Alex Tapscott: Why DeFi and smart contracts are the future of finance

If bitcoin was the spark for the financial services revolution, then DeFi is the accelerant

Author of the article:

Alex Tapscott, Special to Financial Post

A smart contract is essentially a self-executing and immutable agreement settled on a blockchain, often the Ethereum blockchain. Photo by Dado Ruvic/Reuters illustration files

The first era of the internet upended information industries like news, advertising and television. The second era of the internet, enabled by blockchain (the technology behind bitcoin) and other digital assets, will make those changes look quaint. Financial services, foundational to all industry, enterprise, and human economic activity, is about to change.

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Bitcoin aside, a lesser known but insurgent group of projects and protocols, collectively known as decentralized finance or DeFi, is generating new digital tools, marketplaces and asset classes that have the potential to disrupt banking and much else. In one year the DeFi industry’s market capitalization has ballooned 30 times to US$73 billion, while the total value of user deposits (known in the industry as total value locked or TVL) has surged 100 times to nearly US 100 billion. What is driving this growth?

Traditionally, institutions like banks, brokerages, stock exchanges, custodians, clearinghouses and other intermediaries established trust in transactions and performed other essential functions in the economy such as moving, storing and lending money. These institutions have noticeable drawbacks: They charge high fees and add time and friction to transactions. And, because of their cost structures, they exclude more than one billion unbanked people from the global financial system. This is changing, thanks to blockchain, the technology behind bitcoin. Blockchains are tamper-resistant ledgers of transactions distributed across a network maintained by many parties. These shared ledgers serve as common sources of the truth. In effect, they supplant the records of banks and other traditional institutions.

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Bitcoin enabled individuals to move value online peer to peer, without a trusted intermediary like a bank. DeFi builds on that concept, by enabling peer-to-peer models for lending, trading, investing, insurance and more, built on top of distributed networks, not corporations. These innovations are possible, thanks to a breakthrough called a smart contract — essentially a self-executing and immutable agreement settled on a blockchain, often the Ethereum blockchain (Canada’s most successful startup ever). Contracts are the foundation of every asset class, every corporation, and all economic activity. Yet, most of…