2. Nudge Economics - as climate change receives increasing focus there is the potential for Digital Assets to play a greater role in rewarding citizens and organisations for changing their behaviour in an effort to reduce global carbon emissions. With the success of both Plastic Bank and SC Johnson (which paid people to collect plastic) we are likely to see more initiatives like these in 2021.

3. Greater institutional adoption of Digital Assets - much of the infrastructure required over the last few years is now in place: exchanges to trade Digital Assets, availability of custody services and banking facilities, the ability for regulated companies to purchase the required insurance and we are increasingly seeing greater legal clarity in many jurisdictions. In December 2020, Reuters reported the S&P Dow Jones would be launching a crypto index off the back of institutional demand for this asset class.

4. CBDC (Central Bank Digital Currencies) - the Chinese launched their CBDC in 2020 and expect to see other governments follow suit since cash is used less and less as payments increasingly turn digital. Whether we see Diem (formerly Libra)/Novi (formerly Calibra) become the global payment choice for billions of Facebook devotees or not remains a distinct possibility, much to the chagrin of central bankers.

5. Blockchains become scalable - one of the criticisms surrounding Blockchain technology is that it is not able to handle large volumes of data. 2021 could be the year when this is no longer the case. 

6. Stock market turbulence - are we to see equity markets stumble as we enter the eleventh year of a roaring bull market due to debt ridden, COVID-19 ravaged economies? As a comment from Charles Schwab recently pointed out, “..it has been 11 years since we've had an extended bear market, anyone under the age of 30 really hasn't lived through that.” As ever, market crash investors are likely to shun equites for a while and look at alternative investments, many of which will potentially be offered in a digital format.

7. Data democratisation - global bemouths such as Alibaba, Amazon, Facebook, Google and Tencent have monetised our personal browsing and spending data and, in doing so, have accumulated vast fortunes. Digital Assets offer the potential for the data we create by using  our cars, buildings etc to be monetised for us individually, and not to be used by global corporations. Expect to see more initiatives (such as UCL’s smart cities project) look at how technologies such as Artificial Intelligence and Blockchain technology are creating smart cities.

8. Omnipresent SEC - even though the ICO ‘brouhaha’ was in 2017/18, we are likely to see the US Security Exchange Commission (SEC) continue to pursue organisations it believes issued securities under the guise of an Initial Coin Offering (ICO). In June 2020, Telegram cancelled its ICO and returned $1.2 billion to its original investors as well as paying the SEC a $18million fine. Earlier in December the SEC was seen to be taking action against Ripple and some of its executives regarding its £1.3billion ICO, claiming it had not complied with security regulations. This is likely to stifle innovation in America and see the US’s leadership decline in the Digital Asset sector.  

9. Blockchain technology - more akin to an excel spread sheet on steroids, some argue that Blockchain technology needs a ‘killer application’. However, as 2021 unfolds we are likely to hear less about the technology around Blockchain but see more and more applications of how and where the technology is being applied.

10. DeFi v TradFi - in 2020 we have seen Decentralised Finance (DeFi) emerge, offering a digital on-line alternative to many of the financial services we have come to expect from incumbent Traditional Financial service firms (Trad Fi). DeFi ‘kicked off’ 2020 with $700million of value in its various protocols and ended with over $16 billion. DeFi is set to continue growing as the Fin Tech ‘wanabees’ pose a both real challenge to and take market share from traditional banks and asset managers.

1.Tulip mania- 1630’s

Source: History.com

2. South Sea company bubble and Sir Isaac Newton’s bankruptcy - 1730’s

Source: Business Insider

Arguably one of the world’s finest brains became ensnared in the investment mania which was the South Sea Bubble, personally making a fortune only to hand it all back and losing (what some claim) to be over $4million in today’s money! These were manic times, since the share price of The South Sea Company rose almost 10-fold and in doing so encouraged all manner of crazy investments, including a firm raising money to manufacture a gun to fire square cannon balls!

3. UK Stock Market -1820’s

Source: Investment office.com

The defeat of Napoleon at the Battle of Waterloo in 1815 and the advent of peace across Europe was the precursor to a huge rise in the UK Stock Market, reaching its zenith in 1825. Furthermore, this was to be followed by the London banking crisis and a collapse in prices since, in 1816, income taxes were abolished thus leaving the UK government with little income but massive debts from the Napoleonic Wars.

