By Bill Wolf, Chief Investment Officer at TrustToken
The decentralized finance (DeFi) ecosystem has taken off over the past year, spanning around 1,200 percent in locked total value. This is no small feat, especially since just a few years ago most people, including many crypto enthusiasts, hadn’t even heard of DeFi. But if 2021 was the year DeFi took its beachhead, 2022 should be the year it sinks into the realm of traditional financial institutions. The question is—how?
DeFi may be the next step for the world of finance, but so far that world has largely been fine without blockchain. Many components of TradFi are quite efficient. Those who aren’t, however, from risky debt to real estate, unquestionably have plenty of room for improvement, especially when the technology to drive it is booming.
Despite all of its pedigree acquired over time, TradFi has a number of fundamental flaws that hamper trading activities in almost every industry. These defects come from various factors, such as the obsolete tech stack that banks still rely on, and those institutions’ distrust of the expense and early adoption risks associated with massive updates. Other disadvantages may be even more structural, such as contractual or regulatory obligations. Specifically, these are just a few areas where TradFi could do better:
- Transfer speed. Of course, it does not take long to transfer money from one account to another in the same bank. Cross-border payments, however, take longer and cost trillion dollars per year, and still have high fees depending on the transfer method. This creates a clearly inefficient market of a colossal scale.
- Air swelling. The above point also brings us to another TradFi flaw. The traditional system tends to accrue high overhead on almost every transfer, with every trade or exchange transaction accumulating more and more fees and costs with every intermediary.
- Limited scope. Finally, any TradFi service you launch is inherently very limited in terms of geographic reach initially. It is only available to a limited set of approved lenders and borrowers, and diversifying one’s portfolio of financial opportunities is rarely an easy task accomplished from a single platform. In addition, transactions are time-limited: many TradFi activities are restricted to local opening and/or market hours.
While the blockchain ecosystem remains largely specialized in terms of its overall share of the global economy, the technology behind it holds great promise for the financial world. DeFi and TradFi fundamentally revolve around mobile value, with the aim of meeting the supply of capital with the most productive risk-adjusted opportunities.
But TradFi is the proverbial General Motors, an established powerhouse that gives people the vehicles that do their jobs. DeFi, for one, is the tech startup looking to bring people the cars they don’t know they need. The last thing he should do is mindlessly try to duplicate what the competitor is doing; what DeFi needs is a Tesla strategy.
Step up a gear
It’s clear at first glance how different Tesla is from regular automakers. It’s not about doing the same thing as everyone else, but cheaper. Instead, in the words of its own CEOTesla’s vision is “to enter the premium segment of the market, where customers are willing to pay a premium, and then drive the market down as quickly as possible.”
To make further inroads into the TradFi space, DeFi should adopt a similar approach – a corner strategy. It should zoom in on a niche user most willing to pay for what it sells and work its way into the market from there, adding new features and products over time. Blockchain needs to press advantage where there is one, and the good news is that its design offers a functional and effective solution to some of TradFi’s current struggles.
As a trustless protocol, blockchain is effective in eliminating the various intermediaries, greatly reducing the overhead of any business operation. This is twice the case for international transfers, where blockchain eliminates the need to transfer money through a network of correspondent banks, while expanding its reach to a global audience from day one.
Permissionless chains are also infinitely more accessible than banks for institutional and retail users. They are global by definition, transcending national borders, but are also flexible enough to support compliance with different KYC rules through bespoke smart contracts and other solutions. This represents nearly $80 billion of untapped global liquidity – the total value locked in DeFi at the time of writing, immediately accessible to any business willing to reach out and grab it.
As useful as these benefits may be, they are barely enough to secure a beachhead for DeFi on their own without a clear strategy making the most of it. So where to begin its glorious advance? How can he pull off a Tesla?
Welcome to the Blockchain Ice Age
Going forward, DeFi developers should look for financial services and products that exhibit three key characteristics: inefficiency, complexity, and esotericism:
- I for Ineffective: In this case, inefficiency means the absence of broad support from traditional capital. DeFi must look for financial products and business models that lack funds and fail to garner support from mainstream bodies. Think venture capital debt financing for exotic startups, specialized tech loan programs, or even crowdsourcing for underfunded niche projects.
- C for Complex: DeFi should seek to attract projects with a complex underlying business model, which makes them harder to assess from TradFi’s perspective. Think of the complex trading strategies of an automated quantitative hedge fund with smart contracts and on-chain for investors to tap into – this is the type of product the space needs to embrace and is specifically designed for.
- E for Esoteric: DeFi should keep an eye out for products that require specialist knowledge and are harder to grasp for the traditional financial crowd. Credit analysts and lenders can struggle with new and emerging tools, or even things that don’t make headlines in the media. Anything obscure and demanding in terms of specialist knowledge, such as seed debt financing for startups in a specific niche, business loans from emerging economies or even specialist B2B insurance, is a welcome guest on the blockchain. for two reasons. First, the managers of these opportunities have a greater need for solutions, in particular access to greater liquidity and a larger pool of lenders. Second, because these opportunities are usually quite lucrative, thus attracting more interest from lenders.
DeFi has made colossal progress, growing and branching into a diverse and bustling industry. Although still nascent, especially compared to traditional finance, its potential is just as vast as its rival’s field – and to make the most of it, it should use its momentum to take risks and innovate, not to imitate its rival. Everyone is in a continuous pursuit of returns, after all, and in today’s volatile macro conditions, blockchain’s core strengths are in the spotlight.
About the Author:
Bill Wolf is Chief Investment Officer at TrustTokenthe core team responsible for developing the core unsecured loan protocol TrueFi. A graduate of Harvard Business School, Bill has worked as a managing director at Goldman Sachs, HSBC and Credit Suisse. Prior to joining TrustToken, he was President and CEO of Lobo Leasing Ltd., a Blackstone-backed helicopter leasing and advisory service.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.