The TradFi-DeFi Tug of War: Is a DeFi-Only Utopia Possible?
Will Hamilton is Head of Trading & Research at TCM Capital, a wholly-owned subsidiary of Token Capital Management & Technologies Pte Ltd.
Decentralized finance or DeFi is already level pegging with global multinational financial companies in terms of market capitalization and daily volumes. The originally experimental, open-source software for automated peer-to-peer finance has burgeoned into a significant global industry in just one year.
New DeFi entrants were initially dwarfed by the gigantic incumbents of the industry — the centralized, institutional, corporate providers of financial products and services. But what started as a David vs. Goliath contest has become an interesting tussle of new against traditional financial technology.
Similarly to a traditional asset management business, DeFi protocols, by and large, have value prescribed to them based on their AUM [Assets Under Management]. In the world of DeFi, this is known as Total Value Locked (TVL) — the amount of capital deposited by users to earn a yield on their tokens. Currently, the DeFi sector has an estimated TVL in excess of [USD] 165 billion in lending, exchanging and liquidity pools. Major DeFi protocols include AAVE, Curve Finance, Compound Finance as well as Uniswap and Sushiswap.
If the TVL for decentralized finance tokens, apps, and protocols continue to appreciate as rapidly as it has — alongside developers improving the tooling for scale and mainstream use — DeFi looks to be the next exponential leap forward in global finance, not unlike the rise of the Internet, smartphones, and cloud computing.
One of the main reasons for DeFi’s exponential rise is its flexibility and security. The sector harnesses the blockchain as a single source of trust, rather than relying on regulators and central governing bodies who can restrict market access and innovation. It does this all while offering a level of trustless veracity that is virtually impossible in the existing system. As a result, DeFi is drawing a tremendous amount of talent from the traditional finance industry, who perceive the sector as a natural next step in the evolution of finance.
From a Utopian perspective, and on its current trajectory, DeFi looks set to eliminate the need for almost 90% of all the material TradFi [traditional finance] offerings.
For that vision to come to fruition, however, the sector needs to overcome, or potentially side with, powers like the central banks and governments — all of whom pull all the purse strings of the world’s economies. Of course, there will be resistance from these financial incumbents, but in the end, money should flow to those products most innovative and efficient to the end consumer.
That said, regulators and DeFi products are currently at somewhat of a crossroad. There is, in fact, no current legislation that accommodates the products we are seeing coming out of DeFi. Old legislation used for traditional finance will simply not work, purely by the nature of the digital asset space as a whole. This clash can most clearly be seen now through the SEC [US Securities and Exchange Comission] looking to regulate digital stablecoins like USDC as they believe them to be ‘securities’. This fight has only just started and I suspect we will see a lot of digital asset rulings come out of the courts, as we did in Canada regarding their listed Bitcoin ETF [exchange-traded fund].
However, while DeFi may pose an existential threat to its TradFi counterparts, coexistence isn’t being ruled out — and neither should it be.
In order to stay relevant and offer their clients the best possible service, banks and financial institutions should embrace DeFi and integrate the sector into their offerings. This isn’t simply theoretical, either. Already tools are being created to make DeFi more approachable to existing financial firms, and platforms are working hard to expand their ability to provide these types of services to all users.
For example, last year the popular DeFi browser wallet, Metamask, announced it would be offering an institutional grade version of its application, complete with professional tools and control options. This is in an attempt to offer the means for institutions to integrate a complete DeFi trading desk, all while maintaining the level of security and oversight expected from premier companies.
Furthermore, there are signs that TradFi is beginning to take the bait. Recently Mobilum, a technology company focused on making traditional finance more accessible, revealed that they have integrated the Polygon blockchain in order to allow their customers easy on and off ramps to the Polygon/Ethereum DeFi ecosystem. This stands to offer an easier path for curious consumers to dip their toes in DeFi, which has traditionally been too technical for many.
Overall, allowing the masses safe and regulated access to DeFi would put traditional financial institutions back in the driving seat and make the DeFi sector largely more consumer-friendly. While thoughts of bank-sanctioned access and imposed regulation would likely turn the hardcore DeFi proponents off, it may be necessary ‘evil’ if DeFi is to move from the fringe to the mainstream.
Ultimately — and somewhat ironically — even while DeFi continues to slowly consume TradFi, in the end it may turn out that one might not be able to survive without the other.
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