Firstly, I want to start by saying what DeFi will not do: DeFi will not change the world because it gets rid of regulation. As an industry we have already been through that cycle once in 2017, and guess what? Tokens do not sit outside of regulation. Even unregulated tokens are unregulated because they fall into a legal regulatory exception, not because they “cannot be regulated because they are decentralised”.
Regulation is currently playing catchup, and like when the internet was first launched, is getting a more and more nuanced view of where and how enforcement should be applied. After 10 years of discussion and debate, a clearer picture is now emerging of how sufficiently decentralised networks should be regulated; the next questions are going to be around the products and services built on top of those decentralised public utilities.
So, what is Decentralised Finance actually solving?
Right now, every system in finance is essentially built on its own, proprietary, non-compatible technology stack that has a huge amount of human process behind it. The London Stock Exchange, the US NASDAQ the Shanghai Stock Exchange are all built as islands, where I have to integrate specifically into each of their technology stacks to trade across them. Concepts like being to directly and atomically swap an asset traded on the LSE for one traded on the SSE is meaningless.
That is because, at the moment in finance, lending, borrowing, swapping, and issuance are all done in these little islands of technology that require legal contracts and excel spreadsheets sent over email as the connective tissue. APIs are improving this process, but there is no such thing as a standard API; Plaid became a $5.3Bn company for essentially this reason.
The internet was a huge improvement on what came before: you used to need to phone your broker to place orders, as they had to physically be there and had to be given permission to trade on the floor. In the internet age, I can go directly onto a (centralised) platform to trade on the stock markets, even as a retail investor. However, to use each of those platforms, I still need to register and create a user account on every single one, and the assets I hold on one cannot interact directly with the assets I hold on another.
This is the core and key difference for assets and services that are built on public ledgers. As soon as they are built on public ledgers like Radix, they become interoperable. I can seamlessly and programmatically move my assets from the services of one application, built by one company and team, to that of another, built by a different company and team, but issued and launched on the same decentralised public ledger. The public ledger acts as an interoperable platform for many startups to experiment and build better versions of existing products (such as stock exchanges) or entirely new products (such as continuous function market makers) that are just not possible with the current systems.
From a consumer point of view, the products and services are probably not going to change much in their appearance - they will still be accessed via mobile apps, they will probably still be offered via regulated companies in the fullness of time. Their improvement will be speed (seconds not days or weeks to move money between investment accounts); higher rates of interest offered on deposits; seamless ability to swap between asset types without needing to go into cash as the interim asset; and fully customized consumer financial products, rather than one-size-fits-all.
Decentralised Finance is not about moving existing banks onto public ledgers. It is about unbundling of banking services (borrowing, lending, investment) into applications that can all interoperate on a single public network and compete for users’ wealth with the best offerings. Banks are like newspapers coming into the internet age, some will make the transition, but not all.
Fine, but this is all future navel gazing right?
No. Unlike 2017, these are real services being built on real platforms.
Let's take a DeFi stable coin, MakerDAO, a DeFi lending platform, Compound, a continuous function market maker UniSwap. These are all built on the Ethereum public ledger and together they have crypto assets under management of $600m, $1.5Bn and $48M respectively.
MakerDAO can be thought of as a secured lender. They take an asset you own (currently crypto assets like ETH or similar, but already expanding more real world collateral) and allow you to take a loan out against it. This is a programmatic process, requiring no human intermediation - the process of going from Ethereum to a loan against that ETH takes seconds.
My ETH is safe, not because it is being controlled by an individual company, but because it is locked in an open source contract that can be audited by anyone and runs autonomously on top of a public network. Unlike with a bank, if MakerDAO the company went out of business tomorrow, I would still have complete access to my funds as the program does not require the continuous existence of the company that made it to continue to function. Once I lock my Ethereum I can borrow against it's traded value - I get out DAI which is exchangeable on any exchange for $1 USD ≈ 1DAI.
I can take that DAI and put it into Compound where I can earn an annualised interest rate of 4% PA. This is like a bank interest rate. If I would prefer not to hold DAI and would instead prefer to hold USD, I can take that DAI and swap it instantly for True USD (TUSD) on UniSwap. True USD is a regulated, audited, 1:1 dollar backed stable coin based in the USA and issued on Ethereum.
Finally, if I choose to, I can take that True USD and request that the money that backs it be transferred to my current account in a normal bank.
That entire process; from borrowing against my Ethereum on MakerDAO, to depositing DAI with Compound to earn 4% PA, to then withdrawing it again and swapping the DAI for TrueUSD, can be done in less than 30 minutes, end to end. The slowest part is getting TrueUSD to send you a bank transfer because it is using the current centralised infrastructure again.
These are not theoretical examples, these interoperable decentralised applications built on Ethereum that already represent billions of dollars in value being moved between them, as well as in and out of the traditional financial infrastructure.
While Ethereum has managed to get a lot of the early traction here, Radix solves a number of the deep technical issues, principally the scalability of the Ethereum platform and the difficulty of building these decentralised finance applications, that is currently stopping the industry from being able to move as fast as it really could.
OK, so we are just copying existing financial products?
Not exactly. The internet was a revolution caused by standardising the protocol over which information could be programmed and interconnected.
Protocols such as Radix and Ethereum aim to standardise the way in which financial assets can be programmed and interconnected.Today, that lack of standardisation, and lack of a single network across which all assets can be programmed and connected, creates a huge amount of friction that requires many layers of intermediation and manual processes. This alone costs the world an estimated 0.05% of global GDP every year, or approximately $71Bn.
However, this is only looking at the problems that already exist, not what new products may be possible to create with this technology in the future. The internet did both, first by emulating what came before (e.g. email) and then later by creating entirely new paradigms (e.g. social media).
The first hints of what may be possible that was just not possible before are in innovations like Constant Function Market Makers, such as UniSwap. Innovations like this flip existing systems such as order-book based exchanges on their head. Providing liquidity is now a passive rather than active process, one that can be done by large numbers of people, rather than a few specialists, and a zero to 1 innovation in pricing the long tail of currently illiquid financial assets.
To find out more about why this is such a breakthrough innovation, please do check out this very excellent medium post specifically about why these represent a fundamental innovation: https://medium.com/bollinger-investment-group/constant-function-market-makers-defis-zero-to-one-innovation-968f77022159
DeFi represents an unbundling of financial services that can be stitched together via a unified decentralised public protocol - if the internet was the information revolution, this is the asset revolution.
Ultimately, these innovations will be largely invisible to the everyday consumer, who will simply benefit from faster, more responsive and much more cost efficient financial services with better rates of return.
The financial industry however, is likely to be unrecognizable within the next 20 years, where programs, rather than institutions, form the basis for almost all financial services.