The 2020s were nothing short of a revolution for the world of finance, out of nowhere NFTs (non-fungible tokens) and cryptocurrency skyrocketed as companies like Tesla started showing interest in the implications of non-centralized currencies.
Regardless of whatever end of the aisle you stand on these topics, we can all agree on the underlying issue: technology is shaping the world of finance. And for better or worse, we are in the middle of a digital acceleration that even our best estimates cannot have foreseen. One ripe with opportunities for those willing to take it.
While it’s too early to tell, it seems that this acceleration is pushing towards a battle royale involving governments, banks, fintech, big tech, and a small little thing called decentralized finances, or Defi.
What is Defi?
What is DeFi? Well, it can mean many things, DeFi is a collective term that encompasses financial products and services, built on blockchain technology, and is part of the public space.
What all these products and services have in common is that they are a) not regulated by a governing body and b) not managed by a middleman such as a market exchange or third-party payment processor.
For example, imagine acquiring a good or service with digital currency, instead of going through an intermediary like ApplePay or Paypal, you trade the accorded sum directly from your wallet to the service or product provider. No extra fees, or hidden costs.
It’s a financial wild west, a libertarian’s dream, an economy without regulatory bodies (or very few regulations) supported by a public blockchain, that in theory offers as much safety as traditional finance systems.
So, what are the benefits of DeFi?
- Users can retain custody of their assets, with no transaction fees, and no reliance on a third party, the user is in direct control of their personal wallet.
- DeFi is permissionless and inclusive. The user is in full control of their wallet, they can trade with whomever they want, without having to wait for bank fees or dealing with restrictions.
- Transactions are transparent. Since most blockchains are a public ledger, every transaction is out there in the open and can be traced by any user.
- Transactions are in real-time. The blockchain is updated the moment a transaction is completed, and interest rates are updated multiple times every minute.
- DeFi data is tamper-proof. It’s almost impossible for someone to manipulate the data in a blockchain.
- Many DeFi protocols are open source. Ethereum and other projects are built with open-source code, anyone can view, audit, and build on the code. Developers can easily connect DeFi applications to create new financial products and services, without having to seek permission.
If it sounds too good to be true, well, that’s because it is. 2022 has seen the crash of many DeFi initiatives, from pay-as-you-earn games like Axie Infinity, to the overhyped and over-inflated NFT market. And that’s not taking into account the billions of dollars lost with the meltdown of Luna, one of the most popular cryptocurrencies on the market.
The technology itself is safe enough, but DeFi systems are as vulnerable to human engineering as any other finance system. In fact, even more so, if someone steals your credit card information, you can block any purchases with a phone call. If someone steals your crypto wallet, there is very little a user can actually do.
But perhaps the biggest hurdle for DeFi solutions is that they are very hard to understand for the average user. Setting up a crypto wallet is cumbersome at best, and after two years everyone has heard of NFTs, but hardly anyone can define them in precise terms.
The Market is Moving
The volatility of the DeFi market is garnering the attention of governments all over the world. You can’t have a $90+ Billion business and not have regulatory bodies paying attention. For example, The Wall Street Journal reported that the Security and Exchange Commission was probing decentralized crypto exchanges that had so far resisted oversight.
Internationally, the Financial Action Task Force released a new set of guidelines for governments asking countries to gather information on movers and shakers of the cryptocurrency world, specifically “individuals with control or sufficient influence over DeFi programs”.
Can traditional market regulations cope with decentralized finance systems? Probably not, but limiting the transactions between DeFis and other forms of currency would be one way for governments to control, at least in part, the DeFi market.
Perhaps more importantly, the underlying tech and infrastructure of DeFi systems are appealing to financial systems worldwide. With the slow, but steady, decrease in physical currency, Central Banks are encouraged to explore digital currency as an alternative.
China is a market leader in this regard, launching its own digital wallet in a culture that actively engages with digital payments daily. To put in perspective, Tencent’s Digital Wallet has one billion active users on its platform.
What Does It All Means for Startups?
We are going to see a massive surge in digital wallets in the next few years, some government-based, some owned by big tech (like Apple Pay), and others part of DeFi systems. As the market grows, odds are that banks and other financial institutions will be on the market for new disruptive technology in the field.
Big companies will keep pushing for destination platforms, massive ecosystems where users have all their needs covered, as such, it’s to be expected that both Fintech and Big Tech will be on the lookout for potential acquisitions of smaller startups.
DeFi, while in a bit of a rut as of late, will probably recover sooner rather than later; one of the biggest problems with the current environment is the overwhelming amount of hustlers, and bad faith actors preying on potential adopters.
But as new regulations come into effect and public awareness becomes more alert, we will probably see a healthier space for DeFi, in which case, there is a huge market for startups looking for new venues.
Namely, closing the gap between savvy DeFi enthusiasts and potential newcomers, by creating technology that provides safety rails for the public. DeFi has the potential to become a strong competitor against payment processors like Visa and Mastercard with their gross margins of 65 to 80%. But as they are today it’s a bit of a longshot.
Say what you will of traditional payments processors, but they have gained their hold on the market by proving time and again that they are reliable. Until DeFi can be as easy to use and as reliable as our current methods, it’s going to be a limited market at best.
Startups would do well to search to take advantage of these trends because once the dust settles we will be living in a brave new world.
