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Decentralized finance, of DeFi, promises traditional financial products like loans and payment options without the high fees from banks and transaction processors.
Now the Bank for International Settlements, a trade group for banks and transaction processors, is mounting a public campaign to expose the risks of DeFi. The organization’s points of concern are valid.
Investors should reconsider buying Mastercard (MA) and Visa (V).
That assessment is going to seem like heresy to some. Traditional transaction processors are supposed to be the legacy companies being swallowed up in the race to DeFi. That is not necessarily so.
The true strength of blockchain technology, the cryptographic digital ledger behind cryptocurrencies and DeFi, is its trustlessness. The foundation of blockchain is decentralized across many thousands of computers. There is no need to place trust in any one entity for the network to function effectively. In theory, this eliminates trusted middlemen that earn fat fees.
Mastercard and Visa operate businesses that are mostly about being that trusted middleman.
Although credit cards are issued by local banks and financial institutions, all of the actual heavy lifting, the millions of transactions per minute, are carried out on networks built by Mastercard and Visa. These companies have become so proficient and trusted that credit cards are the preferred payment choice by 45% of Americans, up from 36% in 2019.
The great promise of DeFi is the elimination of trusted processors.
As an investment narrative that idea is gaining a head of steam. Even as businesses at Mastercard and Visa continue to grow, their shares have performed poorly. Like the electric vehicle versus internal combustion engine paradigm, investors have bought into the idea that the disruptors must win the future.
The motor behind that sentiment is Ethereum.
Ethereum is an open source blockchain technology that has become popular for of its smart contract functionality. It was conceived by Vitalik Buterin as an alternative to typical financial intermediaries like brokerages, banks and exchanges. As such the platform was built from the ground up to work well with applications, and even allows the creation of non-fungible tokens.
It’s cool technology and big tech innovators like Amazon.com (AMZN), Microsoft (MSFT), JP Morgan (JPM) and even Visa have all dedicated engineers to DeFi development.
The disconnect is that investors are betting the transition to DeFi is coming far sooner than is realistic. They are also wagering that traditional intermediaries will play no role in implementation.
Buterin, a colorful character by any standard, is the first to admit the platform he conceived is not anywhere near ready.
Ethereum is notoriously slow, capable of processing only 20-50 transactions per second. And the cost of performing those transactions, called gas in the lingo of Ethereum, is outrageous. Simple transfers can cost $10, and making purchases often ranges from $50-$100.
A third stumbling point the most popular DeFi applications are neither decentralized nor secure. This is the point being carefully made by Agustin Carstens, general manager at BIS.
CNBC notes that during 2021 these applications collected more than $100 billion in investor capital. According to Eliptic, a blockchain analytics firm, fully 10% of those funds have been lost to theft and investor scams.
Mastercard and Visa have robust networks that are capable to processing exponentially more transactions per second, and at a cheaper rate to the end consumer. They are also far more secure.
That is the opportunity for longer-term investors.
When Mastercard executives revealed third-quarter financial results in early November they noted that earnings and revenue growth is accelerating at the Purchase, N.Y.-based company. If there is any headwinds coming from DeFi, top brass are not feeling them. Despite this the stock is down from a high of $400 in May to o $339.50 today.
Shares of Visa have been upgraded at Morgan Stanley, Raymond James, RBC Capital Markets and UBS, all since October 27. Price targets range from $263 all the way to $297. At the current price of $207.37 moves to those levels would represent gains of 27% and 43.5% respectively.
Longer-term investors should consider buying Mastercard and Visa into the current weakness