Blockchain investors are showing increasingly more interest in DeFi projects, with over $3 bln invested in the market as of Q2 2022, which is close to the figure covering the entire year 2021, according to CB Insights. But what kind of future awaits Decentralized Finance? Will it be truly able to change the traditional finance system or will it just become part of it? And most importantly, will there be a strict regulation that can rule out the risk of questionable transactions in the industry? Artem Genkin, Doctor of Economics, President of the NPO “Center for Protection of Bank Clients and Investors,” shared his vision of DeFi prospects and the blockchain technology in general in an interview with SberKnowledge (a SberUniversity project – ed.). An Invest Foresight correspondent structured the interview for readers’ convenience. You can see the full video on SberUniversity.
Algorithms against brands
– Mr. Genkin, in your opinion, would DeFi be able to destroy the traditional financial system? Or is it an overstatement?
– In my opinion, DeFi will inevitably take a rightful place in the global financial system. However, I am indisposed to agree with those people, sometimes very important and wealthy, who are confident that crypto instruments will replace all banks, lending institutions and insurance companies within the next 5 or 10 years. By the way, one of those people who predict that DeFi will kill traditional finance is Tim Draper, an American venture capital investor, billionaire and crypto enthusiast. In my opinion, it will be rather a natural division between the users of traditional financial tools and DeFi. According to the World Bank data for 2017, 1.7 billion people on the planet did not have access to banking services, and this is a huge niche that DeFi could fill.
– Why is it a niche for DeFi?
– DeFi will be able to gain such a large audience due to its usability, and most importantly, cheap direct P2P transactions. Participants in this network do not need banks or other financial institutions as intermediaries when making deals. In view of this, DeFi will be able to take an important place in the financial system.
– Still, not too many people use DeFi yet. What could change the situation?
– Yes, there are enormously more people who trust financial and banking brands – the bearers of traditional financial values – than those who is ready to trust “soulless algorithms.” But eventually there will be an equal number of both of them; moreover, there unlikely will be a clear line between the two groups. The core of financial services will remain the same but the diversity of providers will increase. If someone needs to, say, insure a car, both traditional insurers and DeFi services will be at their disposal. Naturally, it also depends on the state, which might interfere and make services from each sector visible and legally accessible.
– What stops most people from accepting decentralized tools?
– There is an entire range of challenges that DeFi users face. Most of them are related to security. According to various estimates, up to 70% of smart contracts have vulnerabilities at the moment of their release, and a single vulnerability is enough for a successful cyberattack on the contract and the users’ money. In the future, in part due to the development of DeFi, the problem will no longer exist since there will voluntary audit of smart contracts and self-regulated industry-based organizations, so hastily made solutions will not reach the market. The digital literacy of customers will also improve.
There is also an issue of scalability; thus, the speed of transaction processing in Ethereum, which was initially used by most DeFi protocols, is much slower than the one of VISA. But new blockchains appear and DeFi protocols will migrate there. If the migration continues, the problem will be important only for those protocols that work on Ethereum. I believe that the issue will stop being relevant in a year or year or a half from now.
Regulate it
– The critical stance of the regulators does not help building trust in DeFi. Why is it necessary to regulate DeFi at all?
– Yes, in 2021, almost all key regulators on the global financial market had their say on the subject of DeFi regulation (or plans to regulate), among them FATF, the Financial Crimes Enforcement Network (FinCEN), the United States Securities and Exchange Commission, the Commodity Futures Trading Commission and the German Federal Financial Supervisory Authority.
The main stumbling point is the absence of a procedure of mandatory verification of the client identity (KYC). To use DeFi, one only needs to have a smartphone and access to the internet, which means that the regulator will not be able to identify users and prevent money laundering.
– Is the procedure technically possible in DeFi?
– The most clear-sighted representatives of the sector already speak about the need to create a mechanism of the compulsory integration of the KYC procedure. Some regulators suggest a compromise by granting licenses to decentralized exchanges on the condition that users undergo identification without revealing their identity.
– How do you access regulators’ chances?
– If market players do not agree to this, this is going to be a matter of life or death, with the outcome not in favor of DeFi. As is well known, any financial tool with technological characteristics that allow circumventing regulatory controls will become increasingly popular, including among not-so-conscientious economic entities. As soon as compulsory identification mechanisms are introduced for regular banking products, regulators obviously seek to ensure that similar requirements apply to DeFi.
Moreover, DeFi is becoming increasingly popular as regards staking, which offers crypto holders a way of earning income from their assets – an activity typical for the financial traditional market, with the use of cryptocurrency but without identification.
The regulators will obviously achieve their goal. Over the past five years, they have managed to overcome the resistance from such a strong sector as crypto P2P trading and exchanges, which are currently introducing compulsory user identification. DeFi market players are disregarding these requirements so far, but I believe the situation will change and at least big players will have to agree to compromise.
Future with DeFi
– How will DeFi and blockchain change the world within the next 50 years?
– I will outline two major opposing trends: on the one hand, a trend towards democratization and overcoming the digital divide, and on the other hand, a tendency towards increasing elitism and oligopolistic dominance.
Speaking of the first trend, the blockchain technology has provided access to financial and credit resources as well as to various life benefits not only for bank account holders who belong to the so-called golden billion. With available DeFi services, this will only require broadband internet access, meaning that about 98–99% of the current global population is a potential audience for blockchain solutions.
However, there is also a risk that the increasing use of blockchain may result in social stratification as no equal decentralized access to blockchain solutions exists – if only because developers of a certain blockchain determine rules for access and directions where changes occur, and eventually initiate hard forks. The rules of the game do not depend on the user community but on a separate group of highly technically qualified people.
– Which industries will most actively utilize the blockchain technology?
– I think that blockchain will find its widest application in logistics, primarily due to the opportunity to register and track any transactions, while smart contracts will allow for transactions under the zero trust model. For instance, it can substantially change cargo transportation. Transatlantic cargo transportation involves about 30 participants, with almost 200 types of various interactions between them. These actions can be envisaged in a smart contract, resulting in fewer costs and intermediaries.
Another vector implies efforts to tackle counterfeiting; the blockchain technology will help track the production chain for an entire scope of products, ranging from vegetables and footwear to diamonds.
The technology can be used to organize interaction under multilateral transactions with different duration, location, number of participants and types of assets, allowing for its use in construction and insurance, particularly in medical insurance where claim settlements take several days rather than many months. As regards healthcare, blockchain has allowed for implementation of immune passports thus partially curbing the COVID-19 pandemic. Such solutions make it possible to store and validate information, differentiate access rights, and create a single database.
– The technology is used for creating central banks’ digital currencies. What future awaits this tool?
– The positions of central banks’ digital currencies will be enhanced. I believe that digital currencies are here to stay, and global reserve currency competition may even shift to the digital sphere. I think that the digital yuan will play significant role in challenging the dollar’s domination, with stronger positions against the dollar than during the pre-digital era.
– What blockchain-related challenges will become a thing of the past and when can we expect it?
– As to blockchain issues, such as scalability and low processing speed, I believe they will soon be resolved. However, security problems will persist as this is the most vulnerable node in a multi-nodal system.
Also, despite all functional advantages, we should not forget about the reverse side of technology. Blockchain helps eliminate numerous intermediaries, and we cannot say this is solely positive.
By Olga Blinova