Why Decentralized Finance Isn’t Just Wall Street’s Wild West

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Senator Elizabeth Warren, who frequently rails against cryptocurrency, calls it “the most dangerous part of the crypto world.” She talks about DeFi, or Decentralized Finance, a dark area of ​​the crypto world, which, if successful, could disrupt traditional finance. . The New York Times defines DeFi as “an umbrella term for the part of the crypto universe that aims to build a new internet-native financial system, using blockchains to replace traditional intermediaries and trust mechanisms.” (nyti.ms/3K8fHPG).

Today, to exchange money or securities, you need intermediaries such as stock brokers, banks or stock exchanges, and you must trust them to act in your best interests. Successive scams such as the 2008 financial crisis or the PNB crisis in India have shown that this is not always true: taking care of your interest seems more the exception than the rule. Marc Andreesen, the founder of a16z, wrote how “software is eating the world”. In the case of DeFi, the software “eats” the intermediaries. Instead of trading through exchanges, people deal with each other directly peer-to-peer, with blockchain-based “smart contracts” fulfilling the role of intermediaries and creating a “crypto exchange”.

DeFi goes further than a stock exchange and seeks to replace everything in the financial world: prediction platforms, loans, options, derivatives, works. It’s a shadow Wall Street built by crypto enthusiasts, fully decentralized, user-owned, and open source, with crypto renderings of most TradFi (traditional finance) products, and virtually no regulation or bureaucracy. You can trade crypto versions of Microsoft, Google, and Tesla stocks with these chips reflecting real equity. For now, DeFi is nascent but not small; its “total locked value” is pegged at $77 billion, which would make it the 38th largest bank in terms of deposits in the United States.

Among its fundamental elements are stablecoins, cryptocurrencies whose value is pegged to that of fiat currency. In the DeFi world, stablecoins are what you keep your cash in, in order to trade tokens, lend, and trade. In theory, the typical stablecoin is pegged to a US dollar and therefore needs individual backing by real reserves. But there are no regulations governing this, so it is difficult to verify whether such reservations exist. The uncertainty goes further. DeFi companies issue loans and credit cards and even open savings accounts without much of the protection offered by traditional banks. Almost every regulator on this planet is concerned about this and has started to prosecute these companies. The fact that most of them are intangible entities on the Internet, often with no known physical address, makes this task difficult. No wonder the NYT calls DeFi a “Wild West Wall Street.”

But then why is there so much enthusiasm around him? One technical reason is that blockchain is a superior technology to banks, as most lenders still use software written in Cobol, a programming language from the 1960s. Crypto lives on the internet, and so does internet banking . DeFi enthusiasts say they want to create a financial system free from the ills of today’s half-broken, overly centralized setup.

For many, including me, the reason is more philosophical: DeFi is the financial system of the Web3 world. It replaces biased human intermediaries with trust-building technologies like blockchain and open-source software. This makes transactions cheaper and helps more than middlemen to profit. It’s almost instantaneous, T+3 settlements are a thing of the past, and much more transparent. Importantly, this is a democratizing force that allows the end user to do things that only powerful intermediaries could do. It has the potential to extend the banking system to hundreds of millions of unbanked people around the world. It’s also brimming with idealism about how to fix what’s wrong with Wall Street and reduce its current power over businesses, countries and people. Yes, DeFi has teething problems, but eventually it could become robust and secure enough to replace banks and exchanges with democratic user-owned collectives – a center-left vision that capitalism would scoff at.

While researching this article, I discovered that one of the very first books on a stock exchange was written by a Dutch Jewish trader Joseph de la Vega. He wrote about the inner workings of the Amsterdam Stock Exchange of his time, which he described as sophisticated but “subject to excesses of all kinds”. If you read this treatise from 1688, you might think it describes modern DeFi. The title of his seminal book was apt: Confusion of Confusions. Hopefully decentralized systems can solve some of them.

Jaspreet Bindra is the Chief Technology Whisperer at Findability Sciences and is learning AI, Ethics and Society at the University of Cambridge.

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