Christian kameir

Blockchain VC @ Sustany Capital

As software and hardware engineers around the world unravel the centralization of the internet, a vocal part within the enclave of blockchain-based solutions – commonly referred to as decentralized finance – or DeFi for short – has emerged. While blockchains provide the building blocks For reliable information and – to a lesser extent – transport functions – a middleware layer with the broader concept of protocol-mapped cryptographic primitives, current developments are largely focused on digitally native assets and their derivatives. However, a first principles view on financial services innovation will focus on the central tenet of technology: increasing the productivity of human activity, freeing the attention of individuals – measured over time – than those – these may affect leisure or higher activities. order pursuits, such as the accumulation of knowledge. To this end, network technologies, especially the Internet and the consequent emergence of the World Wide Web, have amplified human productivity by fueling a wave of synchronous and asynchronous coordination methods of human fertility, as well as wider distribution. of economic activity in general.

Until recently, digital coordination was mostly limited to the exchange of information, while the exchange of rights and assets still required multiple layers of rent-seeking third parties, frequently reducing productivity and profitability. Financial service providers are emblematic of these intermediaries and regularly introduce friction into business activities in the form of delays and fees. As research from the Stern School of Business and others has shown, the unit cost of financial intermediation has not decreased so far, despite advances in information technology.

State of Fintech

As with government services, financial services are plagued by administrative and regulatory burdens, most of which date back to the pre-digital age. In addition to creating fiat money through the secured lending process, commercial banks have been entrusted with financial oversight functions through legal, regulatory and procedural means to prevent criminals from disguising illegally obtained funds as legitimate.

The cost of these so-called “anti-money laundering” efforts is passed on to consumers in the form of fees, while the externalities of fiat money creation by commercial banks are expressed primarily in market inflation. housing, and secondarily in the decrease in purchasing power due to an overall increase in the money supply. Leaving aside the delegation of these entities to State objectives, the existing regulatory regimes do not deal with the activity of the parties to the transaction but aim to take into account the principal-agent problems inherent in financial intermediaries.

Banks most often enter into commercial agreements with parties which extend their position as mere custodians of the assets of third parties. To date, the main technology for recording these agreements is database solutions, which in some cases still use the mainframe architecture writing in Cobol, a programming language that has not been taught to software engineers since. decades.

Fake Fintech

One of the first network technologies to facilitate business over long distances was the pantelegraph, which by 1865 was most commonly used to verify signatures in French banking transactions. However, the origin of the term “Fintech” can only be traced over a period of 30 years and was first introduced by the Financial Services Technology Consortium in the early 1990s. The term was later popularized by Solutions built on the World Wide Web, which allowed users to conduct financial transactions without having to interact directly with the banking system. Most notably, companies such as Confinity – later renamed PayPal, have allowed users to set up accounts that use email as payment addresses. While providing customers with a better user experience, these Fintech 2.0 solutions are completely dependent on legacy financial service providers and the infrastructure they maintain.

Decentralize Finance?

The term refers to solutions built on the Internet and public blockchains. DeFi systems use smart contracts to create automated solutions, resembling those in financial services, without the need for a business structure. DeFi’s current building blocks include standardized smart contracts forming digital bearer instruments, non-custodial exchanges, decentralized lending markets, and on-chain asset management solutions.

DeFi systems do not require intermediaries or centralized organizations. Instead, they are based on open networks and decentralized applications. Agreements are executed by automated software and transactions are carried out in a secure and verifiable manner, i.e. recorded on a public blockchain.

This architecture can in principle create an interoperable system with high transparency, equal access rights and little need for custodians, central clearing houses or escrow services. However, so far DeFi offers a small number of applications, as it is limited to digitally native assets. For example, users can acquire assets pegged to the US dollar, deposit those assets on an equally decentralized lending platform to earn interest, and then add the interest-bearing instruments to a decentralized liquidity pool or vehicle from blockchain-based investment.

Financialization

Financialization is a process by which financial markets and financial institutions gain greater influence over economic policy and economic performance. The impact of financialization can be observed as a) an increase in the participation rate of the financial sector compared to real productive activity, b) a transfer of income from production to the financial sector, and finally an increase in inequalities of income. As Thomas Palley and other researchers have pointed out, there is evidence that too much emphasis on financialization puts an economy at risk of debt deflation and prolonged recession (more here). These findings were confirmed in a hearing earlier this year before the US Senate Committee on Banking, Housing and Urban Affairs.

Conclusion

Decentralized finance applications will prove to keep the promise of the solutions promoted under the term fintech. However, economic activity ultimately relies on the delivery of tangible goods and services. And, while the number of DeFi solutions and capital traded using these systems is steadily increasing, at this time the space is still largely limited to the use cases of trade, debt and finance. next to digitally native commodities – namely bitcoin and Ethereum Ether, which as of mid-November 2021 together accounted for nearly 60% of the market capitalization of all cryptocurrencies listed on CoinGecko.

A reliable signal for the evolution of DeFi towards a true Fintech 3.0 is a significant reduction in the participation rates of financial services in the gross domestic product of a country. The latter will likely be seen first in countries with less financialized economies than the United States and other modern nation states. Governments and investors should take note that other countries are not only jumping on traditional banking systems, but also ignoring simple technological debt-wrapping solutions. Hence the idea that new technologies discussed by central banks around the world – such as central bank digital currencies (see my previous article here) will “bank the unbanked” – akin to the expectation that Current smartphone users will return to using rotary phones if offered by their local telecommunications provider.