4.  Wall Street Crash (Dow Jones) - 1920’s

Source: Eureka Report.au

The Wall Street crash in the US ushered-in the 1930’s depression as $billions were ‘wiped off’ equities and stockbrokers on Wall Street in NYC were seen jumping from their offices as losses mounted. However, the market did not fall in a straight line but fell 34%, rallied by as much as 20%, only to continue falling until it had lost over 84% of its value from its peak.

So, what is the relevance of all this? Well, notably, the last of these stock market falls are approximately one hundred years apart: 1630, 1730, 1825 and 1929. Therefore, is it too unreasonable to expect another stock market correction and what is different this time, almost a hundred years on from the last major crash? Points to consider include the fact that the global economy is very different now compared to the past. It is far more interconnected - look at the speed COVID-19 has spread across the globe. International boundaries account for less as people freely live and work where they wish, with an ability to move their money at a whim. Yet more of this globalisation is clearly seen with multinational corporations exploiting favourable tax jurisdictions and low-cost wages, setting up offices and factories in the pursuit of increasing their profit margins. 

But nothing lasts forever, and there arguably now exists an over-concentration of wealth in the hands of a few. We could well be at an inflection point and a time of change. According to Credit Suisse, the world’s richest 1% owns 44% of the world’s wealth. Even more disturbing is that, conversely, 56.6% of the world’s citizens own less than 2% of global wealth. There are individuals such as Bezo (Amazon $113billion), Gates (Microsoft $98billion) and Larry Ellison (Oracle $59billion), to name just a few, who are arguably worth more than actual countries! The pace of change seems to be ever quickening as we see the rate of digital adoption growing and impacting on many aspects of our lives. The chart below shows the change in the leading exporting countries world-wide (1970 v 2019) and this three minute video demonstrates how it has changed. 

How the worlds’ largest exporters have changed

Source: Ranking Royal

While we have born witness to the rise of China, how many have been able to invest in successful Chinese companies such as Alibaba, Tencent and JD.Com, all household names in China but relatively unknown elsewhere despite having hundreds of millions of clients? Now it is relatively easy to obtain exposure to worldwide international equities and, as we see traditional equities being made available in a digitised format, it ought to become even easier for someone in Europe or America to invest directly into an Asian, Latin-American or Middle Eastern company. After all, the biggest company in the world is not American, Chinese or European, but Saudi’s Aramco - worth a colossal $1.68 trillion compared to the world’s biggest listed bank, JP Morgan, itself valued at $292billion.

As mentioned earlier, there exists another reason to account for why this time the investment landscape may be different: investors are beginning to focus on intangible assets as opposed to physical tangible assets (included in which are real estate, commodities, equities and bonds). Intangible assets incorporate crypto currencies and also Intellectual Property (Bob Dillan has recently sold his back catalogue to Universal Studios for an estimated $300 million). Even loyalty schemes are on institutional investors radar as seen by JP Morgan entering this market as it is estimated that  US airline loyalty are worth $200billion, making them more valuable than the airline firms themselves. Furthermore, there are the potential investment opportunities in the ‘e-sports’ market (projected to be worth in excess of $1.6 billion p.a. by 2023) as well as data from both inanimate objects such as cars, buildings and animate objects i.e. people. A common thread runs through many of these intangible investments - data. Since these intangible investments are not physical it is vital that, should they be valued and traded, there has to be a secure record of whom is the actual owner of the asset as well as a mechanism to allow these intangible assets to be packaged and then be bought and sold between investors. As an aside, with citizens beginning to be personally rewarded for their data/activity we could well see a redistribution of wealth. Instead of companies such as Alibaba, Google and Facebook etc making a fortune by aggregating and selling people’s data to advertisers, there now exists the technology to pay and reward people to have personal access to their spending habits, preferences and opinions, thus allowing them to earn from their data.

This is why Blockchain technology (and the Digital Assets this technology is able to create and manage) could well prove to be so important in the future. Yes, for sure we will see equity markets tumble at some stage in the future. We are also very likely to see these new intangible assets, along with new digitised versions of traditional tangible assets, being made available to a world-wide investor-base and traded 24/7.

