In a business school classroom at the Massachusetts Institute of Technology (MIT), a Safaricom executive gave a prediction about decentralized finance and the future of commerce in front of a room filled with enthusiastic but confused MBA students. “You can buy your first house on WhatsApp! Smart contracts on the Ethereum blockchain take care of everything and you don’t need a broker, ”he said with conviction, pointing to a slide.
“How will the title of the house change hands? What about the funds? Can the blockchain act in trust? What is the role of lawyers? How could we buy something worth a million dollars at the push of a button? ”The class wondered.
Students in April 2017 – who hadn’t seen Bitcoin (BTC) above $ 20,000 – had little reason to believe that blockchain would change the world. Nevertheless, they were fascinated. Although those conversations took place back in 2017, the same discussions might sound engaging to many today. That’s because there are still many individuals and companies out there who have not yet experienced the effects of DeFi and Real World Assets (RWAs).
Looking ahead to our present in 2021, after the excitement of DeFi summer and the setback of the recent Bitcoin sell-off, we are at another crossroads. The total locked DeFi value is now over $ 150 billion, MakerDAO is now officially a DAO, FTX has launched the largest private crypto round, and a DeFi future seems more plausible than ever.
This would be a world in which loans, payments and investments take place in a decentralized system in the chain without financial institutions playing such a large role. In the spirit of blockchain and the broader fintech movement, DeFi projects aim to offer innovative financial products with lower fees, fewer intermediaries and greater transparency.
While DeFi has made impressive strides and breakthroughs since 2017, the liquidity in the DeFi ecosystem is only a fraction of what it takes for decentralized funding to go mainstream by bringing more real assets into the chain.
Related: DeFi’s future is spread across multiple blockchains
For this entire industry the question arises: How do we get from early customer acquisition to product market fit? So if there is a version of the 2017 Safaricom manager / MIT student conversation going on today, it doesn’t sound like something out of the ordinary and more like part of most people’s everyday lives. Here are some key deterministic factors for DeFi to gain mainstream adoption.
A comprehensive data and analysis infrastructure
With a decreasing role for centralized financial institutions, the “guarantors” of the financial system, we are forced to rethink not only data traffic but also the control and custody of data. How will a blockchain without banks manage its own identity? How do we rate the risk? How are we going to value assets if we cannot use centralized data sets for valuations?
Oracles have successfully played a vital role in bridging the gap between real data and smart contracts. But what about the data analysis tools like FICO and Bloomberg that power financial markets? We have not seen oracles that offer a workable solution to this. The wider DeFi space needs a crowdsource-enabled solution to value historically opaque and illiquid assets so that we can bring those private assets into DeFi effectively and efficiently.
Taken together, this will accelerate the movement of real assets in the chain, including real estate and collectibles, and has the power to change the world. Still, we raise new questions: what is the right way to manage data in a decentralized universe, and how will laws apply in technological contexts that lawmakers never considered? This question has plagued the social media industry and its reputation for the past few years. How can DeFi avoid similar pitfalls?
A DeFi ecosystem replicates the full CeFi functionalities
China is the world leader in fintech innovation, with penetration of nearly 90% of digital wallets and 62 billion unique transactions in 2020. This textbook definition of mass adoption is made possible by providing wallet holders with a rich banking experience. Alipay by Alibaba Group, China’s leading digital wallet, enables users to purchase insurance policies, invest in mutual funds, exchange currencies, pay bills and donate to charities. Alipay is an example of a digital revolution that allows people to continue the same routines, but easier, faster and cheaper.
Likewise, the cryptographic innovations must be built on a DeFi ecosystem that offers the same secured insurance, credit services, and trusted currencies. While many DeFi veterans have already implemented RWA-based strategies, the lack of adequate RWA on-chain hampers the development of the ecosystem significantly.
Related: Decentralized and centralized finance must work together
After a reasonable pricing infrastructure, DeFi has to offer a solution to bring real assets into the chain on a large scale. The unique value proposition lies in their financing licenses. The space needs a protocol associated with traditional corporate borrowers worldwide to raise RWA on a large scale and bridge funding demand in CeFi with liquidity in DeFi. This can be achieved by providing a smooth lending process for real world borrowers that eliminates the need for “crypto education” by enabling borrowing and repayment in fiat. Additionally, an RWA-based return strategy needs to be developed that will allow DeFi and CeFi lenders to invest in real world income generating assets while maintaining exposure to crypto assets.
