Decentralized Finance (DeFi) already offers some innovative financial products. However, it needs to incorporate more real-world assets on-chain for it to successfully go mainstream.
One senior executive for Safaricom gave a projection of DeFi and the future of commerce to a room of attentive but confused MBA students in a business school lecture hall. The executive was speaking at the Massachusetts Institute of Technology (MIT):
“You will be able to buy your first home on WhatsApp! Smart contracts on the Ethereum blockchain will take care of everything and you won’t need a broker.”
As the lecturer spoke with conviction while pointing to a slide, the class wondered:
“How will the house’s title change hands? What about the funds? Can the blockchain do escrow? What role for lawyers? How could we possibly buy something worth a million dollars with the click of a button?”
In April 2017, these students, who were yet to see Bitcoin peak around $20,000, had no reason to think that blockchain would play a major role in changing the world. But they were excited anyway. Though all these conversations took place in 2017, similar discussions still sound interesting to many people today. Many people and institutions are yet to experience the impact of decentralized finance and real-world assets (RWAs).
Right now in 2021, after the excitement that took over the DeFi space last summer and the setback of BTC’s recent sell-off, we have now come to another crossroads. The DeFi total value locked (TVL) has now surged above $150 billion, MakerDAO has officially become a DAO, and FTX raised the biggest private round in crypto history. Put all this into context and you will see that a DeFi future appears more plausible than ever.
That would be a world where the credit, payments, and investing all happen on-chain in a decentralized system, with no major role set aside for financial institutions. In the growing spirit of blockchain, and the widespread fintech movement, decentralized finance projects strive to provide innovative financial products with lower fees, minimal intermediaries, and increased transparency.
While the Defi industry has made major steps and breakthroughs since 2017, the liquidity that exists in the decentralized finance world represents just a segment of what is required for DeFi to go mainstream by introducing more real-world assets on-chain.
The question comes for the whole industry: How do we go from early customer traction to product-market fit? To ensure that a version of the 2017 conversation between the MIT students and Safaricom executive happens currently, it will not sound like something that is out of this world and seem more like part of many people’s daily lives.
Here are various deterministic factors for decentralized finance to gain mainstream adoption.
A Massive Data And Analytic Infrastructure
With a dwindling role for centralized financial institutions, the ‘guarantors’ of the financial infrastructure, we need to rethink how data moves and how it is controlled and custodied. Without the involvement of banks, how will a blockchain network manage a user’s identity? How will risk be evaluated? How will we manage to price assets if we cannot call on centralized datasets for valuations?
Oracles have managed to play an integral role in bridging the existing gap between real-world data and smart contracts. But, the issues come on how the data analysis tools like Bloomberg and FICO are powering the financial markets.
So far, there are no oracles that are offering a precise solution to that issue. The wider decentralized finance industry requires a crowdsource-enabled solution to value the historically opaque and illiquid assets to enable users to introduce private assets into the DeFi world effectively and efficiently.
In general, this scenario will accelerate the movement of real-world assets on-chain, including collectibles and real estate, and has the power to revolutionize the entire world. New questions come up; what is the best way to manage and govern data in a decentralized universe, and how will various laws apply in technological contexts legislators never considered?
That question has dominated the social media space and its reputation for the past few years. How can decentralized finance avoid similar challenges and pitfalls?
DeFi Replicates Full CeFi Functionalities
China is currently the global leader in fintech innovation, with almost 90% digital wallet penetration and 62 billion unique transactions made last year. That textbook description of mass adoption is made possible by offering a complete banking experience for the wallet owners.
Users can invest in mutual funds, donate to charities, pay bills, purchase insurance policies, and exchange currencies via Alibaba Group’s Alipay, which is China’s leading digital wallet. Alipay is a great example of a digital revolution designed to enable users to continue with their normal financial routines but in an easier, faster, and cheaper way.
In the same manner, the cryptographic innovations need to be powered by a DeFi network that offers the same secured lending and insurance services and trusted currencies. While most of the DeFi veterans have so far implemented RWA-based strategies, the lack of adequate RWA on-chain majorly hinders ecosystem development.
After setting up a proper and functional pricing infrastructure, Defi requires to offer a solution to integrate and onboard the real-world assets on-chain at scale. This unique value proposition is found within their financing licenses. The space requires a protocol interfacing with traditional corporate borrowers around the world to originate RWA at scale and then bridge the funding demand in CeFi with liquidity in DeFi.
All that can be achieved by providing a frictionless lending process for the real-world borrowers, getting rid of the need for ‘crypto education’ by enabling the borrowing and repayment to be made even in fiat.
Furthermore, an RWA-based yield strategy needs to be created, enabling DeFi and CeFi lenders to invest in income-generating real-world assets and simultaneously maintain exposure in crypto assets.
RWA lending will unlock many opportunities for decentralized finance innovations to replicate a majority of the centralized finance functionalities. With more projects now eyeing RWA, the ecosystem will expand rapidly and massively.
Effective And Efficient Decentralized Governance
When people talk about scaling the DeFi space and introducing more RWA on-chain, decentralized governance is an inevitable part of the process. An efficient and effective decentralized governance solution may benefit DeFi in various ways:
- Faster decision-making mainly depends on the governance form of the organization. Of course, some of them can be faster than others, but when they are compared against centralized institutions where there is a wait for decisions to get approved, the decentralized organizations have an outright advantage.
- Easier scaling – the organizations interested in scaling up may facilitate the process easier in case they are decentralized.
- Transparency – every type of transaction is traceable and auditable by all the authorized parties which result in much-increased transparency and fraud prevention.
Global Standard For Regulatory Compliance
In a market that is filled with uncertainties and unpredictable regulatory enforcement actions, decentralized finance cannot afford to fly blind. In July, the US Securities and Exchange Commission (SEC) chairman Gary Gensler stated:
“These platforms — whether in the decentralized or centralized finance space — are implicated by the securities laws and must work within our securities regime.”
The DeFi sector requires a defined strategy for compliance. The views that decentralization makes it challenging to hold any one entity accountable, or worse, that decentralization is seen to make compliance unnecessary, will continue to attract the wrath and scorn of regulators.
How can these platforms reasonably fit their operations and businesses within the existing legal structures of the Bank Secrecy Act and Know Your Customer (KYC)/Anti-Money Laundering, or help in changing the paradigm?
Libra’s woes, though not quite DeFi, appear to represent a missed chance to innovate without insulting the authorities. Currently, the decentralized finance sector risks insulting the regulators and advancing the theory that was put forward by antagonists like Elizabeth Warren that the crypto sector only exists to promote illegal financial practices like drug trafficking, money laundering, and human trafficking.
While the answer is not yet clear now as to how decentralized finance will integrate compliance into the technology stack, it is now clear that it needs to do it. The general public and mainstream institutions will need better KYC standards before adopting.
Some protocols can enhance and secure the global financial system by introducing the much-required transparency and neutrality into a stable currency. Some of the active stablecoin platforms have enabled every user to generate their peer-to-peer cash in a decentralized and trustless environment.
But if the dream of accessible financial services for all is to be realized, the investors and participants in the DeFi space need to leave their comfort zones. The aim is for RWA to integrate billions of dollars in non-digitally native.
Proponents must cross the chasm and step away from collateral into the DeFi ecosystem. But that needs participation from everyone. Many companies and projects need to come in with a clear goal and simultaneously encourage competition from the legacy financial industry to benefit the users.