Unbanked population by region (%)

Source: Findex database, Worldbank

Furthermore, a report from Deloitte has listed a selection of reasons (according to Findex and the World Bank) as to why citizens in certain countries do not have a bank account:

• geographic access to financial institutions is limited

• insufficient funds to operate a bank account

• financial services are too expensive, relative to people’s income

• lack of necessary personal documentation (ID, passport etc) to open a bank account

• family member already has a bank account

• religious reasons

• lack of trust towards financial institutions

Another report, commissioned by Amazon, found that, “Digital payments will be a core foundation for extending basic financial inclusion. More than 90% of respondents consider that innovations in digital payments processes were among the most significant areas in which fintech was improving financial inclusion objectives within their own jurisdiction.” One of the key challenges is provision of assistance to SMEs, which are often unable to obtain credit since they are outside the focus of traditional bankers. The World Bank estimates that the credit gap for SMEs globally is $2.6tn! Given the importance of SMEs to the global economy their financial exclusion is a missed opportunity, not just for them, but the world economy as a whole.

On the subject of financial exclusion, the SEC in the US is considering allowing ‘gig’ workers to be allowed to be paid up to $75,000 worth of share options over a three-year period. Historically, the people who can qualify to be a member of a tax efficient option scheme are fulltime employees.

Gig work as a source of income in different countries

Source: BCG Future of work

The term ‘gig’ has previously referred to temporary employment embracing freelancers and independent contractors, who are typically self-employed since they often have more than one source of income. Increasingly, so as to be as flexible as possible, companies have relied on gig workers as opposed to offering them full-time positions meaning companies avoid having to pay additional benefits such as pension contributions, healthcare etc. Examples of such firms using gig workers include Uber, Deliveroo, Lyft, AirBnB and Amazon. Since the financial crisis in 2018, according to EY, “the full-time hiring rate among the S&P500 index companies (i.e. the largest companies in the United States) has fallen to 2.7 per cent.

 Meanwhile, temporary workers make up 17% of all employees in US companies”.

A firm known to be using digital currencies to help improve the payment of gig workers is Electroneum’s AnyTask. A gig worker in Asia, India or Latin America can undertake freelance work for someone in Europe, USA or Japan and then be paid using a digital currency called ETN, whereby saving the cost of international banking fees. In other jurisdictions we have seen similar initiatives, the Philippines’s (Coins.ph), in Tunisia their postal service have a partnership with Monetas and DigitUS. While those searching for a Blockchain developer, a copywriter or a translator etc can opt for the platforms that source gig workers such as Upwork or twago. Likewise, there is the digital wallet from Abra which gives gig workers the ability to create their own ‘financial footprint’, providing them with a proof of existence and the basis from which to start building a credit record.  

Whilst there was considerable talk back in 2017 as to how Blockchain technology and crypto currencies would be able to embrace the unbanked and make a fairer global economy, we are beginning to see tangible signs of this occurring. There are, without doubt, challenges still ahead: improving the user experience, ensuring people’s wallets are not hackable, that the new digital currencies are interoperable with each other and the platform on which they operate are globally scalable.

The top ten biggest stable coins

Source: CoinGeko.com

Facebook’s Libra project was launched June 2018 and originally in its white paper it proposed to create a digital currency that would be backed by basket bank deposits and government bonds denominated in US Dollars, Euros, Yen, and British Pounds. Libra has now announced that it is to rename itself Diem, although it will be keeping the same logo. Although Facebook would still appear to be very much involved, Dahlia Malkhi, the new CTO of Diem is, and has been, Lead Researcher at a subsidiary of Facebook. Novi which is Facebook’s representation on the Libra, sorry on the Diem governance board. According to a report by the Financial Times, Libra is to launch a US dollar-pegged stablecoin, meaning it will launch a digital currency/coin with each one backed by a US dollar. The project, however, still requires approval from the Swiss Financial Market Supervisory Authority FINMA. 

Therefore, a stablecoin with a governance board backed by the likes of Andreessen Horowitz from Silicon Valley, Facebook, TEMASK (Singapore sovereign wealth fund), Shopify (Canadian version of Amazon), Uber, Women in Banking, to name just a few, is sure to prove popular? The reputational damage to the different organisations on the governance board of Libra ought to ensure risks will not be undertaken so that every Libra $ stablecoin will, indeed, be backed by a $ in a bank account somewhere? Consequentially, would Libra not be a safer option than Tether?

The main challenge Facebook’s Libra has been confronted with is a barrage of negativity from different jurisdictions since these countries fear that, with Facebook’s 2.4 billion and WhatsApp 2 billion active monthly users, it means Libra could become very popular, very quickly. If Libra were to become the payment mechanism of choice, it is feared it may undermine various governments’ control over their supply money, and potentially their economies. How justified these fears are is questionable. Libra, if backed 100% by assets such as cash or government bonds, would not be able to create unsecured coins. Ergo, Libra’s ability to influence monetary policy through artificially expanding or contracting its supply would not be possible - a course of action that many of the governments expressing concerns over Libra regularly do with their own currencies. 

