Sonia Shaw, President at CoinW
There were several key impacts on traditional finance resulting from the DeFi summer of 2020 – namely an increased interest from institutional investors, hedge funds and analysts who could not ignore the huge potential to make substantial returns from the rapid growth of so many projects. It also marked an initial showcase of Blockchain’s potential to innovate financial products and services for those who’d not yet by then been enlightened – significantly the creation of ETFs which continue to capture huge focus of predominant players.
During this cycle, with trading volume reaching up to US$14 billion daily, we can expect more sophisticated influences on traditional finance. TradFi has recognised the threat posed by DeFi’s disintermediation, and we’ve witnessed the development of CBDCs in acknowledgement of that, with banks and other service providers careful to keep up by enhancing their own efficiency and reducing the costs attached to their typical fee-based models. We’ve literally just seen HSBC China roll out their e-CNY services to corporate clients and it is only a matter of time before other international banks follow suit in making CBDC available to the whole spectrum of their customer base.
New investment opportunities such as yield farming and liquidity mining are putting pressure on TradFi to adapt and evolve if they wish to retain investment from those who are fast becoming attracted to the higher returns available elsewhere. The current advances of tokenised real-world assets is also in direct correlation to DeFi’s impact on the global financial market and there will be no surprise to see traditional institutions merge with decentralised services to make investment in these assets available to their customers.
The issue of the ensuing regulatory challenges puts the ball back in DeFi’s court, which as a market can obviously not compete with the well-established frameworks that govern traditional finance. The grey areas created by the underpinning philosophy of decentralisation still run deep when it comes to scepticism around security, fraud and systemic risks. The institutional melee that persists on all fronts when it comes to unravelling how to effectively oversee DeFi activities do not cease anytime soon – the challenge this year is to ensure that those advances do not stifle ongoing innovation in the space.
David Ben Kay, President at Function X Foundation
DeFi is creating a paradigm shift in traditional finance (TradFi), basically by removing the need to go through intermediaries – like brokers and banks – and thus enabling individuals to deal directly with their finances. This harkens back to the initial principles underpinning the blockchain and cryptocurrency. DeFi and its attendant DApps have expanded the accessibility to financial products without the need for intermediaries. This is particularly game-changing in those markets where a significant portion of the population has been unbanked or underbanked and, in those markets where the fiat is devaluing and highly volatile.
Removing intermediaries, at least in theory, should also reduce the transaction costs compared to TradFi. This has at the same time presented a challenge for DeFi to reduce gas fees, the blockchain analog to TradFi’s transaction fees.
It’s axiomatic that governments and their regulations lag behind technical innovation; the catch-up can often be ham-handed and clumsy. Also, unfortunately, what has become the norm, or at least a growing trend globally, is for any issue that governments encounter to become politicised. Political parties seem to feel the need to take a position on everything, sometimes with a knee-jerk reaction of simply opposing what the other side is promoting. Exacerbating that political tension is the role of lobbyists, groups paid by ‘interested parties’ to persuade politicians to take a particular position regarding regulation that protects or promotes a particular group’s interests. In this particular instance, you have some established TradFi groups, say banks, insurance companies and investment firms, and their lobbyists opposing any innovation that might threaten their market share.
This disruptive scenario has prompted the creation of some strange bedfellows. Risking being left behind, some TradFi players have responded to the challenge that DeFi presents by creating cryptocurrency products, like the BTC and ETH ETFs – as well as pursuing a growing interest in tokenization of real-world assets. At the same time, risking being regulated out of business with heightened licensing requirements, we’re seeing a growing number of crypto companies partnering with TradFi institutions. The best example of this being Coinbase partnering with BlackRock, forming Coinbase Prime. Likewise other TradFi companies are forming so-called non-custodial exchanges – EDXs, using a third-party custodian – enabling institutional and retail investors to engage in crypto trading.
Maybe this evolution is inevitable given the relative greater power of centralized institutions, like governments and their more influential (richer?) constituents, compared to the more decentralised players in the crypto world. But given the anarchistic, off-the-grid philosophical roots of Blockchain, will Blockchain crypto OGs and those attracted to those philosophical roots, just go with the flow, or will those who feel that the crypto world is being co-opted come up with alternatives that go back to their philosophical roots?
Nicole Valentine, FinTech Director at the Milken Institute
I see the rapid growth of DeFi protocols catching the attention of traditional finance (TradFi), as it is proving its ability to unlock areas that have been untapped by TradFi. Specifically, DeFi is influencing new approaches, and creating greater expectations of capital and how innovative financial transactions can benefit stakeholders and end users. More traditional institutions are building teams and divisions to research, test and deploy financial applications on the Blockchain, following industry peers like Fidelity and BNY Mellon, who started their journey before the crypto hype cycle began. The recent approvals of 11 Bitcoin ETF license applications by the Securities and Exchange Commission (SEC) are an example of the evolving relationship between DeFi and TradFi. That moment was notable when the SEC, which has not been crypto-friendly, opened the ETF channel to Bitcoin holders.
DeFi may have a much smaller market share than TradFi, but it has captured the imagination of what the financial ecosystem of the future could look like. In a DeFi world, intermediaries are replaced with smart contracts, and governance structures are administered through DAOs. DeFi promises transparency, immutability, traceability and security. The security of transactions on DeFi has been tested by hackers presenting a challenge for regulators to quickly get up to speed. The International Organization of Securities Commissions (IOSCO) has been a global standard setter in developing policy recommendations and regulatory frameworks for DeFi. Because the current regulatory environment is uncertain in many jurisdictions, IOSCO’s recommendations that address market integrity and investor protection are crucial to understanding and mitigating global risks. I believe this early work and leadership by IOSCO is going to prove invaluable as DeFi continues its ascent.
In the US, regulators and policymakers are also working to understand the DeFi landscape and its potential impact on markets. There has been early work on defining and categorising decentralised finance. Regulatory agencies like the Commodity Futures Trading Commission (CFTC), have active committees comprised of industry experts, market participants, service providers, and regulators who recommend standards for the digital assets markets. I am a member of the CFTC Global Markets Advisory Committee’s Digital Assets Markets Subcommittee and our work is an opportunity to provide the CFTC with recommendations for a principles-based regulatory framework that addresses evolving technology and financial applications in this rising DeFi world. I believe regulators must keep pace with innovative FinTech protocols and applications and design regulations that do not stifle innovation. DeFi may have over 17,000 protocols and applications but this is just the beginning. We have an opportunity to shape a future that delivers the benefits of DeFi in an inclusionary way and this early thinking together can get us there.