Decentralized Finance Today is Not What Was Promised

According to Cross, although COVID-19 may lead to more frequent use of technology, it may not be enough to drive crypto adoption rapidly

The concept of digital currencies has been around for a few decades, but the concept of a digital currency called Bitcoin, operating on a decentralized network, was first introduced by the pseudonymous Satoshi Nakamoto in his whitepaper in 2009.

Nakamoto introduced the world to blockchain, a chronological record-keeping system (also called a distributed ledger system) that is maintained and verified by the public. This eliminated the need for a trusted third party, like a bank or other financial institution, to execute transactions or issue currency, allowing for instant trustless peer-to-peer payments.

Decentralized Finance (DeFi) refers to financial products and services that replicate traditional financial offerings by leveraging the trustless and transparent platform of a blockchain.

Nakamoto was inspired by his aversion to governments and other financial institutions after the real estate bubble of 2008. In the same spirit, DeFi essentially eliminates the need for financial institutions and governments when accessing financial products, and is therefore also referred to as Open Finance.

DeFi is an alternative to traditional loans and mortgages, and can be accessed by anyone with a smartphone and Internet connection. Common examples of DeFi include cryptocurrencies and digital assets, smart contracts, crypto lending and borrowing, trading, insurance, derivatives, payments, stablecoins.

Since governments and financial institutions have a monopoly over almost all financial products and services, the concept of DeFi was considered revolutionary, with some expecting DeFi to become the future of banking. However, Neal Cross, Co-founder and Chairman of PictureWealth, an Australian wealth-tech startup, believes DeFi has so far failed to deliver, both on its promise of universal access to currency, and as the future of banking.

Blockchain has grown slowly

Although introduced in 2009, blockchain has barely evolved or been adopted, says Cross. He draws a comparison between iPhone, which was introduced in 2007, and DeFi. According to him, iPhone has evolved significantly in terms of technology and become the market leader, in almost the same time in which DeFi has failed to gain a foothold in the market.

“12 years is a long time in technology. In 12 years, we’ve had Facebook, Snapchat, TikTok. Think of everything that’s changed in the world of technology. And yet blockchain hasn’t really moved forward fast enough,” says Cross.

Over the past decade, blockchain technology has been implemented in various fields owing to the ease of developing applications and systems on the blockchain. These are referred to as ‘dapps,’ or decentralized applications.

“From a technical developer perspective, I really like [blockchain] because there’s lots of stuff you don’t have to code. It’s like a great framework,” says Cross. “You could configure it, you can bake some code or a lot of code if you want, or a little bit. It doesn’t matter. It’s kind of enterprise-grade out-of-the-box.”

Blockchain has various use cases

According to Cross, blockchain is especially suitable for connecting disparate entities that don’t have a formal trust relationship. Payments is the perfect example, and Cross says its acceptance is growing in the field of finance.

Cryptocurrency’s lack of popularity as a currency, however, can be attributed to its illiquidity and notorious volatility. According to Cross, cryptocurrency tends to act as a commodity, like gold or an investment product, that people want to hoard in hopes of gaining value in the future, and is therefore not as liquid as traditional fiat currency.

This problem was, however, solved with the introduction of stablecoins that were pegged to a stable asset like the U.S. Dollar or Euro, or to a group of cryptocurrencies to mitigate the impact of volatility.

The other use case of blockchain that has gained momentum is in supply chains. However, Cross cautions that blockchains do not necessarily guarantee the truth in supply chains and should not be blindly trusted.

“People keep telling me that this is tracking the food. No, it isn’t. It’s tracking the packet the food comes in. And as someone who’s done a lot of work in developing countries knows full well, sometimes the food in that packet is not the food it should be,” says Cross.

Therefore, decentralization with blockchain does not eradicate issues with supply chains, although it does make it harder for people to cheat or commit fraud by simply increasing visibility.

Blockchain is also being used in identity checking in finance, but according to Cross, it does not eradicate the problem of fraud – it simply makes it harder for people to misrepresent things.

In the same vein of misrepresenting things, Cross references another instance in blockchain’s history that resulted in a great deal of losses and fraud at the time.

Back in 2017, Initial Coin Offerings (ICOs), where new coins were offered to people in exchange for other crypto or fiat currencies, were all the rage. People invested in worthless currencies in ICOs in the hope that the currency’s value would appreciate in the future with greater usage.

“We did see a lot of fraud and a lot of failure in that market as well. So a lot of ICO prices have virtually gone to zero now,” says Cross.

CBDCs are a game-changer

What is peaking Cross’ interest now is the concept of fiat digital currencies or Central Bank Digital Currencies (CBDCs). Currently, China is testing its own digital Yuan and plans to launch it later this year.

“I think for me, you know, getting fiat currencies onto the blockchain is really is a game changer,” says Cross.

This is because CBDCs can allow governments to track each single unit of currency when transactions are being recorded on a blockchain, thereby eliminating counterfeiting and the problem of illegal untaxed incomes.

According to Cross, governments currently pour funds into the economy at a high level by investing in infrastructure development like the building of roads and bridges to create jobs, along with providing loans to businesses, in the hopes of achieving economic improvement at the grassroots.