Different governments express concerns over Libra

Source: Belfin club

One of the criticisms of digital currencies relying on Blockchain technology is that they are unable to handle large volumes of transactions. However, Libra, instead of relying on a decentralised peer-to-peer network, will rely initially on the Libra Association and those with permission to modify its Blockchain. Nonetheless, a concern is - will this more centralised structure make Libra more vulnerable to cyber-attacks? It is understood that Libra is therefore looking to transition to a more decentralised style of Blockchain so as to minimise the dependency on the Libra Association. Thus far, there are no further details as to when, or how, this change will be implemented.

Meanwhile, Goldman Sachs is predicting that the digital currency already launched by the Chinese will attract over 1 billion users within 10 years. The Chinese government hopes its new digital currency will help the nation’s traditional banks (which have been facing stiff competition from FinTech rivals) potentially increase their market again in the long-term. The Chinese government is clearly generating a tightening of restrictions on the FinTech sector, as can be seen by the suspension of Ant Group’s (Ant) IPO. Ant, with its one billion users, runs Alipay (one of the most popular payment systems in China) and is now facing a monopolies investigation by the Chinese government along with WeChatPay, which is owned by Tencent. Reuters reported these two payment platforms were responsible for over 90% of mobile banking transactions in the third quarter of 2019. Therefore, it would seem that if the Chinese digital currency is to be a success, Alipay and WeChatPay are potentially more of a threat to its adoption than cash!

Janet Yellen at a congressional hearing in 2017- bet she wished she had bought BTC! 

Source: YouTube

In the past Yellen has not been a fan of cryptos and made that very clear when she was Fed Chair speaking to the House Financial Services Committee on 13th July 2017. She was ‘photo bombed” by a Bitcoin fan, holding up a message “Buy Bitcoin”, who allegedly was subsequently sent small crypto donations worth the equivalent of 7 Bitcoins. Those 7 Bitcoins would have been worth approximately $16,000 back in the summer of 2017, compared to today’s value of over $131,000. One might suspect Yellen did not take the photo bomber’s suggestion. Or maybe she did since she has said very little in public about cryptos in the last few years! 

One muses that with Yellen’s classic Keynesian economic training she will favour another significant injection of cash into the US economy. Reuters has reported she is “someone who normally favors looser monetary policy to reduce unemployment”. Given the current almost 0% interest rates, it will be interesting to see how supportive Yellen will be towards a US Central Bank Digital Currency (CBDC) so that the US government can, in effect, give money to those most in need. To have a ‘new tool’ to stimulate the economy in a focused manner, as opposed to ‘helicopter cash’ i.e. giving cash to many and additionally having to pay the banks to distribute it for the government. A CBDC would make it possible to make payments incorporating the stipulation for it only to be spent on certain products and services within x weeks as opposed to be being saved, which would seem to have happened earlier this year. The Wall Street Journal reported that the US personal savings rate soared to 33% between Feb-April 2020  so, in effect, the US government increased its indebtedness whilst its citizens repaid theirs. If inflation were to return, then a transaction fee could be levied on those using a CBDC as a method to slow down the circulation/speed of money in the economy. 

Who knows how much Yellen takes counsel from her Nobel-prize winner husband, George Akerlof, who wrote a paper called the ‘Market for Lemons’? In it he says, “If a market has substantial “information-asymmetry” (sellers know a lot more about the good than buyers -e.g. 2nd hand cars), it will come to be dominated by lemons (bad cars)”. Since one of the challenges cryptos face is the perception caused by many of the 5,000+ ill-conceived ICOs which were launched in 2017 and 2018: many, at best, were ‘iffy’ and, at worst, fraudulent. As reported by the publication, Finance Magnet, the SEC has, “since May 22017, with its 4,500 staff, revealed over 2,750 enforcement actions obtained over $14 billion in financial remedies and paid around $565 million to the whistleblowers in the same period.”

