Decentralized finance or De-Fi has experienced exponential growth and is now viewed as an alternative financial model to traditional financial services.
De-Fi has many similar applications to those in traditional finance, with a few key differentiators.
As De-Fi begins its journey into the mainstream, the question is how this alternative model can work with traditional financial markets and services.
This topic was discussed during a panel at World Economic Forum, hosted by Rahul Singh, President, Financial Services and Digital Process Operations at HCLTech.
De-Fi vs traditional financial models
De-Fi operates on the blockchain, which is an immuted distributed ledger that is managed by multiple nodes across the globe.
“De-Fi is financial services carried out on the blockchain. It’s an alternative financial model that doesn’t have any intermediaries and that’s the biggest benefit – compared to traditional models, transactional or exchange costs are reduced and friction is eliminated,” said Singh.
Operating with a start-up mindset, decentralized finance emerged in 2019 with “almost zero in value. It now has $250 billion in assets residing in the De-Fi world,” added Singh.
Joining the discussion, Jirayut (Topp) Srupsrisopa, Founder and CEO at Bitkub, the cryptocurrency exchange and one Thailand’s first unicorns, is unsurprisingly a supporter of decentralized finance.
He said: “Open systems of the internet fostered innovation, but the financial sector is happening in closed system. The next decade will bring an open financial web where innovation can come from anyone, anywhere at anytime.”
The new model has many applications like traditional financial services products, such as loans payments and exchanges.
The opportunity for inclusive financial services with De-Fi is very high. With mobile penetration rising across the world, Singh referenced that “70% of the 2 billion unbanked people in the world have access to mobile. It’s an opportunity to use De-Fi to provide access to financial services.”
Despite all the promise, a financial system with a lack of governance and without intermediaries does come with its own risks and challenges.
Governance
Traditionally, financial services have relied on compliance and regulation because it has custody of people’s savings and investments – “people have relied on giving their money into an institution of trust,” said Singh
To build trust in De-Fi an “open-ended, self-governance mechanism has to be built that offsets the risk in an ungoverned world. It must adapt,” said Singh.
He suggested a self-governance concept called “decentralized autonomous organizations, where regulations be written in code,” as a potential solution.
Akash Shah, Chief Growth Officer at BNY Mellon, was also participating in the panel.
Commenting on this issue of governance and trust, he said: “People need something that they can trust. We’re very early on the innovation curve [with De-Fi] and for a while, there will need to be a lot of tolerance to market and regulation.”
It’s worth staying on the ride as “the underlying tech has enormous applicability to the financial or banking system today,” added Shah.
Hans-Paul Bürkner, Global Chair, Boston Consulting Group, also participating in the panel, agreed that financial “institutions need to take the next step.”
He said: “Banks that don’t digitize will fall by the wayside. It will be a long process that will be slowed down by those politicians and regulators who don’t understand it.”
How does De-Fi interact with existing financial services?
Traditional models are regulated, but De-Fi works on an algorithmic model based on smart contracts that reside on the blockchain, which is not regulated.
A middle ground of regulated De-Fi products is emerging, what Singh calls “a handshake between the two.”
Explaining what this could look like, Srupsrisopa said a new word will emerge: permissioned De-Fi.
“This will bridge the old world with the new. De-Fi products will have an upper layer that’s regulated for Know Your Customer (KYC) purposes to remove risks around transparency, compliance and security. Once you’re using this type of service, users will get the best of both worlds, such as decentralized borrowing and lending.”
Responding to the possibility of permissioned De-Fi and decentralized autonomous organizations, Bürkner said: “What is technically possible won’t be immediately possible or viable.”
It is evident, however, that the financial services future lies somewhere between traditional and decentralization.
Shah stated that BNY Mellon’s “long term goal is to be a bridge between De-Fi and financial services. We’re obliged to think about the scope of infrastructure across different financial permeations – De-Fi being one of these with huge applications.”
Within this space he mentioned three key focus areas:
- Bring crypto assets into banking, because people’s wealth is invested in this area.
- Stablecoins and use of blockchains for payments
- Tokenization to create more liquidity, transparency and availability
