency, Wall St. J. (Dec. 18, 2021), https://www.wsj.com/articles/crypto-and-its-many-fees-what-to-know-about-the-hidden-costs-of-digital-currency-11639825202.

[12] Id.

[13] Banking the unbanked: How DeFi can help the low-income population, Cointelegraph, https://cointelegraph.com/learn/banking-the-unbanked-how-defi-can-help-the-low-income-population (last visited Mar. 31, 2023).

[14] Judy Mok, Hot Topic: The Fed’s Proposed Entry into Real-Time Payments Through the FedNow Service, A.B.A. (Dec. 5, 2019), https://www.americanbar.org/groups/business_law/publications/committee_newsletters/consumer/2019/201911/fednow/.

[15] FedNow^SM Service, Bd. of Governors of the Fed. Rsrv. Sys., https://www.federalreserve.gov/paymentsystems/fednow_about.htm (last visited Mar. 31, 2023).

[16] Id.

[17] Id.