The ability for cryptos to be tracked has proved very helpful, particularly when a crypto has been ‘forked’. One of the reasons cryptos may need to be tracked down is because their owners may have misplaced them when there is a ‘fork’ - a term used to explain when a Blockchain splits, often instigating the creation of a new crypto currency. Forks usually occur due to a significant change in a Blockchain’s protocol leading to splitting the Blockchain into an ‘old’ way of doing things and a ‘new’ way of doing things. It is claimed that between 2017-2019 there were 58 Bitcoin forks, resultant from which the original Bitcoin Blockchain has now spawned other versions, e.g. Bitcoin cash, Bitcoin Gold etc. In addition, forks can be categorised into either a ‘hard fork’ or a ‘soft fork’; a hard fork is when a Blockchain totally changes the way it functions so that those running the Blockchain need to change the software they use and, conversely, a soft fork means that although the rules of the network change the old software is still used to validate transactions. 

Chart of Bitcoin Blockchain and Software Forks

Source:Unhashed.com

Unsurprisingly, it can be a challenge to keep track on these different forks and the cryptos they create. However, there are websites to help one track and trace forks such as ForkDrop.io and Forks.net, and now there is a service called Reclaim Fork (from UK-based Coinfirm) which can also help. The crypto and blockchain analytics firm has looked into the digital wallet which was holding over $1.2 billion of Bitcoins (which the US government recently seized) that were allegedly linked to the infamous illegal Silk Road website. Coinfirm has discovered that there could be in excess of another $380,000 worth of different cryptos due to forks linked to the seized digital wallet that have, as yet, been taken under the control of the US government.

Another company active in tracking down cryptos is Chainanlysis which has just raised $100million, valuing itself at $1billion (up from only $266million in July 2020). Chainanlysis provides information and analysis to governments, exchanges and financial institutions using a range of compliance tools helping to track and trace the source of funds and lost cryptos. There are also other longer established firms such as Kroll (owned by Duff and Phelps) and Alaco, which this year launched Alaco analytics. These firms are employed by organisations such as banks, corporate brokers, accountants and law firms to help conduct background checks, due diligence and investigations on individuals and corporations including sources of funds. Henry Burrows at Alaco analytics has stated, “We are definitely seeing institutions warm to virtual assets.  There is far greater regulatory clarity than there was in 2017, and a far better understanding of the risks.  Services like ours provide clear and concise information on customers and customer’s funds – in more granular detail than traditional financial services.  As that understanding grows, we will continue to chip away at the misplaced perception of crypto as a refuge for financial crime.”

The ability to track and trace cryptos ought to offer traditional financial institutions greater comfort as they continue to embrace this asset class, together with the increased transparency and independent due diligence which are now available. Furthermore, as people understand what their transactions do, indeed, create a digital footprint, this should lead to more trust in cryptos as an asset class and possibly deter cryptos being used for illegal purposes - unlike the preferable ‘suitcase of cash’ which has historically been used so often for shady deals….

IBM and its New Co - different services offered

Source: NewPlatform.com

When announcing the spin out IBM’s CEO, Arvind Krishna, said, "IBM is laser-focused on the $1 trillion hybrid cloud opportunity." This follows on from IBM having reported only in September 2020 about how Blockchain adds trust to AI and IoT and stating, “Blockchain and AI are on every chief information officers watchlist of game-changing technologies that stand to reshape industries”. IBM has 1,500 staff and over 500 projects dealing with Blockchain work in a wide range of industries, including financial services, shipping and healthcare. IBM extols Blockchain as being able to both help improve supply chain logistics and offer greater transparency as to the provenance of the origin of food. Indeed, IBM has had some great successes developing the Blockchain-powered TradeLens with Maersk, the shipping conglomerate, and TradeLens has now signed up five of the biggest shipping companies. A subsequence of this has been the been the necessity for TradLens to obtain special exemption in the US in order to overcome any potential anti-trust legislation, otherwise even discussions between a competitor regarding how cargo documents might be used on the TradeLens platform would have been illegal. This, itself, demonstrates how Blockchain technology is changing the shipping and global supply chains and logistics with the blessing of government regulations. Furthermore, IBM has also been successful in helping supermarkets provide provenance from where the food they sell is sourced using IBM’s Food Trust Blockchain platform. Food trust has been used by the supermarket giant, Walmart, since 2017 and this short video gives an insight to the advantages food trust offers for farmers, retailers and consumers alike.

