Decentralised Finance (DeFi) has certainly caught the attention of our readers with a number asking whether DeFi is “just another fad, or does it truly offer real innovation in the way some of the financial markets operate?” 

Written by Jonny Fry
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DeFi what is it?

  • DeFi uses Blockchain technology and removes the need for intermediaries such as banks, brokerages, exchanges, clearing houses, custodians etc, to enable financial transactions to take place.

  • DeFi is decentralised and often relies on computer-based Smart Contracts, many of which use the Ethereum Blockchain (which currently means that some transactions can be relatively expensive and slow).

  • The net value of assets locked into DeFi platforms is approximately $86.5 billion, a considerable rise since as last September as then there were only $20billion worth of assets on DeFi platforms.  

  • DeFi platforms enable users to lend or borrow funds, offer insurance or trade assets.

Why the fuss?

DeFi platforms can offer the ability to trade 24/7/365, unlike the current financial markets. In October 2020, the FCA announced retail investors are not allowed to buy derivatives that give exposure to cryptos. According to the UK newspaper, the Telegraph:Bitcoin is the original and still the most important cryptocurrency, but it cannot be owned directly in traditional tax-efficient accounts such as Isa and pensions”. Yet it would seem you can now simply pop down to the Post Office and buy a crypto as using  your EasyID verification with Swarm Markets. The German regulator, BaFin, has given regulatory approval to the Swarm Markets DeFi platform so will the FCA, therefore, ban retail investors from dealing with a regulated DeFi platform? Are we to see fund managers being allowed to use Swarm and buy cryptos in UCITs for ISAs and pension funds? Payment firms such as Visa, Mastercard, Applepay, Google Pay, Samsung Pay, PayPal have all taken a market share from the banks in the payments markets so could we see DeFi platforms that offer higher returns from depositing funds or DeFi lending services begin to threaten another core service which was historically offered by the banks?

What are the regulators doing about DeFi?

Depending on which jurisdiction you look at, it would appear that the regulators take almost opposing views. In the US, the SEC is very active in pursuing firms  that are not regulated and whom it believes are selling securities as Blockchain Credit Partners, based in Cayman, as its two founding directors found out. The company Blockchain Credit Partners has been paid penalties of $12million  and two of its directors have each paid to in penalties $125,000 as the SEC claimed that Blockchain Credit Partners had sold $30million of securities via their DeFi Platform. 

DeFi future?

DeFi offers anyone with internet connection access to any global currency, allows anyone the ability to generate an income on their deposits, or get access to loans instantly. The challenge is, is that because DeFi is decentralised, then were an investor to use an unregulated DeFi platform there would be no redress in the event of some nefarious actor ‘running off’ with your money. However, there is a possibility that the derivatives market could turn its attention to DeFi since the International Swaps and Derivatives Association (ISDA) has been looking at smart contracts for a while. The ISDA released its seventh paper on smart contracts in November 2020. It is worth remembering that, according to the Bank of International Settlement, the value of over-the-counter (OTC) derivatives increased by $300 billion to $15.8 trillion during the second half of 2020. Much of OTC derivatives are carried out peer-to-peer, so it is not that difficult to see this type of activity migrating to a DeFi type exchange. Given that NASADAQ is now supplying stock price feeds to DeFiChain and DTCC, which processed $10 trillion of derivatives last year. NASDAQ is looking to launch a Blockchain-based platform in 2022, are we to see DeFi be truly embraced by the financial markets? Perversely, DeFi also offers the opportunity to reach out to the 1.7 billion unbanked globally and make the financial sector more inclusive. However, how big a threat will DeFi prove to be for banks around the world?