From CeFi to DeFi: Moving traditional finance onto blockchain

14 Oct, 2020 22:12
source: John Wu

Singularity Financial Hong Kong October 14, 2020 – From CeFi to DeFi: Moving Traditional Finance onto Blockchain

About this author: John Wu is President of AVA Labs, a company creating the next-generation blockchain platform. In this role, he leverages his expertise from over 20 years as a fintech executive and technology investor to create a blockchain-enabled solution for originating, issuing, and trading financial assets.

John joined AVA as part of its acquisition of Investery, a SaaS platform he founded to facilitate investor discovery, management, and transacting of private market assets. Before Investery, he was CEO of the SharesPost Digital Assets Group, working with investors and issuers to enable compliant token trading at a global scale. Prior to that, he was a technology investor and the founder of Sureview Capital, a global hedge fund backed by the Blackstone Group.

John began his investment career at Tiger Management, a preeminent hedge fund with $20 billion in assets under management at its peak, before managing a global technology portfolio at Kingdon Capital.

John received his MBA from Harvard University and holds a BS in Economics from Cornell University.

This article was originally published on John’s blog.


DeFi is an exciting realm of innovation and experimentation for financial products inspired by traditional finance (or centralized finance, “CeFi”). It’s permissionless and driven by passionate communities with new ideas and significant capital. It also gives many retail investors a chance to learn and be part of a growing industry.

Permissionless technology means that anyone can use it. DeFi projects are taking financial innovation to heart by creating entirely new classes of synthetics, monetary policy, and structured assets according to their imaginations. This draws amazing ideas and network effects, but it also brings terrifying risk from both financial and regulatory standpoints.

The lack of frameworks around project governance, inevitable regulation, and financial risk of new asset classes is currently a boon for DeFi. Projects and networks are building out infrastructure and partnerships to handle the blitz of services and customers flocking to DeFi. New market participants want access to the incredible innovations that interoperable permissionless technology allows.

 To be clear, institutional money is not really in DeFi yet. There are a few bets here and there, mostly by early enthusiasts making calculated risks. Allocating material levels of capital to DeFi are simply not a part of major funds’ plans.  An institutional strategy to jump on a highly technical trend for a week to try to 100x an investment simply does not exist. That’s no better than taking investor money to the roulette table by risk model standards.

It is understood that some DeFi projects will never cater to institutional money. Part of the libertarian ethos of crypto is that you can be your own bank. Those protocols and projects will thrive as long as they can find their niche user base and value proposition. However, institutional finance will come to DeFi projects that build for scale (and soon) once the infrastructure is in place. How do protocols and projects need to evolve to accommodate institutional money? What will a fund that brings hundreds of millions into DeFi need to deploy capital for the long term?

What CeFi Needs

Risk Analytics

Financial institutions need accurate and reliable data on different risk factors specific to blockchain, such as smart contract risk or platform risk.

Compliance

Financial institutions need more guidance from regulators in many areas but primarily in securities and commodities regulations and tax treatment.

Downside Protection

For many investment funds, going naked long is not a viable strategy. Instruments that provide downside protection must have deep liquidity with sophisticated tooling.

Social Proof

CeFi is not an industry of early adopters. We will need to see industry leaders take the initial leap. The unavoidable failures AND the successes need to be well publicized and understood so that others can learn how these leaders assessed the risk and delivered long-term value with DeFi.

How will institutions impact DeFi?

Blockchain and cryptocurrency emerged with libertarian and DIY ideals to move away from the financial and banking structures of the time. As the industry has grown into a diverse range of projects, many are attempting to join traditional finance, serve traditional finance, or connect traditional finance with DeFi products. If there is a valuable and proximal way for CeFi to integrate DeFi as part of a broader strategy, financial institutions just might diversify into DeFi to gain exposure, partnerships, and market share.

Exposure 

The simplest way for institutions to become involved is to join the ecosystem and inject liquidity into protocols. As discussed above, there are many requirements that need to be met before this can happen. What kind of impact would significant sums of money have on protocols?

Risks

First, governance attacks or centralized voting are risks for some DeFi protocols if the amount of funds in a given pool are not large enough to absorb significant sums of money from one party. Kyber Network is a good example of this. At time of writing, Kyber has $86M staked in its liquidity pools and governance token. That’s a highly active DEX that could be relatively easily influenced by something considered a small amount by a hedge fund. In a case such as this, an investment of $5M can give an institution a pretty significant seat at the decision-making table. Decentralized systems are designed for this in many cases. Relative percent of the stake in a protocol gives players more voting power but this still doesn’t solve the problem. Some protocols may be forced into significant changes by several players colluding to make highly impactful governance decisions.

Benefits

There are also significant advantages to more liquidity in DeFi protocols. More liquidity will supercharge the capabilities of advanced financial products that require deep liquidity to scale. As liquidity grows, we can expect to see demand drive more innovation in creating more financial products. This creates a virtuous cycle that will drive incremental investment from traditional financial services companies.

The Avalanche Value Proposition

At Avalanche, we set out to build the Internet of Finance. We are building a tech platform so simple to use that any Wall Street banker can set up trading, lending, and other types of financial services in 2-3 hours by leveraging our documentation and tooling. In the same vein, we want crypto developers who have been in the space for 4-5 years to be able to grow their projects without being crippled by network congestion and high transaction fees.

How do we seek to accomplish this ambitious goal? We are currently gearing up for the launch of our mainnet by making sure we have significant integrations in place on day one. We are supporting special projects who want to build the early community of use cases by participating in our grants program, Avalanche-X. To date, we have rewarded grants to projects to provide tooling for Avalanche users. We are currently looking for entrepreneurial teams to launch their own DeFi applications.

If you share this vision of bringing CeFi to DeFi to improve and grow the ecosystem for current and future users, come build on Avalanche. Feel free to reach out to talk about use cases and partnerships by sending me a note. Let’s build without limits – together.

(This post is republished with permission from author‘s personal blog. )