We have seen many tech firms ‘muscling in’ on financial services with IBM (aka Big Blue) being of no exception, having developed its own banking payment platform and signing up banks such as Australia's National Australia Bank, Spain's BBVA, and Indonesia's Bank Danamon. Working with StellarLumens, IBM claims that using Blockchain technology can help banks make international payments faster and cheaper as well as being less susceptible to errors - a real win, win solution. More recently IBM has been working with the Thai Government, having just issued $1.6 billion of bonds using Blockchain technology. The process to issue government debt usually take 15 days but took IBM only 2 days, so illustrating the improved efficiency. The issuance of bonds is huge, with over 22,000 deals creating $7+trillion of bonds in 2019. IBM, with its massive global corporate client bank and contacts within governments, is in an enviable position by getting its clients to switch to using Big Blue’s Blockchain technology for issuing bonds going forward.

% of customers who make a purchase and earn loyalty rewards weekly

Source: The truth about consumer loyalty KPMG.com

When researching over 18,000 consumers, KPMG found that 60% of millennials would prefer to donate their rewards with 81% also stating that loyalty programs encourage them

to spend more with the company offering the rewards. It is not only KPMG which has been researching loyalty programs as according to Forbes, 52% of American consumers will join the loyalty program of a brand from which they make frequent purchases, 84% of loyalty program members have used some of their rewards points and 57% of consumers wish to engage digitally, i.e. via mobile devices. However, the average consumer belongs to 14.8 loyalty programs but is only active in 6.7 of them. Despite the ubiquitous nature, it would seem there is still plenty of opportunity for the sector to expand since it is estimated that in the next four years the global value of loyalty programs is expected to increase to over $5.2 billion - a 17% p.a. growth.

Feedback about loyalty programs

Source: Big Commerce.com 

Whilst historically North America has dominated loyalty programs, Asia is fast catching up. In 2019, Carrefour China launched a 100% digital loyalty program, with the company entering into agreements with WeChat and Tencent. It is predicted that across Asia the loyalty sector will grow in the next four years by 25% p.a, to be worth nearly $2.3 billion. An example of the interest in loyalty programs in this part of the world can be seen with the recent announcement from luxury car manufacturer BMW in Korea which is set to launch a digital rewards program (initially in Korea) and based on a Blockchain-powered platform, and then expand it globally.

Interestingly though, reward points are of value not just to consumers. In the airline industry, despite unclaimed loyalty programs being worth over $200 billion, the airlines themselves are looking to use their loyalty schemes as collateral to borrow money and, in some cases, remain alive! As a consequence of COVID-19 and the huge decline in airline travel, four of America’s biggest airlines are now using their ‘frequent flyer’ loyalty programs as security to borrow capital from the US government. A recent article in Simply Flying.com notes, “According to analysis by the Financial Times, Delta’s loyalty program is worth $26 billion, while the airline itself is worth $19 billion. United Airlines’ MileagePlus is valued at $20 billion, while the airline is worth a measly $10 billion. And the world’s largest airline by fleet size, American Airlines, can thank its passengers for its $24 billion valuation of AAdvantage, four times the value of the airline itself, which analysis pegs at just $6 billion”.

A number of firms have been involved in the DeFi sector for years, such as Maker DAO which was established in 2014. However, DeFi really took off this summer. It now offers a range of financial services such as lending, borrowing, insurance, payments, derivatives and even the opportunity to bet on the outcome of elections. This option to profit on the result of an election may offer citizens in some jurisdictions the ability to gamble by buying an asset such as the FTX’s TRUMPWIN or TRUMPLOSE token, even though betting may well be illegal - another question and hurdle DeFi may need to tackle as it gains more widespread adoption. As with anything new and different, education is vital in order to understand the facts before becoming involved. Certainly, if you wish to learn more about DeFi then click here to watch a short video giving a simple to understand explanation of how the YFI tokens operate and are governed.

A term to note which is used in DeFi is ‘yield farming’, being described as the rocket fuel of DeFi since it provides the collateral for many of the DeFi products available. In simplistic terms, it refers to when a holder of a crypto is paid a return/interest, yield (hence the name ‘yield farming) which is far higher that depositing the equivalent amount into a bank account. Unfortunately, given the almost zero interest rates available in banks, DeFi looks almost ‘too good to be true’. This always rings alarm bells as I have heard that expression too many times in over 40 years of studying investments, so please remember caveat emptor- buyer beware as all the glistens is not gold.

