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DeFi the Odds

The financial system as we currently recognize it is largely characterized by the centralization of everything. The issuance of money, the performance of banking services, and the facilitation of market transactions are all performed by entities that exercise outsized (or in some instances, complete) control over these functions. In other words, there aren't a ton of players in the provision of financial services.

The U.S. government is the sole issuer of our currency. As of last year, the top 15 bank holding companies in the U.S. held $13.7T (yes, T for trillion) in assets (out of a total $20T). There are three major U.S. stock exchanges that facilitate the exchange of billions of securities on a daily basis. Those bank holding companies and stock exchanges (not to mention the broker-dealers that facilitate the exchange of those billions of securities each day) operate in a heavily regulated space. This is a pretty simplified overview but I think it demonstrates the takeaway: the vast majority of the activity in our financial system is facilitated by a handful of players and centrally regulated. But does it have to be this way?

According to a growing camp in the distributed ledger technology/cryptocurrency space, no, it does not have to be this way. And it is from this perspective that the idea of decentralized finance, known as DeFi for short, emerges.

So many important financial system functions are centralized because it is simply more efficient to have fewer players in the space. I mean, it seems much more efficient to have a few entities that are experts that can settle large volumes of transactions at the end of the day and maintain records of the who, what, where (sometimes) and when as opposed to thousands of entities. Even with the seeming efficiency of having fewer entities, it still takes a lot of time for securities transactions and bank transactions to settle. But distributed ledger technology is capable of performing those same settlement functions much more efficiently--both in terms of time and in terms of cost. Distributed ledger technology can settle transactions at more regular intervals and it presents an opportunity to minimize (or even eliminate) the need for intermediaries in transactions. Intermediaries equal increased transaction costs. The case for the technology is so compelling that many of your favorite bank holding companies have invested in it.

But big banks don't have a place in the DeFi utopia. DeFi purists may imagine a world in which individuals are able to perform peer-to-peer trades of securities without a broker. Or perhaps individuals maintain some form of currency or other asset on a blockchain with which they can conduct peer-to-peer transactions, like pay for a cup of coffee, without a payments processor. Or maybe a community creates its own home insurance pool that is maintained on a distributed ledger and payouts only occur when certain conditions are met. Or what about a rural township with no bank but with a blockchain that facilitates individuals with surplus money lending directly to their neighborhood businesses in need. The possibilities are endless.

However, there is one significant hurdle to this decentralized financial utopia and that is government. Taxes, the elimination of organized crime, the elimination of terrorism, anti-corruption measures, anti-fraud measures, financial stability. The list of goals that are reflected in the complicated web of federal financial regulation is lengthy. And the government ceding even an iota of oversight of the national financial system is unlikely. When you throw in the brute political power embodied by the handful of players that are essentially responsible for keeping the money moving, the odds dwindle even further.

But we can all dream, right? What do you think about DeFi? Is it a future for all? Or a future for some? Let me know by email ( or on Twitter (@blockchainblawg).


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