This economic improvement is measured by indicators like employment, circulation of money, and incorporation of new businesses. However, this is a less efficient way of tracking economic improvement, says Cross.

However, if fiat currencies went digital on a blockchain, the government would be able to track each currency, and along with it the economic improvement in exact figures, says Cross.

“You can micromanage an economic plan, which you couldn’t do before. So you can see wherever that currency goes, you can see where it flows through the economy, and the impact that it has,” he says.

Challenges in decentralized finance

According to Cross, there’s an increasing challenge facing the growth and proponents of DeFi – one that could threaten its adoption entirely.

“The truth of what we’re seeing at the moment is, we’re still seeing way too many hacks. And in the meantime, I don’t see many bank hacks,” says Cross.

Apart from the large-scale scams and frauds during ICOs, the cryptocurrency world is vulnerable to frequent hacks, often resulting in large sums of money disappearing, which has made some people point fingers at crypto wallets and exchanges.

On July 15, for example, an unknown hacker took control of several Twitter accounts through a cryptocurrency giveaway hoax message sent to Elon Musk, Kanye West, Bill Gates, and U.S. Presidential Candidate Joe Biden among others, according to a report by CoinTelegraph. 12 Bitcoins (around US$114,000 at the time of writing) were stolen in the incident.

According to Cross, another reason behind blockchain’s failure to become mainstream is because the problems it solves are not profitable enough, while the cost of change is too high.

For example, banks have separate lending systems to handle loans and mortgages. Integrating blockchain might save a million dollars a year.

“The trouble is, to rip out and replace your lending platform will cost you $20 million,” says Cross, pointing out that these problems are not considered serious enough to warrant the investment required to implement blockchain technology.

However, banks’ reluctance has provided opportunities for fintech startups to combat the problems in the financial sector with cheaper solutions. One example is the case of cross-border payments, which was traditionally expensive through banks, says Cross.

According to Cross, humans always want things to be easy and either cheap or free, and in the future, decentralized platforms would allow financial services to be provided at low cost and to be simplified. However, in a decentralized future, Cross believes that banks will have to improve efficiency by integrating new technology in order to survive.

“One future is that they get way more efficient, reduce a lot of their costs and implement some of this cool technology like blockchain,” says Cross. “And they can become a lot more customer centric, and do lot more partnerships with fintechs.”

Cross’ second vision of a bank’s role in the future is that of financial advisors that do not control the flow of money, but provide advice on how to optimize liquid assets.

“I believe if the future is decentralized, there will be fewer banks, but they’ll be focused on helping people achieve their financial outcomes and not control the flow of the money,” he says.

COVID-19 may not accelerate crypto adoption

Some crypto experts like Henri Arslanian, PwC Global Crypto Leader, believe that the global pandemic will act as a catalyst for the crypto world as people grow averse to the use of physical cash for fear of disease transmission.

However, Cross does not believe that cash will be completely replaced in the near future, although its use is declining.

“Would I bet my house on the fact that cash will be completely wiped out in 10 years? No, I would not bet my house on that,” says Cross. “Is it declining? Absolutely. Has COVID-19 helped it decline? Yes. Will it fundamentally keep doing it? I don’t think so.”

Cross believes that the increase in digital payments and crypto trading is a temporary fad. According to him, people like going out and touching things, and the restrictions that were imposed did not eradicate the need for physical experiences.

For example, in the U.K., several illegal rave parties were reported in June after the initial lockdown relaxations, as people were starved for physical intimacy and social interaction. Cross cites this as an example of how forcing people to adopt change can often backfire.

“My view is that just because technology can do something, doesn’t mean that humans will adopt it,” says Cross.

He says that the technology to work from home was available for a long time, but companies did not accept it until governments implemented movement restrictions and social distancing measures. Therefore, there is a high likelihood of them reverting to the old ways once the pandemic is over.

Cross agrees that the pandemic has introduced people to technology that they would have never used before, like ecommerce and delivery of groceries, but he argues that although people may continue to use these technologies and services in the future more frequently, they will not give up their habits of using cash or visiting shops to buy products.

“I don’t think the future is digital. I think it’s hybrid,” says Cross. “I think COVID-19 has opened the door, but I don’t think it’s been enough of an accelerant to fundamentally change it.”

Regulation is key to DeFi growth

According to Cross, regulation is the key factor behind the lack of advancement in crypto. Too many bad players, hackers, and fraudsters have cast a shadow over the legitimacy of this field of tech.

Since banks are comparatively more secure at present, people put their faith in banks rather than the crypto market. However, this problem could be solved with clear regulations and legislations that can fend off bad players and provide security to investors.

“We’re seeing more replication of the traditional financial system into DeFi, and so we’re already seeing people [showing] interest,” says Cross.

“I’m still positive on decentralized finance, and it certainly has a place, but what roles will the banks play, the fintechs play, and the regulators play in the future is still up for discussion,” he adds.

Header image by Alex wong on Unsplash.

SHARE THIS STORY