DEFI is a new financial system built primarily (for now) on the public Ethereum blockchain.
Its implementation on Smart Contracts makes it incredibly transparent, efficient and innovative and carries the implicit promise of eliminating the entry barriers that until today had excluded more than 1.7 billion people from the traditional financial system (most of them, small farmers in emerging economies). It is growing exponentially and I believe that due to its obvious advantages it will end up being adopted as the de facto financial system.
Internet was unable to cause a profound disruption of the financial sector because it kept requiring trusted agents to carry out money transactions: when you "buy" online you are sending a message to your bank to ask it to transfer money to the seller's bank. In contrast, with blockchain you can transfer the value directly to the seller, without intermediaries and with pre-programmed conditions in Smart Contracts, eliminating the need for trusted third parties, which is a profound disruption of the current financial system.
First stage DEFI.
On a first stage DEFI has been focused on decentralized and trustless loans and financial assets collateralized 100% or even much more (700% in Synthetix) to achieve a trustless system with low perceived risk, making it very attractive despite the complexity and technical risks. The collateral used in this first stage has been cryptocurrencies or tokens, since they are the only assets that can be operated by Smart Contracts without counterparty risk.
But focused on a model on cryptocurrencies or tokens, DEFI only serves holders of such assets who are willing to invest them to receive interest or to cryptocurrency traders requesting loans to leverage their operation on their crypto assets price increase, therefore, the ecosystem as a whole has been criticized for being little more than a speculators’ casino.
So, it’s a big operating system powered by crypto tokens, for the purpose of moving around… crypto tokens.
A healthy banking system in the real world would consist of people depositing money, and the banks making various loans for mortgages and for business financing, to generate real-world utility.
A speculation-based banking system, on the other hand, would consist of a bunch of banks taking deposit money, and then lending to speculators in the nearby stock market, along with technology providers that make this easier, and then what those speculators aretrading mostly consists of shares of those banks, shares of those tech companies, and shares of the stock exchange, resulting in a big circular speculative party.
The biggest use case so far for Ethereum is a decentralized version of that circular speculation-based system".
For this financial system to achieve reaching the real world people and businesses in need of better financial services (mostly without cryptocurrencies or assets as collateral) DEFI must take a step forward to begin building trust and reputation within the productive economy and capitalize on the benefits generated by these new tools instead of focusing exclusively on its endogamous speculative casino.
Focusing DEFI on the productive economy can bring trillions to this sector since governments, development agencies, large corporations, etc. would perceive DEFI as the way to deliver their resources in a much more transparent and efficient way.
Better yet, this is the only way to avoid the next crypto winter to be as bad as the last one. The price of bitcoin has a 4-year cycle caused by the halving (a 50% reduction of the rewards issuance that encourages miners to secure the network) a cycle that affects the other crypto assets since they are all tremendously correlated.
The fact is the capital deposited in DEFI keeps growing exponentially not only because there are more and more users, but also because cryptocurrencies (mainly ethers and bitcoins tokenized in the form of WBTC) deposited as collateral, rise in price on the cycle’s growth phase, generating increased capacity for new leverage to buy more cryptos and fuel the fire of price growth. The problem is that this cycle will inevitably end when a huge bubble forms that eventually collapses, leading then to a new crypto winter. At that time, the value of the capital deposited in DEFI will plummet if the step has not been taken to equip this ecosystem with other purposes than mere speculation around cryptocurrencies.
But above all, focusing on reaching the productive economy is the only way for this innovation to reach the billions of people and SMEs who need it most and also where more wealth would be generated.
Imagine for a moment that the Inter-American Development Bank buys billions in cryptocurrencies with the aim of depositing them in Smart Contracts that serve as collateral to facilitate financing (equity, debt or hybrids) of the supported projects. This would allow investors to see their risk mitigated by investing through Smart Contracts supported by that collateral pool.
Mixing concessional capital from development agencies or foundations with non-concessional capital is what is called blended funding and it is what is allowing the exponential growth of impact investment now approaching a trillion dollars. Blended Funding is a perfect use case for Smart Contracts. The money traceability on blockchain and the ability to tokenize the impact as a way to unblock resources is something these investors value very positively.
There are several projects taking important steps to build bridges between DEFI and real-world productive activity. Aave and Akropolis have made the developments for these bridges but the step has to be taken to cross them.
EthicHub is one of the first projects with a full focus on using these new tools to connect DEFI to the productive (and better yet) impact economy for the unbanked small farmers.
We started 3 years ago building a credit system without collateral (but with 0% defaults to date), using Smart Contracts on the ethereum blockchain. Now, by launching the Ethix, we are endowing these loans with collateral so our solution can scale exponentially.
Such a solution consists of creating a blended funding system in which, on the one hand, we have lenders who want a return as secure as possible and who by lending to farmers generate demand for Ethix, and on the other hand, we have Ethix holders who buying Ethix to stake them as top-level collateral in the compensation system and, among other benefits, share the incentive Ethix (25% of the total Ethix have been reserved for incentives to support adoption over the next 16 years). At some point, the Ethix Holders will not only be people but also development agencies, foundations and other types of concessional capital that will see in this system a way to channel resources aligned with their objectives in the most efficient and transparent way possible.
At the end DEFI is nothing more than a tool and it lies in ourselves to decide what our money is used for: that is your great superpower, to decide who you buy from and where you invest, because it is the way to generate the incentives to change the world.
I encourage you to read more about DEFI in general and about EthicHub in particular and to step forward the positive use of this new financial system.
Jori Armbruster - CEO EthicHub