In Jamie Dimon’s annual letter to JP Morgan Chase shareholders, he explicitly stated that “DeFi and blockchain are real,” which sparked comments in crypto circles, given his earlier statement that “I don’t care about bitcoin. I do not feel like it.” But I think it’s possible to believe that tokenization will be huge and that defi protocols will play a serious role in the next generation of financial services, while I’m skeptical that cryptocurrencies will play a big role.
DeFi without Bitcoin? Opinions are certainly divided, but when it comes to the ongoing entertaining discussion between Marc Andressen and Jack Dorsey, I’m on the Andressen side of the fence. It is not at all clear to me that Bitcoin
I don’t see that as a controversial position. In fact, I think this has long been the view of serious players in the financial services mainstream. Irfan Ahmad (VP of State Street, the world’s largest custodian bank) recently said that cryptocurrencies have not just entered a new winter, but a “polar vortex”, which seems like a reasonable opinion given the collapse of the Celsius decentralized finance (DeFi) protocol and the news that Three Arrows Capital has filed for bankruptcy, etc. However, under the ice, its investment bank and others are working on using shared ledge technologies to create new ones. creating trillion dollar markets that do not include speculative cryptocurrencies, but instead use digital representations (i.e. tokens) tied to real and durable assets.
There is no paradox: Whether cryptocurrencies survive the next regulatory storm, central bank digital currencies, instant payments and digital identity, institutional markets will eventually use the new infrastructure to trade bonds, gold and carbon in digital form. It won’t just be goods that are tokenized and traded without clearing or settlement. Banks symbolize all forms of collateral, such as title deeds, using technology. As the Bank for International Settlements (BIS) stated in its current Bulletin (#57, June 14, 2022), “DeFi loans should engage in large-scale tokenization of real-world assets unless they are not a self-referential system fueled by speculation.
Tyrone Lobban (Head of Onyx Digital Assets at JPMorgan) spoke at Consensus 2022 last month described in detail the bank’s institutional DeFi plans and underlined the value of tokenized assets waiting behind the scenes. He said that tokenized assets ranging from US Treasuries to fun money market stocks can all be used as collateral in DeFi pools, bringing trillions of dollars of assets into DeFi, “so we can use these new mechanisms to exchange, borrow [and] loans, but with the size of institutional assets.
It will be an entirely new sector of financial services, and it will be an important sector. Since, as The Economist noted, tokens can be digital representations of almost anything, “they can be effective solutions to all kinds of financial problems.” Apart from everything else, tokens signify a lower cost trading environment, which is why major players want to use them once the regulatory environment is stable.
As Thomas Zschach, Chief Innovation Officer at SWIFT, the dish: “Financial institutions today generally do not engage in unauthorized digital assets, due to their unregulated status and anonymity … But many financial institutions, central banks, market infrastructures and others, including SWIFT, are experimenting with digital assets – especially CBDCs and tokenized assets.”
Why? Well, SWIFT says it’s about discovering new opportunities to increase efficiencies, reduce costs, encourage financial inclusion, and continue to bring more value to their communities. It’s not a one-size-fits-all perspective. This is why forward-looking financial institutions look: not because of ideology, but because of money.
The advent of institutional DeFi requires a digital identity infrastructure due to the need for KYC etc in legitimate markets. This has already started happening here and there (for example in Aave
I was lucky enough to have Tyrone on my digital identity panel at Money20/20 in Amsterdam last month. He is a caring man and I take his point of view very seriously. His view is that the way forward is to use digital identity building blocks such as W3C Verifiable Identifiers (VCs). I have to say that I fully agree with his opinion, VCs are the key to large scale solutions and that “since verifiable credentials are not kept on-chain, you don’t have the same overhead to write this kind of information to the blockchain, pay for gas costs, etc.
In reality. And they have another important advantage: confidentiality.
Transparency is one of the main reasons why we would all like to see a renewed and reinvented financial sector. Look at some of the recent problems in the financial world, such as the Wirecard collapse. Company accounts contain assets that simply did not exist. Given that auditors, regulators and the board of directors have been unable to prevent large-scale crime here, it’s reasonable to wonder whether technology could possibly do a better job. Well, I think the answer is yes, and I think tokenization is part of a cohesive picture of how it might do that: If I claim to own one-thousandth of the Mona Lisa, it’s easy for you to verify on the digital asset platform to see that the thousandth Mona Lisa token is in my wallet. You are not dependent on accountants or other intermediaries.
As can be seen in the current crypto cryogenic polar winter vortex or whatever its current name is, DeFi has significant advantages. Arthur Hayes write down with precision that DeFi protocols control some hulking lending books with fully transparent lending standards, counterparty addresses, and liquidation levels. Observers can continuously assess the health of these books. Depositors can process all relevant health information from the various protocols before wagering their funds. And when the value of the collateral falls, it is automatically liquidated, so there are no bad debts.
However, transparency does not mean that everything should always be visible to everyone. The Wharton School published an article on “DeFi Beyond The Hype” last year, noting that there may be some tension between increased accountability and transparency of shared ledgers and stakeholder privacy. For me it’s one thing to be able to look at your loan portfolio somewhere on a shared ledger to determine if you are creditworthy, for me it’s another thing to know who your counterparties are.
Business cannot work that way. Secrecy is essential for trade† Not only is it important for companies to protect the privacy of their customers and suppliers, but they don’t want to reveal their strategies to their competitors. Anonymity doesn’t work for markets, but full transparency doesn’t work for participants. What is needed is not the anonymity of consent minus the blockchain, but privacy in a well-regulated environment, and that when verifiable credentials are provided. In the proper context of trust, it’s easy to show references that say I’m a US citizen, over the age of 18, and have a brokerage account (for example) without telling the world who I am.
(If I don’t do any good, though, the providers of such important tokens will, of course, hand over my true identity to law enforcement.)
Thus we arrive at a nexus between DeFi, verifiable credentials and privacy-enhancing governance structures that is the potential site of a kind of big bang in the financial world: the creation of a new universe of financial services.
That’s why I finally agree with Richard Turrin who wrote this there is an immediate need to “fix the endemic corruption, fix the DeFi protocols that encourage leverage, fix the scams and restore the greed culture”. and Lisa Wade who says “Once it’s regulated, it’s essential to have portfolio management knowledge to bring these new asset classes into the portfolio.”
They are certainly right that DeFi will change financial services for the better.