Performance of the Yearn Finance (YFI) token

Source: CoinGeko

Andre Crojne, founder of Yearn Finance that created the YFI token which has appreciated so much, has gone out of his way to try and introduce governance and controls, will others have created structures that have proved to be been less Decentralised. An example of a DeFi token that turned out not to be very DeCentralised is Sushiswap, where the chef at Sushiswap was able to take $14million of ETH tokens. The chef clearly had ‘baked-in’ the ability to get control/access of others’ money, but fortunately he could not ‘stomach’ the pangs of guilt and has subsequently handed back the $14million…. Nevertheless, this has to be a salutary lesson for all to check on how DeCentralised the DeFi products and services you are acquiring are, before you buy! Double check the protocols and be sure that someone cannot gain access and walk away with your money….

Furthermore, when studying the DeFi sector there are potentially lessons which Traditional Finance (TradFi) can learn regarding some of the innovation being used in the DeFi sector, as well as the TradFi sector offering lessons for DeFi practitioners:

Jargon free/user friendly language: 

In order to gain mass adoption, DeFi needs to have less ‘jargon’ terms such as flash loans, yield farming, staking, liquidity pools, vaults algorithmic market-making APY and even stablecoins (which may not be so stable if they are not 100% backed by $ such as Tether). This type of jargon serves potentially to confuse and, therefore, dissuade new customers to engage.

Education:

Exposure to equity markets is greater now due to the increase in investor education. Just look at any weekend newspaper, or the vast range of investment publications and websites for people to read. However, despite the rise in personal pensions and massive expansion of mutual funds, many citizens are struggling with financial products and services and hence, the need arises for strong regulators to protect investors. TradFi has promoted diversification i.e. promoting funds, as opposed to just buying equities. While companies, such as FTX, have launched the Top 100 Uniswap index, DeFi possibly needs to develop more funds and other ways to diversify the risk of investing in only an individual token. Arguably, DeFi also needs to address the systemic risk of Bitcoin and, to a lesser extent, Ethereum.  

Need for KYC/AML:

Money has attracted nefarious actors, and always will. Hence, TradFi insists that before invests are made, clients must undergo comprehensive KYC and AML checks as, in effect, these act as gatekeepers to try and ensure TradFi companies manage ‘clean’ money. Organisations offering DeFi products and services would also be well-advised to start insisting on KYC and AML checks. In doing so it will offer comfort to regulators and governments who have spent years introducing KYC/AML legislation as, rightly or wrongly, they see this a vital plank to help maintain confidence in financial markets. There are allegations that the hackers who stole $150 million from  KUCoin have been trying to launder their ill-gotten gains on DeFi exchanges. 

Disintermediation:

A term often ‘banded about’ and seen as being good for consumers since, in theory, the less intermediaries involved in a transaction the lower the end price ought to be. DeFi exchanges have manged to do what TradFi exchanges have been barred from - providing market - making services – the setting of prices based on the amounts of assets being bought/sold for customers in order to set the price of an asset. This removes the need for third parties (i.e. traditional market-makers and their fees) by handing control to DeFi exchanges to decide prices.

Trust and confidence:

When dealing with money, trust is paramount since it goes hand-in-hand with confidence. One of the core questions often asked is, “How safe is my money, can someone get access to it?”. The TradFi markets have developed the role for custody i.e. independently third-party firms which physically hold clients’ funds and assets (equities, bonds, etc). Whilst there are a few companies beginning to offer custody for Digital Assets, this is one area which continues to hold back greater engagement into digital assets for many traditional institutions, as legally independent custody providers have to be used. Arguably of equal importance to custody is governance. It should not have been possible for the Sushi Chef to walk off with $14million. The DeFi sector needs to address these challenges in order to allay future potential regulatory scrutiny. 

User experience:

If DeFi is to really bring finances to the masses, it needs to find a way to improve the user- experience and not be ‘geeky’. The same way that TradFi previously suffered from being seen as elitist and only for the rich but, by now offering more and more products and services on-line, it is attracting a growing audience who wish to deal via ‘clicks’ and not by talking to a stockbroker or bank manager!

DeFi has certainly experienced a rollercoaster of fortunes in the last couple of months. To survive and thrive it will need to ensure it truly is decentralised in order to avoid the ability for money to be siphoned off/ stolen i.e. it needs to have stronger self-regulation before regulators step in to protect those less-sophisticated investors from another ‘chef cooking the books….’ If it can overcome these challenges, then it could potentially be a massive threat to incumbent TradFi providers. Indeed, there is evidence that some of the DeFi exchanges are already taking the trading volume of some of the larger crypto exchanges, (such as Coinbase and Binanace) which, in turn, have responded by launching their own DeFi offers.

