Decentralized Finance and the Future of Money
As a society, we’re increasingly resisting expectations that we should abide by established norms and that we should utilize the institutions our parents and grandparents held as sacrosanct. In short, we don’t like middlemen – realtors, stock brokerages, bookkeepers, accountants, and even brick and mortar retail stores. More often than not, there’s an app for much of that.
For years, our financial systems have been centralized. Banking, insurance, securities trading, and other similar services have relied on institutions … and their people who we assume are experts working behind the curtain. We didn’t dream of making any of those kinds of complex transactions outside of these centralized financial systems, or CeFi.
CeFi hasn’t been foolproof of course. Humans make errors and bad decisions. Machines can be incorrectly programmed. Worse, there have been occasions for fraud and more than one nefarious financial institution.
Will CeFi make way for DeFi?
Now, thanks to Cloud storage, cryptography, blockchain, and cryptocurrency, it’s possible to bypass banks and lending institutions and move to decentralized finance, or DeFi. DeFi’s cryptocurrency-based applications include lending, insurance, and asset trading – all without the “benefit” of an intermediary financial institution or a centralized clearance system. That also means transactions without the fees, delays, paperwork, consumer protection, and regulations we see today that are often promoted by the CeFi institutions themselves.
The catch with DeFis, though, is that you need to be willing and able to use cryptocurrency. That’s a big “if” today, since people are still having trouble getting their minds around the concept. They’re also noting the risks from cryptocurrency speculation thanks to the tremendous fluctuations in price in those markets. And then there’s their tie to criminal activity, such as ransomware cases. Overall, it’s not a comfortable space for many people.
How does DeFi Work?
If you can get past those educational and psychological hurdles, the DeFi process is fairly simple.
If you’d like to earn money, offer up your coins on the DeFi platform you feel best about and make them available on your terms. If you need a loan, deposit digital coinage as collateral and then receive the borrowed funds. After you pay off the loan, the collateral is returned to you.
It’s really as easy as point and click on drop-down menus. Interest rates are quite competitive, and the transactions happen immediately.
What’s DeFi Used for Now?
We’re all familiar with cryptocurrency and our ability to use it for buy-and-hold investments and money transfers in a variety of situations. We can also increasingly use it to buy everything from cars to fast food – in the U.S. or other countries.
Like cryptocurrency, blockchain-empowered DeFi banking is likely here to stay, and it’s following right behind. The amount of assets deposited as collateral on DeFi platforms has been estimated at $100 billion, up from just $1 billion a year ago.
Much of the DeFi activity is related to borrowing in order to provide assets for additional cryptocurrency speculation. Of course, that kind of leveraging is happening with traditional stock exchanges and other CeFi institutions as well.
By design, blockchain, and therefore cryptocurrencies and DeFi, aren’t regulated. Loans and valuations might not be insured. We’ve seen recently in the case of ransomware recovery, that DeFi platforms can be hacked by the good guys by the good guys. And still the bad guys are always eager to prey on novice crypto participants.
The anonymized nature of DeFi apps also means it’s difficult to know exactly who or what is behind that great loan offer on the drop-down menu. Platforms set their own rules and it’s sometimes difficult to shop around to determine the details.
Since the first of the year, it’s estimated that cryptocurrency fraud (55% of which was related to DeFi scams) totaled $432 million worldwide. No doubt there was much more that was not reported. The FTC noted that 7,000 U.S. consumers reported losing more than $80 million in cryptocurrency scams in the six months ending in March of this year.
Implications for the Future of DeFi
The future of DeFi is tied to the future of cryptocurrencies. Without some level of regulation and oversight, most people will continue to steer clear of the whole arena. Of course, any significant centralized oversight will be strenuously opposed by most of those currently engaged licitly or illicitly in that market.
DeFi’s future is also tied to whether the legitimate DeFi platforms sufficiently regulate themselves. If too many platforms get hacked, prove to be scams, or fail to adopt internal controls, the movement will fail.
But if the ongoing record is strong, and the stories turn out to be more positive, DeFi will continue to slowly become more mainstream. And as more and more regular people and traditional businesses get comfortable with cryptocurrency, and as their price fluctuations become more rational, DeFi will assuredly cut into banking industry business.
There are some newer, emerging financial products that could make that happen even faster.
Stablecoin May be the Future of DeFi
Recently we’ve seen a new variety of cryptocurrencies gain acceptance. “Stablecoins” are cryptocurrencies tied to an asset like gold or the U.S. dollar. They still offer much of the security and privacy of traditional cryptocurrencies, but their price is more stable.
The third-most widely used DeFi application after Bitcoin and Ethereum is Dai, a stablecoin whose value is tied to the U.S. dollar. Some say a stablecoin cryptocurrency or digital token like Dai could emerge as a widely accepted worldwide currency. It would certainly provide a more stable foundation for De-Fi services than the current industry leaders. Reportedly, Facebook is even working on developing a stablecoin.
We live in an unusually disruptive era. Technology breakthroughs are combining with generalized citizen unrest. Members of younger generations are questioning nearly everything, and creative minds, with the benefit of amazing technology, are happy to offer alternatives.
It seems that the primary question related to DeFi and similar new paradigms is not “Why?,” it’s “Why not?”