Today, “Fortune” magazine released a series of cover reports on the theme of “Encryption VS Wall Street.” Investigate and analyze the influence of traditional financial markets, and at the same time summarize the response methods of some traditional financial institutions.
This summer, I took the first step to become a “degen”. The word-short for “degenerate gambler”-comes from the 1.5 trillion dollar cryptocurrency world, where cheeky speculators have accepted it as a cute term. I entered one of the clubs, a “Pool” party organized by a pure digital organization. One day, it will be happy to replace your bank.
The event is a “lossless lottery” project run by an application called “PoolTogether”. Leighton Cusack, who co-founded the project two years ago, prefers another name for the game: a savings account linked to bonuses. Although the traditional savings account only pays meager interest among all depositors, PoolTogether often sends large bonuses to a few winners.
As of the end of July, the app’s total deposits were close to 200 million U.S. dollars, and a weekly bonus of nearly 100,000 U.S. dollars was distributed. Although this makes PoolTogether sound a bit like a casino, most of its activities involve playing the role of a bank. This application can absorb deposits, lend out and pay interest.
But this is not a bank. There are no reinforced concrete vaults, no tellers, and no supervisors. In fact, no company controls this project. The incredible thing about PoolTogether is that the system runs entirely on software. Cusack and a group of online collaborators quickly developed the application using open source code and cryptocurrency, built a beautiful website, and launched it all. The program runs on Ethereum, a global computer network that lists a distributed ledger together, through which interest and awards are issued every week.
PoolTogether is a typical example of decentralized finance or DeFi, which is a thriving part of the unpredictable crypto economy. PoolTogether and similar projects are attracting a generation of tech-savvy tinkers, early adopters of cryptocurrencies, out-of-the-box thinkers, and occasionally turning to another largely independent financial system. In this system, they can borrow, lend, save and insure according to their own rules.
Although not the largest DeFi project, the structure of PoolTogether is typical of this emerging world. Those who deposit assets earn loyalty points in the form of tokens, allowing them to vote on the direction of PoolTogether. Over time, savers will accumulate more project tokens, even if they have never won a lottery draw. People can sell these tokens on cryptocurrency exchanges to make a profit, which is another incentive to participate. (At the time of my participation, the transaction price of a coin was about $10, which was lower than the March high of $32.)
This is a fully encrypted world: in almost all DeFi projects, deposits and income are denominated in cryptocurrency, not legal tender. In addition, it should be noted that assets are not covered by the federal insurance system that protects “normal” accounts.
As a largely unregulated economic field, DeFi has exploded with the demand for cryptocurrencies such as BTC and ETH. Most of the transaction activity takes place on Ethereum, the second largest encrypted network, and its blockchain comes with a built-in programming language Solidity, which makes it easy to build so-called decentralized applications. Currently, users of this ecosystem are mainly people who are satisfied and enthusiastic about cryptocurrency-despite its risks and legal uncertainties.
But this state of isolation may not last. DeFi represents a coordinated crowdsourcing effort that aims to make digital tokens work and provide people with financial reasons to hold tokens, not just guessing price trends. Olaf Carlson-Wee, one of the earliest major investors in the crypto market, stated that cryptocurrency is “ultimately more than just a new gold or a new currency”. He believes that DeFi has “shattering importance” and added: “This is not just a question of assets, but all financial instruments.”
This fact, in turn, may pave the way for mainstream consumers. In the not-too-distant future, it is expected that the Fed will decide whether to mint the digital dollar itself or whether the private industry will provide support for such issuance. Both of these measures can open blockchain-based services to the public, and today’s evolving DeFi infrastructure may shape a new financial order.
This possibility is attracting more and more established financial companies to get involved in the DeFi industry. At first it was just a plaything — fans called DeFi tools “Money Lego” because they were easy to assemble — but now it has brought the wider business world into its orbit. In this large-scale wealth reorganization, nerds have mastered the initiative. They are replacing Brooks Brothers suits with blockchains. Software has finally started to eat into finance.
DeFi uses the blockchain as a slingshot to throw stones at the giants of Wall Street. The promise of this technology has always been to make transaction costs lower, more efficient, and more fair by replacing intermediaries with shared, instantly updated distributed ledgers that anyone can monitor.
Although the bank has office hours and observes holidays, DeFi never sleeps. Institutions use paperwork and committees to make decisions, and DeFi relies on algorithms. Although “OldFi” wire transfer and stock transaction settlement may take several days, Ethereum-based transactions are relatively instant and usually take about 5 minutes to be finalized.
“It’s fast, open, unauthorized, and transparent,” Mike Novogratz said. He used to be a hedge investor and now runs a crypto investment and financial services company called Galaxy Digital. He said that fewer intermediaries also means fewer systemic risks. “If we can take a look at the information shared on the blockchain and see Bear Stearns’ mortgage risk exposure, we will not have a mortgage crisis in 2007.”
