During Singapore Fintech Festival’s panel session ‘Decentralised Finance: Redefining the Architecture’, ChainLink co-founder Sergey Nazarov and Celo CEO and co-founder Rene Reinsberg examine the forces currently driving the decentralised finance (DeFi) sector and how financial institutions should be approaching their DeFi and cryptocurrency strategy.
Defining DeFi as a system where you have full control through private keys, Nazarov states that users have full transparency through the protocol they give the asset to and are also getting anywhere from two to 8% returns. “You’re getting more transparency, more control and better returns. This is the simplest -in my experience -, most straightforward way to explain DeFi.”
He furthers that because of these benefits, DeFi is redefining the core value proposition of financial products and the financial system.
“Why would I want to give my money to a financial system where I have no transparency about what's going on, after repeated global failures and corrections centred around solvency? Why wouldn't I give my assets to a system where I have complete transparency about what's going on with the system second to second?”
“Imagine if your bank's internal operations and backend were completely open to you, you could examine every decision your bank ever made, from everybody fired and hired, to every loan given and every loan that defaulted. You would know that every single second it happened. That's what DeFi is.”
Moderator Morgan Beller, general partner, NFX, observes that this definition sounds like a “financial Narnia,” a utopia that’s almost too good to be true. Beller questions Reinsberg about what “the catch” is in this brave new world.
Agreeing with Nazarov’s definition, Reinsberg furthers that DeFi is necessary because current markets are not efficient in a way we would hope, particularly with regard to inclusivity and accessibility.
While the current state of DeFi has grown significantly in recent history and certain entry points becoming more accessible, Reinsberg argues that it is still hard for the regular person to gain access to DeFi yield, or collateralised loans, which may not be the case in the traditional financial sector.
“One of the big blockers has been that a lot of the services built today haven’t been available via mobile phones. Most of the world accesses the Internet through a mobile device. If you ask what are going to be the driving forces for wider adoption, it's definitely about making it a lot easier for people to meet them where they are and actually make these tools more easily available.”
Nazarov believes that we’re only at the very early stages of DeFi growth, noting that while the current state of the sector fluctuates between $100-250 billion, “if we have approximately $2-2.5 trillion in the crypto market, this is a format of value that can flow into DeFi.”
Numbers -wise, he states that DeFi currently only represents single digital percentages of the overall value of cryptocurrency which could potentially flow into DeFi. This isn’t even considering the potential of real estate, commodities, equities, and derivatives industries which could also stream into DeFi.
“If we take the value strictly from the crypto format, then we can view the current state of the DeFi market as not having fuelled the rocket. The fuel to the rocket just got connected, we’ve started pumping some fuel into the rocket, but it’s nowhere near being fuelled […] I expect DeFi to be in the trillions of dollars in the coming years.”
Nazarov believes there are several underlying forces which are accelerating and driving DeFi adoption. These tend to centre on inflation, peoples’ continual lack of trust in centralised systems that fail them (through solvency issues, or trading halts for example).
He describes these failures as ‘say one thing, do another’ situations.
“Centralised systems may claim to be solvent, but then announce ‘oops, we’re not solvent,’ so we can’t give you your mortgage or apartment. They claim to allow you to trade, but then say, ‘oops you can’t trade, we’re halting your trading.’”
These scenarios, in addition to inflation, are pushing an undercurrent of interest in DeFi as people are driven to look for and experiment with alternative means of financing.
On top of this, Reinsberg explains that even these examples can be viewed as being a conservative estimate of how significant DeFi may become.
“We’ve only drawn comparison to the traditional system - where that's that and where we are as a percentage of that. What's happening here is that there's a much bigger mega trend at play. Suddenly, money as we know it is changing. These digital assets are currencies and are a lot more expressive in terms of their monetary policies and in terms of what they represent.”
Drawing this out, he adds that if we see more of these assets moving into digital or having a digital equivalent and becoming productive assets to be used within DeFi, it’s possible that the addressable market is a lot bigger than the current market.
“So many people are excluded from even getting a loan, using the assets that they have as collateral. That is a pretty restricted worldview. A future where someone uses an NFT as collateral to take out a loan to start a business, in a market where they would have never accessed a loan from a traditional bank, is a nice example of incrementally increasing the overall size of this economy.”
While we’re seeing early hints and sparks around this, it probably indicates that we are underestimating just how big the market will become in the next few years.
Beller then questions the two panellists what people and institutions in positions of power should be doing to assist in this transition.
Banks are generally client-oriented institutions, explains Nazarov, and through this lens “the fundamental question that all fintechs, banks, institutions need to ask themselves is, at what point will my user base want to interact with crypto related products through me? At what point will people come to me as a bank and institution or a fintech and say, I can buy crypto on PayPal, where can I trade crypto with you?”
He notes that players which don’t have an answer to this question of what they’re going to do when their user base starts requesting crypto or defi related capabilities, should be adopt one of two approaches.
The first is to disagree with the premise that this type of service is unnecessary or unneeded and to get back to your original product offering - Nazarov strongly recommends against this approach.
The second option is to build a dedicated team with a significant budget working toward how to integrate and interface with a variety of protocols. He emphasises that the worst position for institutions to find themselves is one where they know that evolution and system changes are coming, but they don’t know how to react to or manage this transition.
Given the amount of institutions which are taking this proactive route -particularly in the institutional banking world-, Nazarov warns that there will be a lot of players flowing into the space fast. “My advice is not to be one of those institutions or banks. My advice is to get ahead of this, just like there were people who got ahead of the Internet, and there were people who didn’t. It's going to be exactly the same story.”