The promise of Web3: can DeFi dethrone TradFi?

Decentralised Finance or Web 3 DeFi makes it possible to pay, trade, borrow and lend outside traditional institutions. Here’s how DeFi is progressing in its mission to overthrow the old order

The first crypto transaction was at Papa John’s. For 10,000 Bitcoin a chap called Laszlo Hanyecz bought two pizzas. That was in 2010, just two years after Satoshi released the white paper inventing cryptos, and a year after Bitcoin’s launch.

Since then, cryptos have been on a roller-coaster, but real-world applications remain the stuff of hen’s teeth. We’ve got coins, tokens, and blockchains galore. But paying for stuff is rare.

Rarer still are the most complex financial transactions, such as lending, borrowing and trading. Yet there is a growing array of platforms in the crypto world, based on peer-to-peer and blockchain technology, called DeFi, which hopes to enable just that.

‘Free of regulation, Web3 services can offer faster access to finance’

Unlike a bank or stock exchange, no single body owns or controls the platform.

DeFi for derivatives trading

For example, the Synthetix platform offers derivatives trading. Users can tokenise a variety of real-word assets into derivatives, which can then be traded. In March 2023, DFW Labs invested $20m into the platform, which passed $400m in daily trade volume in the same month.

Although the Synthetix platform was created by Kain Warwick, it is not owned by any single organisation or individual; it is run by its community of users, who own the native SNX token, so is a true Web3 concept.

DeFi for borrowing and lending

For borrowing and lending there’s AAVE, a decentralised lending platform on the Ethereum blockchain. Borrowers provide collateral, which is liquidated in the event of non-payment. Interest rates are set algorithmically based on market conditions. And transactions are governed by smart contracts – rules written and enforced by computer code, rather than any individuals or body. Current Total Value Locked (known as TVL in the industry) on AAVE is currently $7.7bn.

DeFi for trading crypto

There’s Uniswap for trading cryptocurrencies. Or Compound for borrowing and lending. And MakerDAO, which offers financial services based on its DAI stablecoin, which is pegged to the US dollar.

So Web3 DeFi is a real thing. But why is it needed?

The reasons DeFi exists

“It’s open and transparent,” says Alex Felix, CIO and managing partner of Coinfund, a VC fund in the Web3 space. “I can assess the risks and health of a system very easily. It’s accessible, so anyone with an internet connection can access these products without having to go through another set of onboarding or whitelisting.”

Felix says the lack of regulation is a double-edged sword. While lacking oversight of a central body can be an issue, Web 3 DeFi can sidestep some of the shortcomings regulators can unwittingly introduce. “In the early days governments banned encryption,” explains Felix. “It was a national security issue. Then credit card payments arrived, and the regulators realised these require secure encryption.”

Free of regulation, Web3 services can offer faster access to finance, can impose their own vetting processes, and even run across national borders.

Felix argues that Web3 DeFi has a bright future across finance. Payments, for sure – cryptos are proving that. Trading and transactions, also, are doable via DeFi. Borrowing and lending are possible, but currently tricky. Traditional Finance, or TradFi, relies on bank managers or something similar to assess the creditworthiness of borrowers. This is not easy to replace.

“You can’t borrow from the internet yet, unless you put up something of equal or more value,” notes Felix. But he says that may change.

“In the future, you can think about unlocking the value of real-world assets as collateral. You could use your car deed, house deed, or something else that is physical, and post that as collateral.”

The challenge is to offer connectivity to registries of asset ownership, such as the UK Land Registry or the DVLA car ownership database, to make this possible. It’s a “five-year plus” timeframe suggests Felix.

His view is representative of the consensus in DeFi. Payments and trading are doable. Lending and borrowing are still in their infancy.

Leon Gauhman, co-founder of digital consultancy Elsewhen and experienced Web3 commentator, is also enthusiastic about the underlying philosophy of DeFi.

“If you take financial instruments and turn them into code, it becomes something very, very powerful and different,” says Gauhman. “We can transact very quickly, and seamlessly, with no custodian relations or anything like that.”

But the real-world cases of Web3 DeFi are limited. “The jury is still out,” he says. “The recent slump in the crypto space put a break on everything.” But timeframes can be hard to predict.

“Innovation can happen very quickly. Look at AI. It’s been progressing for 60 years, and then suddenly within the last quarter everything’s changed. The technology that underpins DeFi is the best use case of blockchain I’ve seen yet. And I think it’s too good to be ignored. It’s just a matter of time.”

Countries go crypto

Perhaps the final push DeFi needs to enter the mainstream is the adoption of national cryptocurrencies. Central Bank Digital Currencies, or CBCD, are being researched at an advanced stage by the UK, China, US, EU and Japan. The Central Bank of Nigeria launched the e-Naira CBCD, and the Bank of India has the Digital Rupee under trial.

The idea is to harness the transactional advantages of cryptocurrencies – speed and stability – with the reliability of a national currency and strong regulatory oversight. McKinsey estimates 87 countries – representing more than 90 per cent of global GDP – are exploring CBCDs.

The emergence of government-issued cryptocurrencies may reassure the general public and prompt adoption of other DeFi platforms and tokens.

The timeframe? Sir Jon Cunliffe, deputy governor of the Bank of England, told a Treasury select committee in March 2023 the UK is at least five years away from launching a national crypto (nicknamed “Britcoin”). Furthermore, the bank currently lacks the technical skill to do so.

Michelle Bowman, who sits on the board of the Federal Reserve, said in April that risks of creating a US digital dollar could outweigh the benefits. The Fed is keeping the concept under consideration, rather than adopting a concrete plan to adopt.

The ECB is at too early a stage of research to offer definitive guidance.

But Sir Jon at the BoE suggested the future could still lie with DeFi and a CBDC: “The iPhone launched with 15 apps… By the time they launched the App Store a year or two later, it had 8,000 apps. Now it has several million. This is not about ‘here is a particular thing that needs to be done’ – it is about opening a new frontier for people to improve payments and the way in which money is used in how we transact.”

The direction of DeFi is uncertain. The timeframe hard to calculate. But even the Old Lady of Threadneedle Street is aware of the huge potential of Web3 DeFi. This is an industry on the move – even if no one yet knows quite where.

More on Web3

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Four UK Web3 start-ups making wavesIn this article, we explore the Web3 infrastructure innovations of four UK start-ups that are making waves in the space

Five key job roles we’ll be seeing more of in Web3In this article, we identify five key job roles that we’re set to see more frequently going forward in the Web3 space

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Charles Orton-Jones

Charles Orton-Jones is a business and tech journalist. He's a former winner of the PPA Business Journalist of the Year Award, and currently edits and Forward magazine, a journal devoted...