For every traditional centralized financial product, there is a DeFi version related to cryptocurrency, which has either been launched or is under development. Have you just entered the crypto market? Buy some tokens on Uniswap’s decentralized exchange. Borrow money? Take a look at AAVE’s “Flash Loan”. Insurance? Nexus Mutual has your protection plan. Want high-yield savings? Use Compound loans, which is one of the loan agreements PoolTogether relies on.
At the center of these operations, there is no chase from JPMorgan Chase, and no Nasdaq. All this is just code. A community of software developers and token holders — people who own virtual tokens distributed by various crypto projects — runs the show. Rebecca Rettig, Aave’s legal counsel, said that DeFi’s commitment is to “allow individuals to have autonomy in their own financial situation.”
DeFi is still experiencing growing pains to a large extent, especially because it is based on cryptocurrency, and the price of cryptocurrency is notoriously unstable. The total value locked in DeFi projects reached a peak of $90 billion in May, and then plummeted as the price of cryptocurrencies plummeted.
Nevertheless, as of late July, the total deposits of these blockchain-based projects exceeded 60 billion U.S. dollars, and at the beginning of 2020 it was less than 1 billion U.S. dollars. If all DeFi applications were considered a bank, it would rank among the top 50 in the United States in terms of assets under management.
It is difficult to say how many people participated in DeFi events. Creating a blockchain wallet is a passport to any project, no ID is required (this feature shocks many regulators), and many users have multiple wallets. Nevertheless, according to data from Dune Analytics, the number of wallets interacting with the DeFi protocol has soared from nearly 300,000 to more than 3 million in the past year. Crypto wallet provider MetaMask counted more than 8 million active wallets worldwide in July.
Brian Brooks, CEO of Binance.US, a cryptocurrency exchange, said that considering that DeFi has attracted so much capital from hedge funds, wealthy investors and retail enthusiasts, “it can no longer be ignored.” Brooks, who served as the top banking regulator in the United States during the last year of President Trump’s administration, believes that blockchain applications will have the same impact on banks and brokers as the Internet and Amazon will have on brick-and-mortar retailers—forcing them to either be in a new The competition in a technology-driven game will either perish.
“This raises the question of whether we really need these institutions to perform these intermediary functions.” Brooks said, “If I were the head of Bank of America, I would be worried.”
If the chief executives of the big banks are worried, they will not speak out publicly. But established institutions are beginning to explore DeFi-assuming that young customers are satisfied with encryption and application-driven financial services, they will eventually demand it. Fintech companies have already believed the call to come.
In a blog post in June, Brian Armstrong, CEO of Coinbase, the largest cryptocurrency exchange in the United States, wrote: “The products that crypto users are using today will be used by mainstream customers within a year and will be used by institutions in a few years. Use.” Payment giant Square announced in July that it is preparing to build a DeFi business focused on Bitcoin. Dan Schulman, CEO and President of PayPal, said: “We are in the midst of a major shift.” The time is ripe for the use of encryption to modernize the financial system.
The old conservatives also joined in. Companies such as JPMorgan Chase, Wells Fargo, and Goldman Sachs have hedged against a possible future without banks by injecting millions of dollars into crypto start-ups. The credit card era giant Visa has partnered with one of the latest federally chartered banks, Anclage, to accept commercial payments in privately issued digital tokens, such as U.S. dollar tokens pegged to the U.S. dollar. Companies may begin to increasingly engage in reverse transactions with such portals, even if their own businesses are settled entirely in U.S. dollars.
Diogo Monica, co-founder and president of Anclage, said that the bank “wants to establish a relationship with these millennials. They are the next generation who will inherit trillions of dollars from the baby boomers… These traditional, centralized financial institutions have a lot of distrust.” He concluded that banks will have no choice but to know the law: “It’s just a matter of how, when and where they enter.”
In terms of dollar value, P2P loans account for about half of the DeFi market. It also promotes one of its most attractive selling points: providing a higher rate of return for depositors who convert their deposits into loans. DeFi interest comes from a combination of nominal accrued income and passive loan income, which can reach double-digit percentages. Even single-digit yields exceed the national average interest rate for traditional savings accounts, with an interest rate per bank of only 0.06%.
Stuart Sopp, CEO of Current Bank, told Fortune that his business plan is to integrate the Compound business to obtain higher returns. For Sopp, this is a simple decision, not related to the encryption wave, but entirely related to mathematics. “Money is for profit,” said, “It will go where the returns are the best. If you can get a 5% rate of return and it is fairly safe, then the funds will be transferred.”
However, the mechanism behind these debt yields is a bit confusing. The jaw-dropping interest rates are mainly due to banks’ risk aversion, technological lag, and regulatory concerns about cryptocurrencies. To a large extent, banks will not provide credit to cryptocurrency borrowers. Even Bitcoin billionaires have difficulty using digital tokens as collateral. This makes supply and demand imbalance-especially considering that many crypto whales are eager to make leveraged bets on more cryptocurrencies.
