As applications of blockchain technology advance and cryptocurrency edges toward mainstream acceptance, a curious term has started to crop up—DeFi.
Emerging from fintech esoterica only recently, DeFi stands for “decentralized finance.” The goal of DeFi is to disruptively redefine financial services for the entire planet. The creed of DeFi entrepreneurs holds that basic services—including digital savings accounts, lending, payment processing, transaction fulfillment, currency exchange and currency transfer—shouldn’t be controlled by what are known as centralized sources: banks and other traditional financial institutions that charge lucrative fees to act as middlemen.
Rather, DeFi devotees believe these services should be controlled by and for the individuals who actually create value for centralized institutions by letting them use their money. Much more than a concept, DeFi is here and now, with digital “banking” platforms springing up to facilitate services that hinge on peer-to-peer (P2P) principles rather than centralization. Ultimately, DeFi is seeking to disrupt the full gamut of financial services.
The central tool of DeFi is blockchain, the transparent digital ledger technology that enables bitcoin and other cryptocurrencies and has become a Wall Street buzzword because of its vast potential. Blockchain is gaining traction from the use by established companies (e.g., IBM) and startups alike, marketing to various industries where precise record keeping, verification and indisputable documentation is critical. A salient feature is that blockchain is “trustless” because, with its unparalleled transparency and accountability, trust isn’t necessary; verification and confirmations are crystal clear for all to see.
Though DeFi is in its infancy, advisors who become aware of it now will be able to answer questions from clients and provide guidance. Moreover, to the extent that DeFi ultimately succeeds in disrupting the existing financial order, it could threaten advisors’ revenue streams in various ways. Getting a grip on DeFi now would give advisors a head start on modifying their practices and business-development efforts accordingly. The larger context of these adjustments involves the broad impacts of blockchain on advisory services.
Concrete examples of the DeFi movement—as democratic social philosophy underlies the goals of DeFi-based entities, it is indeed a movement—are here now, as evidenced by:
• Startups of banking platforms (not actual banks and not FDIC insured), which share the value created by depositors. As a result, they’re able to pay high-interest rates on deposits of regular currency, cryptocurrency and a less volatile crypto equivalent known as stable coins (or stable value coins), whose value is pegged to the dollar or another so-called fiat (non-crypto) currencies. These platforms make loans in dollars and crypto, convert currencies and handle payment processing. Players up and running include Celsius Network and BlockFi. Fledgling platforms include Dharmalever, CompoundFinance and Nexo.
Celsius founder and CEO Alex Mashisky, a pioneer in VoIP (Voice over Internet Protocol) says he believes the time has come to similarly reinvent banking. In a recent interview I did with him for a book I’m co-authoring on the future of blockchain and a more decentralized world, Mashinsky outlined his vision of DeFi as rewarding the value creators based on their contributions. He’s seeking to realize vision with what he calls MoIP (money over internet protocol). Just as VoIP made the traditional billing system for phone calls obsolete, MoIP seeks to do the same regarding money transmission and banking in general by creating an infrastructure that enables global P2P transactions without what Mashinsky calls “toll collectors,” banks and financial institutions in the middle. The Internet protocol rides on blockchain.
Celsius’s goal is to return 80 percent or more of its net profits to its customers. The company’s interest on crypto deposits, including stable coins, had ranged from 2.5 percent to 8.10 percent, its website stated in June. (Not all services are available to U.S. residents, and some services are restricted in some states, including Washington and New York.) Though his goal is disruption, Mashinsky is realistic about the resilience and permanence of centralized financial authorities. He and other DeFi players see DeFi as challenging traditional finance but also coexisting and interacting with it. “If you think of communism, socialism and capitalism, decentralization is effectively like a fourth system,” he says.
• The emergence of asset tokenization. Just about any asset, including valuable art works and eventually, even your home or your car, can be tokenized. This means digital tokens representing a fraction of the asset’s value can be sold by owners to investors. As do cryptocurrency exchanges, the new banking platforms accept fractions of a unit of cryptocurrency—e.g., .002 of a bitcoin—for deposits. It’s only a matter of time before these platforms begin to accept deposits of tokens of ownership in all manner of assets.