There are many things to learn from traditional finance to the new DeFi

[ad_1]

Existing companies in the traditional capital market and new entrants hoping to seize market share should pay attention to innovations in the crypto ecosystem collectively referred to as decentralized finance or DeFi. These innovations provide a model for the development direction that the traditional capital market may take in the next few years, because supervision has caught up with the functions of distributed ledger technology or DLT, and as the technology itself is refined through “wild” perfect. usage.

Decentralized exchange protocol, Auto Market MakerOr AMM is one of these innovations that have been widely adopted in the encryption field.

Real-time settlement can change the rules of the game

Immediately, we can see that using AMM, transactions are settled almost in real time. In contrast, in today’s advanced capital markets, it takes two days (T + 2) to settle most liquid securities. AMM’s near real-time settlement brings two main benefits: reducing counterparty risk and improving balance sheet management.

Financial institutions participating in the capital market must reserve cash on their balance sheets to make up for the risks of undelivered by their counterparties. Reserve requirements are defined by the parties to the transaction, and before the transaction is settled, they must occupy cash on the balance sheet to compensate for the risk. With the almost real-time clearing and settlement enabled by the DLT infrastructure (demonstrated by the DeFi protocol), the reserve requirement is only a small part of the reserve required for the two-day clearing and settlement. If an AMM-like agreement can be used in the traditional capital market, most of the capital occupied on the balance sheet today can be used for economic purposes in the capital market, thereby converting opportunity costs into economic benefits.

The use of real-time settlement on a sufficiently large scale can also reduce systemic risks. Since the 2008 financial crisis, in response to regulations designed to reduce the risk of systemic failures, Central counterpartyCCP is increasingly used as an intermediary. Although CCP deploys complex risk mitigation strategies, they are now interrelated to the extent that they exacerbate the risks that should have been mitigated.In fact, according to a 2018 report by the Financial Stability Board, the 11 largest CCPs are connected Of the other 16 to 25 CCPs, the largest two accounted for “nearly 40% of the total pre-funded funds provided to all CCPs.” The default of a single CCP will adversely affect most accounts, and may lead to cascading defaults even more serious than the defaults related to the 2008 financial crisis.

related: Will encryption and blockchain shape the future of finance?Expert answers

Reduce rent-seeking and accelerate bootstrapping

In addition to near real-time settlement, decentralized transaction agreement (AMM) can also reduce operating costs and reduce rent-seeking behavior through intermediaries. The basic structure that makes up the exchange is simplified into codes and is distributed among participants, and participants themselves provide the required liquidity. The latter function has the ability to guide capital formation and democratize access to capital-this is exactly what we are seeing in the emerging cryptocurrency-native AMM space.

The AMM protocol has rapidly gained popularity in the “Wild West” of the cryptocurrency market. By default, self-custody and anonymity are among them.By April, the volume of spot transactions conducted through the AMM agreement exceed It reached 164 billion U.S. dollars in one month, representative It accounts for more than 10% of the total spot transactions in the broader cryptocurrency market.

related: The rise of DEX robots: AMM promotes the industry revolution in the industry

Not just communication

In the past year, other DeFi products have also become more and more popular. An example is loans, Users lock digital assets in mortgage assets that can be borrowed from them. Compared with traditional loans, the automated management of escrow, settlement and escrow reduces the rent charged for performing these operations. Outstanding debt in DeFi loans (key indicator to track adoption) rose Increased from 500 million US dollars in mid-2020 to 25 billion US dollars in May 2021, led by the Compound, Aave and Maker agreements.

In addition to loans, more complex derivatives are being deployed, including options, futures and synthetic assets. In short, the DeFi protocol is rapidly forming a mirrored version of the traditional capital market, but it has significant advantages.

related: The new digital and decentralized economy needs academic verification

What does this mean for traditional capital markets?

Of course, DeFi (which currently exists in the crypto world) is not compliant from a regulatory perspective due to its pseudo-anonymity and reliance on self-hosting. However, this fact should not discourage traditional financial companies and start-ups. There has been a clear roadmap on how to adapt innovations in the DeFi space to traditional capital market infrastructure.

related: DeFi is the future of banking that mankind deserves

Large companies in the traditional capital market have realized this shift and are taking action. For example, they actively participate in digital asset custody games. For example, Standard Chartered Bank’s investment in Metaco, a Swiss digital asset custody solution provider, shut down Carried out two oversubscribed US$17 million Series A financings.

In addition, many far-sighted jurisdictions have established regulatory sandboxes to encourage experimentation and innovation of DLT-based solutions for capital markets. For example, the Monetary Authority of Singapore with the Fintech sandbox and Sandbox Express, the European Fintech Regulatory Sandbox and Innovation Center, and the Fintech Lab of the Saudi Arabian Capital Markets Authority and ADGM RegLab in Abu Dhabi.

related: Europe awaits implementation of a regulatory framework for crypto assets

In these sandboxes, more and more new entrants are leading the trend. Singapore-based regulated digital securities platform iSTOX FinTech regulatory sandbox graduated from MAS. This makes it one of the first DLT-based capital market platforms approved and licensed by major regulatory agencies.

ISTOX shut down In January, a US$50 million Series A round of financing attracted investment from many Japanese state-owned entities, including the Japan Development Bank and JIC Venture Growth Investments, the venture capital arm of the Japanese investment company. This type of investment is another strong signal that the operators of the capital market see DLT-based infrastructure as a winner.

opportunity

Naturally, with complex, structurally critical systems (such as modern capital markets), changes will be gradual. Consider the example of custodians, who are rooted in the structure of the capital market, both in law and in practice. Since 1) the regulations need to be changed, and 2) the DLT-based market infrastructure needs to be developed, tested and widely adopted, it may take ten years to disintermediate the custodian on a large scale. statement In the report titled “Opportunities of Blockchain Technology in Capital Markets”.

This means that existing companies and new entrants have many opportunities to establish their position in today’s DLT-based capital market. For the far-sighted traditional financial industry, now is the time to take action.

This article does not contain investment advice or recommendations. Every investment and trading action involves risks, and readers should conduct their own research when making a decision.

The views, thoughts and opinions expressed in this article are only the personal views of the author, and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Matthew Van Niekerk He is the co-founder and CEO of SettleMint (a low-code platform for enterprise blockchain development) and Databroker (decentralized data market). He holds an honours degree from the University of Western Ontario in Canada and an international MBA degree from the Vlerick School of Business in Belgium. Matthew has been engaged in financial technology innovation since 2006.