This posting in Advisor Perspectives takes on the topic of DeFi (Decentralized Finance) which has a few ways to be described, but we’ll settle on the use of alternative currencies (non-fiat) to conduct financial transactions potentially without a bank intermediary. Readers may not be 100% familiar with the term or how it is evolving, but those who follow cryptos in their various forms will know that stablecoins are tied to fiat currency values, but are only representative of those values and may not be fully backed by a USD, for example. So the author discusses some of these evolving risks and how CBDCs may offer a compelling way to create more certainty in this developing method of global financial value exchanges.
‘Much of what passes as DeFi today is just “decentralization theater,” as Fabian Schar, a University of Basel professor of blockchain, describes it. In theory, this hot new crypto corner wasn’t envisioned to be controlled by big-bulge intermediaries. The self-executing computer code deciding how digital assets would be lent or invested was supposed to be impervious to manipulation. Developers weren’t expected to have special rights…
The reality has turned out to be different: From backdoors to kill switches, discretionary power is concentrated in a few players. You even have to pay for protection from “sandwich attacks” that place one transaction before and another after yours on the blockchain to steal your profit. The distributed ledger technology was supposed to leave all this Wall Street chicanery behind. But if a big chunk of DeFi has moved far away from its original vision, why not at least make it safe for all users by introducing the biggest centralizing force of conventional finance? The central bank.’
Of course, as we have been covering here and elsewhere for some time now, CBDCs are nascent, but given the plurality of central banks that are using, testing, and/or evaluating their uses, will likely be mainstream for a number of cases in the next five years. Worth a read through to gain familiarization.
‘DeFi’s linkages with traditional finance will grow, and not only because banks, brokers and asset managers will come under pressure to allow their Gen Z customers to pay, save, lend, borrow, trade, invest and insure in crypto. To Lex Sokolin, the global fintech co-head at ConsenSys, which analyzes DeFi projects and related risks, the real opportunity — and threat to a central bank’s relevance — might lie elsewhere. “You have this web3 economy that’s generating actual operating activity that matters, and out of this grows a finance system,” Sokolin said on a panel at the same BIS conference. “How do we build a pathway of fiat money there?”’
Overview by Steve Murphy, Director, Commercial and Enterprise Payments Advisory Service at Mercator Advisory Group