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DeFi: Who Will Build The Future Of Finance?

This time last week, the world’s largest FinTech event, Money 20/20, was in full swing. To say that DeFi and cryptocurrency left an indelible mark on the show’s return to Las Vegas would be an understatement. In a turnabout from the last time FinTech enthusiasts roamed the halls of the Sands Convention Center in 2019, standing room only panels on crypto and Defi took center stage. Yesterday, the day after the 13th anniversary of the posting of Satoshi Nakamoto’s Bitcoin whitepaper, the President’s Working Group on Financial Markets (led by Treasury), the FDIC, and the OCC issued their Report on Stablecoins.

The hype and excitement surrounding DeFi’s impact at Money 20/20 stands in stark juxtaposition to the issues raised by the Working Group. As institutional investment and interest in the blockchain and crypto exploded over the past year, one thing has become clear: crypto and DeFi are the future of finance. What is less clear, however, is who will build the DeFi future?

During a panel that posed this very question, the points raised by panel members echoed potential concerns raised by the government. However, the approaches from industry favor an environment that fosters innovation, rather than squashes it, as overregulation has often been seen to do.

Bitcoin, the largest cryptocurrency (by market capitalization), rose in the shadow of the 2008 Global Financial Crisis. Some point to its genesis as a rebellion against a broken financial system—a financial system that is closed to many, but when distressed, negatively impacts all. The goals of the crypto community point to a desire for a brighter financial future for all. While institutional finance decried cryptocurrency as worthless and a fraud, they dove headfirst into the development of the underlying technology, and, in some cases, created their own coin.

Crypto, however, poses a threat to firms that benefit from centralized markets. DeFi, by definition, is the antithesis to the way in which the world’s financial system currently operates. At this point last year, DeFi was an idyllic concept. Today, Total Value Locked (TVL), the value of the digital instruments posted as collateral, stands at an All-Time High of $250 billion.

The open source, peer-to-peer nature of the blockchain opens financing possibilities never imagined. These features also pose challenges in building the future of finance in a highly regulated industry. These challenges revolve around accountability. Who is working on what projects? When will those projects be “due”? In the case of hacks and smart contracts gone wrong, who is responsible?

While it is easy to point to malicious or nefarious activity as the largest driver for enhanced regulation, it does not occur to the extent that regulators fear. Industry insiders acknowledge that, yes, innovators should be allowed to flourish, but that they should build with the mindset that markets will demand accountability. The DeFi community has increased the pressure among its participants to heed the concerns raised by regulators. While the memory of Mt. Gox still lingers, the return of almost half of the $600 million stolen from the Poly Network points to a community that is united in finding bad actors, forcing them out of the industry, and preserving its ability to grow within the the existing financial system. While self-regulation is often offered as a panacea, it is highly unlikely to be accepted.

Are Stablecoins Really Stable?

Stablecoins are integral to the continued growth of DeFi protocols. By some estimates, stablecoins enabled over $1 trillion in transaction volume. Their appeal lies in their ability to insulate investors from the price volatility that exists with even the most liquid of cryptocurrencies (thus their duly earned moniker). However, the proliferation of stablecoins, poses a challenge for US regulatory authorities as they attempt to understand their inherent risks—key among those is the loss of value (or confidence) in the instruments, especially in times of stress. Analogous to the concerns raised when money market funds break the buck, consider the case of the Reserve Fund in 2008. 

As markets struggled to digest Lehman Brothers’ impending bankruptcy, even the safest of financial instruments, money market funds, touted for their stability due to investment in the highest quality assets and short duration, bore the brunt of investors’ doubt. While holding only 1.5% of its assets in Lehman commercial paper, investors questioned the rest of the portfolio, causing a “run on the bank,” and the fund’s ultimate liquidation. This concern was raised earlier this year as investors questioned the reserves behind Tether (USDT), the 4th largest stablecoin by market capitalization, which disclosed that only 8% of its assets were held in cash or cash equivalents (Treasury bills and “reverse repo notes”).

So, Who Will Build The Future of Finance?

The rising tide of capital flowing into DeFi is meeting headfirst with an equivalent amount of regulation that seeks to better understand the ramifications of a decentralized financial system. Some may argue that regulation is being crafted to better control the growth of the industry. With all of the points and counterpoints, the question still remains: Who will build the future of finance?

Enter Gajesh “Gaj” Naik, a DeFi prodigy. Gaj was pointed out as one example of whose hands the future of finance rests. A self-taught coder, Gaj started coding at eight years old. Starting with C, C++, Java, and JavaScript, he eventually taught himself Solidity with the help of YouTube lectures and online courses from the University of Buffalo. Since his first foray into DeFi, Gaj has been able to raise and manage over $1.25 million in cryptocurrency in just the past year. The irony of this feat is that at 13 years old, Gaj is not even old enough to open his own bank account, much less pass existing KYC regulations. While Gaj’s success is cheered on by many, it also amplifies the very concerns raised by regulators. In the event well-meaning coders’ smart contracts go bad, who is left holding the bag? 

“I got to know about Solidity, and then I learned it in two or three months.” — Gajesh Naik

Allowing the development of the DeFi ecosystem within the existing framework is in everybody’s interests. Building the regulatory framework around this new world, however, requires patience as innovators like Gaj solve the problems that hamper the most efficient flow of capital.

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