Behind the scenes, the new rich, including crypto-friendly hedge funds, pay a premium to obtain loans from DeFi protocols such as Compound and Aave, and professional lending institutions such as crypto companies BlockFi and Celsius, and these loans are turned to DeFi projects for liquidity. For borrowers, paying a relatively high interest rate-say 10%-is much better than selling crypto assets and suffering a short-term capital gains tax of 37% or higher. At the same time, high-interest loans mean that depositors’ returns are much higher than normal.
There is a paradox here. As cryptocurrencies and DeFi mature, such high yields may not last: as banks become more comfortable with digital token assets, crypto investors will find it easier to borrow at lower interest rates. At the same time, in a world where “yield farmers” act quickly to find the highest returns, there is no risk-free return. In the crypto world, fast-moving funds can mean large fluctuations in the price of tokens.
It is not uncommon for advertisements to obtain super-high returns from non-performing loans, usually driven by supply and demand and crazy price speculation. A project called Iron Finance has shown an amazing rate of return this year. But on June 16, the token TITAN mysteriously collapsed within 16 hours, and its price plummeted from $64 to almost zero. Iron Finance claimed that it was the victim of “the world’s first large-scale cryptocurrency bank run” and accused the whales of initiating large-scale withdrawals. But chat forums such as Reddit, Telegram and Discord are full of accusations of hoaxes.
Cryptocurrency and misconduct are no stranger: According to data from the blockchain analysis company CipherTrace, from 2019 to April 2021, people lost $6.5 billion in cryptocurrency-related fraud and cybercrime. Massachusetts Democratic Senator Elizabeth Warren called cryptocurrency the “Wild West of Investment.” She told Fortune that when it comes to DeFi, the risks are magnified. “There, anonymous developers can deceive investors through scams such as scams without transparency or accountability.”
In a community with decentralization as a philosophical pillar, accountability is a major issue that needs to be resolved. As early as 2019, Compound co-founder Robert Leshner often woke up in a cold sweat and worried about his responsibilities. If there is a bug in the code, can he and his team make up for the loss? “I am afraid to leave this house because I think someone will kidnap me and try to steal all the money in the yard.” Leshner told Fortune magazine.
Leshner’s solution is similar to retirement. His team created a governance token, Comp, and gave control of the protocol to the Compound community, to those who obtained and owns the COMP token. It is now a collective responsibility.
For most DeFi projects, Compound’s model is standard: the basic unit is not a registered company, but a DAO, or decentralized autonomous organization. The common denominator of these projects is that no one is responsible, or that everyone is responsible to varying degrees. Each token holder has the right to vote on the management decisions of the agreement, such as updating the code, setting parameters related to interest rate calculations, or providing funds to developers to build new features.
In practice, it is usually full-time enthusiasts and institutional investors who participated in most of the voting, rather than ordinary users. In any case, they have a common goal: as more people use the protocol, the digital tokens behind the protocol become more valuable. Build a better project, everyone involved will become richer, and the idea begins.
However, these tokens are inherently risky. Their volatility increases the risk of any DeFi project: if your cryptocurrency earns you 9% interest, but your principal value drops by 75%, you are not a winner.
There is also an unresolved legal issue, that is, whether tokens are just securities under another name. The US Securities and Exchange Commission has made a decision on multiple occasions and believes that this is correct. Ripple and its managers were sued by the SEC for allegedly selling unregistered securities in the form of XRP digital tokens. The same logic, if applied to DeFi, may greatly change its operating mode.
“I think the fall of 2021 will be very similar to the regulatory investigations we received in 2017 and 2018, when a large number of information requests and subpoenas were sent from the SEC to early crypto innovators.” Crowell & Moring Law Firm’s Blockchain Business Leader Michelle Gitlitz said that people may have tried their best to comply with the law, and the government and regulators may disagree at all.
At the same time, the pioneers of DeFi continue to experiment in an atmosphere where technology is mature and “degen” is combined.
When I deposited 15 DAI (a token pegged to the U.S. dollar) into the Pooltogether fund pool and participated in the lottery together, digital confetti and rainbow ribbons rained down on the screen to celebrate. I am with other deposits of 35 million dollars. I have a 1 in 468,660 chance to be one of the five winners who share $25,000.
While I was waiting for the results, I entered the Discord community conference call, which is a chat application that many DeFi projects use as a virtual headquarters. PoolTogether’s Discord group has nearly 6,000 members, and dozens of members are on the phone that day. At some point, the conversation turned to marketing efforts. The collaborators are looking for a way to explain to ordinary users why they should put their “baby boomer money” into PoolTogether. A participant under the pseudonym Oops explained that he was promoting the advantages of DeFi savings to his father. “I tried to persuade him to change something.” Oops said.
While the chat was going on, I checked the lottery. A message popped up on the website: “Oh! An error has occurred and we have been notified.” The note read, “Don’t worry! Your funds are safe. This is just a user interface issue.”
Back in the conference call, someone asked Oops’ dad if he had been persuaded. “I must educate myself further,” the father said suspiciously.
As for me? When I came back to check later, I knew I didn’t win. But it is too early, maybe next time I will be lucky.
Author | Robert Hacket
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/fortune-cover-report-defi-is-occupying-wall-street/
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