• the need for legal certainty; 

• to support innovation;

• to ensure adequate investor protection;

• maintenance of financial stability.

It would appear that stable coins are very much on the EU’s agenda, presumably following the announcement, in June 2019, of Libra and the strong consortium of global organisations which were involved - not least of which was Facebook, with its 2.3 billion users globally.

Source: EU.eu

Together with this, the EU has also announced the Digital Finance Package that it is mindful that the EU needs to keep pace with an ever digitising environment; “If there was still any doubt it is now clear: digital finance has a lot to offer, and the people and businesses of Europe are ready for it. Europe must take full advantage of this in its recovery strategy to help repair the social and economic damage brought by the pandemic.  Digital technologies will be key for relaunching and modernising the European economy across sectors. It will move Europe forward as a global digital player”. 

The report went on to state its strategic objectives were to embrace digital finance for the good of consumers and businesses:

• Europe and its financial sector must embrace these trends and all the opportunities offered by the digital revolution;

• Europe must drive digital finance with strong European market players in the lead;

• The aim is to make the benefits of digital finance available to European consumers and businesses;

• Europe should promote digital finance based on European values and a sound regulation of risks.

It cited that, having consulted various parties, there was a general consensus of support due to:

• Digital finance has the potential to “unleash” innovation and create opportunities to develop better financial products for consumers including for people currently unable to access financial services. Furthermore, it offers the ability to unlock new ways of funding to EU businesses, in particular SMEs.

• Boosting digital finance would therefore support Europe’s economic recovery strategy and the broader economic transformation. It would open up new opportunities to support of the ‘Green Deal’; and the ‘New Industrial Strategy’ for Europe.

• As digital finance transcends borders, it also has the potential to enhance financial market integration thereby to potentially strengthening Europe’s Economic and Monetary Union.

• Finally, a strong and vibrant European digital financial sector could strengthen Europe’s ability to retain and reinforce its financial services and thus its ability  to regulate and supervise the financial sector to protect Europe’s financial stability and its values.

There was broad agreement to target 2024 as the date when it would be possible to have one license to cover all EU members, ensuring there were no national barriers to restrict access to EU citizens or to restrict those organisations looking to issue Digital Assets. Additionally, there was an acknowledgement of the efficiencies that Blockchain technology can bring to the financial services sector such as cutting the cost of payments, helping SMEs to raise capital while offering access to ‘real time’ financial information. 

In reference to firms looking to issue Digital Assets, three of the recommendations were, firstly, (as stated in 16) that small SMEs offering smaller issues would not need to produce a whitepaper/a prospectus. Secondly, see (19) there should not be the necessity for relevant  authorities in each jurisdiction to review any documentation prior to an issue being made available. Thirdly, (see 22) in order to ensure consumer protection, consumers should be offered a ‘cooling off’ period. The report has also suggested that issuers of tokens be required to keep investors regularly updated (see 31) on the progress of the organisation that had raised capital. One item of significance for those firms wishing to offer Digital Asset services is the need to have a legal entity based within the EU (see 50). This could have an impact for the UK post BREXIT. Furthermore, the EU Commission stated its support of the ECB, which is looking into the issuance of a retail central bank digital currency (CBDC) available to the general public.

The intention is for the legislation to be pan-European, therefore once a Digital Assets provider/issuer has been approved in one European country, they will be able to promote itself to all other members. However, this will not transpire quickly since each member needs to agree the terms of the proposal being tabled in this report, hence the 2024 suggested deadline for the introduction of these various proposals. Consequentially, in the short term we are likely to see other countries, in effect, ‘do their own thing’ by following France which, itself, has been quicker than other EU members with legislation to encourage Digital Assets/ICOs. Although German too have recently issue draft legislation, called, “eWpG-E”, to offer greater clarity around the issuance, transfer, custody and distribution initially of  Digital Assets backed by debt instruments. However, it is being proposed that regulators also wish to include equities and funds. Currently financial investments need to have a paper version of the proposition, but the aim is if issued in a digital format there would be no requirement for a paper version as well to be created. 

If these proposals are passed it will make Europe one of the most regulated jurisdictions for Crypto trading, offering legal clarity for the custody of Digital Assets and the obligations and rights between token issuers and buyers. This surely puts pressure on other jurisdictions to review their legislation and hence ensure they do not fall behind the competition to digitise their own financial services sectors.