Throughout 2021, DeFi investors have enjoyed yields of 10 per cent, 15 per cent, sometimes 20 per cent on certain digital assets. Very few traditional financial instruments can compete with those returns – and the finance sector knows it.
This is what happens when an industry gets disrupted. Hotels and taxi companies learned this with the emergence of Airbnb and Uber, respectively, and incumbent companies pulled every financial and regulatory lever they could to maintain their positions.
The same is happening now in traditional finance, but with even higher stakes. Throughout 2021, as well, lawmakers, regulators, and heads of central banks have stepped in to nudge the regulation of decentralised finance in their countries. And yet DeFi keeps growing. At the time of writing, more than $100 billion is locked into the DeFi markets. In just a few years, the disintermediation of traditional finance has moved from theory to reality. That reality concerns those who have a vested interest in maintaining the status quo.
Suppose the innovations that Uber and Airbnb — or Netflix and Napster before them — brought to market are at all analogous to what is happening in finance today. In that case, we already know how this story ends and who the winners will be. The only mystery that remains is how this will happen.
Below, we explore how the relationship between decentralised and traditional finance could play out and how institutions can leverage the innovations of the former to ensure they end up on the right side of history.
Central banks and regulators recognise DeFi’s disruptive potential
In the United States, there is a narrative emerging around decentralised finance in Washington that it represents a ‘shadow bank’ and must be brought to heel.
Two comments illustrate this point:
- ‘In my view it is untenable to allow an unregulated, unlicensed derivatives market to compete, side-by-side, with a fully regulated and licensed derivatives market’, Commissioner Dan Berkovitz of the Commodity Futures Trading Commission said in a June speech. ‘… Experience with the development of the “shadow banking” system shows that competition between regulated and unregulated entities in the same market can result in the regulated entities assuming either more risks to generate the higher yields necessary to compete with the unregulated competition or seeking less regulation for themselves to level the playing field’.
- Massachusetts Senator Elizabeth Warren made headlines in September when she called crypto ‘the new shadow bank. It provides many of the same services, but without the consumer protections or financial stability that back up the traditional system’.
While both framed their criticisms of decentralised finance in terms of fair competition and consumer protection, both were clear in their comments that they felt it was the…
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