Many of you have heard of blockchain before. It is a widely discussed topic and its prospects are acknowledged by many researchers as something that potentially can be revolutionary. One of the most exciting use-cases is the implications it can have on financial services. Decentralized Finance (DeFi) is the interlocking of the financial system denominated in cryptocurrencies and can address many of the difficulties faced in the existing financial system. It offers many parties the opportunity to utilize this technology to provide access to the financial system. Moreover, it offers a wide range of services such as lending, and derivatives that can be accessed globally, peer-to-peer, and without any intermediaries. Anyone can access this technology just with the use of the internet. However, how do smart contracts work and what specific implications does it entail?
First, all Decentralized Finance services are offered on the blockchain. Parties can establish laws, rules, and regulations which are programmed on the blockchain to automatically enforce protocols that are established and agreed between two parties that entered the contract. These contracts are intended to automate and replace many of the functionalities in financial services that are currently necessary for parties to go through. Think of the long waiting times when you apply for a small loan. Many of the contracts can include for example insurance, loans, and investments. Second, what Decentralized Finance offers is that it is secure and readily available to the involved parties. Research of PWC has shown that 45 percent of financial intermediaries such as money transfers and stock exchanges suffer from serious cybercrimes every year. Through the use of Decentralized Finance, smart contracts can act as legal evidence including information such as ownership, auditability, and traceability that are also more troublesome for third parties to commit cybercrimes. Lastly, Decentralized Finance can act as a platform for those that are not fortunate enough to have access to financial services as it offers transparency and interoperability due to it being borderless. Parties can easily access many of such contracts without the need to go through traditional channels that consume much of your time. Thus, Decentralized Finance has a high-value proposition.
However, to this day, Decentralized Finance is facing many difficulties. As Decentralized Finance operates on a peer-to-peer network, it needs to create a healthy ecosystem in which it needs to generate distributed trust, generate liquidity, and stability. Additionally, currently, decentralized finance faces substantial regulatory uncertainty as governments are not sure what the effects of this technology have on many practices today. Hence, there is still a long way to go for Decentralized Finance to reach its full potential.
Please let me know your thoughts on this topic. Do you think that blockchain technology has the potential to establish a Decentralized Finance system in which parties can enter contracts without any intermediaries? Can it replace the current financial system or do you think that it will coexist next to our financial system and provide a platform for those that are not privileged to have access to the financial services? Is there any chance that it can reduce many of the difficulties faced by financial institutions?
https://www.ft.com/content/16db565a-25a1-11ea-9305-4234e74b0ef3
https://www.forbes.com/sites/ilkerkoksal/2019/09/29/the-shift-toward-decentralized-finance-why-are-financial-firms-turning-to-crypto/#36f7ff356392
Hi Ting,
Thank you for your very insightful post. I think it will be very interesting to see how DeFi will develop in the upcoming years. As the DeFi industry is still in the early stages of adaption, we are seeing a lot of new DeFi projects popping up every day. Some of these projects introduce new ideas and innovations, but many of these project are blatant copies of other DeFi projects, or even outright scams. We also see various DeFi platforms that promise high APY rates to people that invest or store their funds in these DeFi projects, which some of the time results in permanent loss of capital, which leads to DeFi being seen as a fraud or scam by many people. It will be very important for the DeFi industry to reach some kind of maturity in the next couple of years, as I think the reputation of the industry as a whole is very important for these services to see any widespread adoption. This will also be very important in terms of regulation. Even if these services are fully decentralised, interference or bans by regulatory institutions of DeFi services will have a devastating effect on adaption. It might be wise for these DeFi projects to actively involve these institutions from the get go, which could prevent major regulatory problems later on. All in all I think DeFi definitely has the potential to transform financial services, although it will be a big obstacle to challenge incumbent institutions, as these institutions such as banks are very powerful and will not easily step aside for DeFi, and might even actively try to stop these decentralised services from being legal to use.
Best regards,
Max