RWA lending will undoubtedly open up numerous opportunities for DeFi innovation to replicate most, if not all, of CeFi functions. As more and more projects have RWA in mind, the ecosystem will grow rapidly.
An effective and efficient decentralized governance
When we talk about scaling decentralized finance and adding more RWA to the chain, decentralized governance is an inevitable part. An effective decentralized governance solution could benefit DeFi in a number of ways:
- Easier scaling. Organizations interested in scaling up can make the process easier if they are decentralized.
- Faster decision making. This largely depends on the form of governance of that organization. Of course, some may be faster than others, but when compared to centralized organizations that wait for decisions to be approved, decentralized organizations have a clear advantage.
- transparency. All types of transactions are traceable and verifiable by all approved parties, which leads to much greater transparency and fraud prevention.
Related: Decentralized Parties: The Future of On-Chain Governance
A global standard for regulatory compliance
In an unpredictable enforcement market, DeFi cannot afford to fly blind. Just last month, SEC chairman Gary Gensler said:
“These platforms – whether in the decentralized or centralized financial sector – are subject to securities laws and must function within our securities regime.”
The DeFi industry needs a strategy for compliance. The view that decentralization makes it difficult to hold a single entity accountable, or worse, that decentralization makes compliance unnecessary, has and will continue to attract regulatory scorn.
Related: The FATF draft guide aims to achieve DeFi compliance
How can platforms meaningfully fit their business into the existing legal structures of banking secrecy and Know Your Customer (KYC) / anti-money laundering or at least contribute to a paradigm shift? The Libra’s mishaps, if hardly DeFi, represent a missed opportunity to innovate without offending our authorities. In its current state, the DeFi industry risks insulting regulators and advancing the theory put forward by antagonists like Elizabeth Warren that the cryptocurrency industry only really exists to promote illicit financial practices like money laundering and drug and human trafficking. While the answer is currently not entirely clear on how DeFi will integrate compliance into the technology stack, it seems clear that it is required. Mainstream institutions and the general public will demand better KYC standards before adoption.
There are protocols that have the potential to improve and secure the global financial system by introducing much-needed transparency and neutrality into a stable currency. Some stablecoin platforms have enabled anyone to generate their peer-to-peer cash in a trusted and decentralized environment.
But if we really want everyone to realize the dream of accessible financial services for everyone, then those of us in the DeFi room need to get out of our comfort zones. Our goal is for RWA to pour billions of dollars into non-digital natives. We have to cross the divide and step outside of the collateral into the DeFi ecosystem, but we cannot do it alone. We have to work with a whole range of companies and projects that have a clear goal and at the same time encourage competition from the old financial sector in order to capitalize on what is most important – the users.
This article was co-authored by David Lighton, Kevin Tseng and Mariano Di Pietrantonio.
This article does not provide investment advice or recommendations. Every step of investing and trading involves risk, and readers should do their own research when making a decision.
The views, thoughts, and opinions expressed herein are those of the authors alone and do not necessarily reflect the views and opinions of Cointelegraph.
David Lighton is co-founder of Lithium Finance. He is an entrepreneur with a passion for inclusive financial innovation and the founder of SendFriend, a fintech startup that uses blockchain for international money transfers. David also served as a special assistant in the World Bank’s Haiti division and is a co-author of the Haiti National Financial Inclusion Strategy. David holds an MBA from MIT Sloan School of Management and an MA and BA with honors from Johns Hopkins University.
Kevin Tseng is the founder of Naos Finance. Before Naos, Kevin was a serial entrepreneur and investor. Kevin founded and left three tech startups in China and Southeast Asia, and led strategic investments at The Walt Disney Company and Alibaba Group.
Mariano Di Pietrantonio is Head of Strategy for MakerGrowth, a MakerDAO Core Unit. He works primarily on developing and researching new use cases, including education, partnerships and communication activities. Mariano has 15 years of product and marketing experience in industries such as pharmaceuticals, banking and gaming, among others.