The promises of “DeFi”, between cryptoanarchist dream and fintech revolution

Decentralized finance (DeFi) is an experiment led by entrepreneurs and developers in search of an alternative financial system. It remains to be seen if finance can definitively do without traditional mechanisms and its centralized intermediaries.

Simply put, “DeFi aims to accomplish many of the key activities found in traditional finance that possess a risk-reward paradigm but without the intrusive overlay of traditional intermediary institutions,” as summarized by Usman W. Chohan, Ph.D., an economist and subject matter expert, in his analysis “Decentralized Finance: An Emerging Alternative Financial Architecture.”

A powerful example of cryptoanarchism, the author continues, as manifested in the context of cryptocurrencies. The ambition remains indeed to emancipate individuals by granting them the power to control their financial activity without the intervention of state power. This is an attractive promise for those predisposed to independence in the digital world.

More pragmatic than ideological

More pragmatically, DeFi remains an umbrella term covering various fintech solutions ranging from financial computing protocols to crypto derivatives. This “blockchain” finance promises overall cheaper and more open access to banking, insurance, loans, etc.

And it does so precisely by reducing the costs and risks associated with the use of centralized intermediaries through blockchain and cryptographic technologies. The phenomenon therefore promises interoperability between blockchains that could help eliminate silos in the financial sector and significantly promote innovation.

More than a trend, it is a likely forced march that is pushing more and more traditional players into the crypto world. Since even Quebec’s own Caisse de dépôt et placement (CDPQ) is contributing several million dollars to the funding round of an English cryptobank.

The limits of progress

The emerging DeFi industry is one of the most innovative fields, acknowledged U.S. securities regulator Chairman Gary Gensler while speaking at Yahoo Finance’s All Markets conference on Monday. If Satoshi Nakamoto, the pseudonymous creator of Bitcoin, “was putting pressure on the definition of money, […] DeFi is starting to put pressure on other innovations,” Gensler said.

That’s because DeFi is not without its challenges. And these remain understudied. Yet it is critical to conceptually understand the risks inherent in the decentralized nature of blockchain (operational risks, smart contract vulnerabilities, governance risks, scalability, etc.).

“The goal of automating financial service delivery and reducing human dependencies also has the congruent effect of reducing oversight and control,” authors Nic Carter, a venture capitalist, and Linga Jeng of Georgetown University recently pinned down in their paper “The DeFi Paradox.”

And the paradox, too, keeps swelling when looking at the “total locked value” (TVL) of these DeFi protocols, an estimated metric that refers to the cryptocurrencies and other digital tokens (tokens) contained in decentralized lending or trading platforms. The capitalization of the DeFI market has doubled since the end of June and currently stands at about US$247 billion, according to the watchdog site Defi Llama.