Thought Leaders are articles that are contributed by respected members of the fintech & digital assets community. They may or may not necessarily reflect the views held by the Securities.io team.
The biggest value proposition of decentralised applications, as well as all related services for the user, is that they're self-custodial. This is a very powerful feature, although the general audience can find it difficult to understand at first glance.
It’s not that the learning curve has been steep. Instead, it has been flat — with a small upside angle because the self custodial ship is still hard to execute and people continue to lose their wallets quite often. Even crypto professionals sometimes struggle to keep everything under control. For example, a developer from my team has recently been receiving salary into his wallet. Unfortunately, because of his young children, he lost his backup password, and as a result — access to the wallet is denied and the funds are impossible to recover. If people involved in the crypto industry can make such mistakes, we cannot expect the general public to access and use these apps easily. There’s fear due to inadequate technical skills, and a lack of understanding on how it all works. However, the concept of using crypto remains sound, so going forward, self-custodial instruments will be more valued. Why? Because this represents the power with which you can store your assets wherever you are, and you can cross borders or access your cryptocurrencies from anywhere.
On-demand access to financial services, without an intermediary or third party, empowered with the mathematical certainty of settlement transactions, works! This, right here, is the secret formula for disrupting currently existing financial services. It’s not just a current account replacement, but also a wealth management product.
Going forward, it’s very likely that DeFi will replace banking and account services as we know them. There are start-ups building a simple interface in a self-custodial way to help people manage their accounts and assets.
Obviously, previous attempts were successful in attracting users, but were ultimately unsuccessful in actual deliverables. There’s also the example of decentralized lenders, Celsius and Voyager, who failed because of the mismanagement of assets.
Taking into account the major crashes in 2022, volumes of funds are already skyrocketing on decentralized exchanges. Why? Since the value of self-custody outstrips the risk of a non-transparent balance sheet. Users switch from centralized to decentralized rails to shield their capital from the grip of any entity and conflicts of interest.
Security and hacker attacks
This is probably another reason why growth in DeFi has been stalling and flatlining — it’s the security that concerns people, and while this can mean the physical security of your wallet, or the security of the online exchanges, we’re actually talking about security at the blockchain level.
The question is how do you manage risk in a credit default swap, and how do you know the exchange you’re using won’t double spend the transaction?
This part can be tricky, because regulators are even further behind the learning curve than users. Indeed, Gary Gensler from the SEC said the ‘Ethereum Merge’ questioned its security status recently, so there is of course a risk that they will add some fuel to this uncertainty fire and even maybe try to go after some of the developers as was done with Tornado Cash. So yes, there is of course no clarity on the regulation front in the U.S., and with European big bureaucratic mess with this Mecca coming online in the next two or three years, it is indeed tricky.
Who knows? There are even rumors that Europe wants to restrict ownership of Euro-denominated stablecoins to Europeans only. Canada has just introduced a similar restriction, besides Bitcoin-related ones. It puts or will put a cap on nations to invest in digital assets. So definitely the regulatory landscape does not help at all at the moment, and I doubt we’ll get any type of certainly any time soon.
November 2022 events only added fuel to that particular fire and unleashed regulators to closely watch the ongoing turmoil in the crypto sector. Mt. Gox, Bitfinex, Celsius, Bitwala, 3AC and a few dozen experimental applications were not a big deal until economic gravity finally caught major institutional counterparties such as FTX & Alameda together with their clients like BlockFi. And we likely yet to see this contagion spread in the coming weeks).
There is a very low chance a regulator, especially a European one, will now grant something like an EMI license to the crypto exchange. On the contrary — organizations like STASIS, which have been positioning themselves on the high road without a conflict of interest, a track record, an external balance sheet audit, or an external AML audit — will be in demand by regulators.
At the end of the day, institutions will start differentiating counterparties by credit risk. Future products will evolve to satisfy the need for regulation, compliance, and transparency. Onboard with STASIS to access DeFi & Web 3 services via EURS which was designed to build trust and confidence.
There’s no doubt that ETHW (Ethereum Proof-of-Work) is something to keep an eye on — if only to at least understand the dynamic of newly-emerged assets.
EC (Ethereum Classic) in that regard is also interesting, and especially so if something goes wrong with ETHW, Ethereum Classic will once again capture users’ attention.
There’s also the Cosmos ATOM coin, which is very interesting because its creators have been quietly building one of the best blockchain technologies out there.
I say it’s a hidden gem across the entire crypto spectrum, with this network containing some very interesting assets within, such as Osmosis, a Cash network. There are also a number of interesting technological developments happening in that space, and I am interested to see what will happen, especially after this long and exhausting market correction, which took many assets down by 70-90 percent.
I find it very interesting that yields in crypto and DeFi are now lower than in TradFi. If you allocate to a short term government bond, it’s a higher rate than if you put some funds to work in DeFi — an interesting phenomenon. In a world where the actual risk-free rate is the U.S. government, this should not be happening. It will not make sense for any other asset to yield less than the U.S. government.
But it’s happening and it has been this way for quite some time already, which gives you some idea about the value proposition that I mentioned at the beginning. People will value self custodial assets in the future. Perhaps once you try it, once you see how easy it is to move, how reliable it is to settle transactions, and just how reliable it is in general, you won’t want to go back to outdated financial systems — even if there is a higher interest rate!
The right way to see this is to consider it a value proposition. The yield is lower, but perhaps the product is better. You can carry it with you all over the world, without limitations, being able to enjoy options of borderless finance.
The other way to see it is that we’re setting up a new benchmark for risks in DeFi. Skeptics would maybe say yes, it’s still U.S. dollars in the end, and they would be right, but the crypto community has a history of experimenting with the way finance works.
Perhaps the stablecoins we’re using now in DeFi will ultimately decouple from traditional finance assets, and there may be a separate interest rate across the DeFi spectrum and separate benchmark on which other assets will be valued, but that is yet to come.
Even so, it’s quite a phenomenon, and unless it changes quickly and adjusts, I think there will be plenty more to write about, as it looks like a new financial interest benchmark is setting up on our watch.
But this reality is even more proof of why having crypto assets in a DeFi world definitely looks like the financial system of the future, being built today, to fix TradeFi problems we’re all sick of seeing and dealing with.
All of that said, the general economic outlook continues to be grim: growth deceleration across the board with central banks tightening financial conditions into the fastest slowdown in decades, leading to four quarters of a recession. The problems of the crypto industry continue with the fall of giants like FTX and is likely to create some headwinds for new players.
DeFi will certainly bounce back in the future. This is because of macro pressures — currently there is significant financial condition tightening happening across all the major central banks, and of course when two-year treasury bonds yield 4 percent, it’s hardly a case for zero yielding asset allocation. It has to be a really significant argument to speculate on those bonds, because there are so many safe securities which are yielding a safe single digit percent.