DeFi for Corporates
Is it Inevitable?
When bankers and corporates talk about DeFi or Decentralized Finance it might seem like a very tense standoff between Protestors and Police with no room for discussion or compromise. Good news B2B Buzz readers, there is room for both sides in DeFi land.
First what is DeFi…
“Decentralized finance (commonly referred to as DeFi) is a blockchain-based form of finance that does not rely on central financial intermediaries such as brokerages, exchanges, or banks to offer traditional financial instruments, and instead utilizes smart contracts on blockchains, the most common being Ethereum.” Source: Wikipedia
I like this icon view of DeFi from the YouTube channel Finamatics, which let me say is a must subscribe if you want to go deeper into the various aspects of DeFi.
A couple of key points to unpack here:
DeFi does NOT rely on Central Financial Intermediaries so we can see why bankers would not be jumping on the DeFi bandwagon too quickly. That is like telling bankers, “we don’t need you anymore.” Actually that is EXACTLY what it is. But is this true? Notice in the icon above we have finance but not bankers, traders or brokers.
We have to point out here that instead of relying on people in transactions you are relying on code. If you have faith in the code that is great. But it is worth pointing out that code is written by humans with hopefully good intentions.
I have to share a story from many years ago here: I worked with an accountant named Jim, great guy and he told me a story about a previous job he had where a programmer had written into the payroll code, if <programmer name> disappears from the payroll program <delete database> instruction occurred. Talk about job security. I share this as a point about relying on code, it is written by humans and can be manipulated. Obviously open source and crypto relies on communities of people so hopefully this prevents an obvious bad actor scenario, but you have to be aware of the possibility that the code is designed to defraud someone.
Now imagine this US Bank error screen was about a $50,000 transfer you were expecting via a smart contract on a DeFi app.
There is no 1–800 number to call, there is no email address to write to. The transaction just didn’t happen and you are short $50,000. Of course you would call the person you had the deal with but maybe they are across the globe and you don’t know them. Anonymity is a key benefit of DeFi transactions, so you might not know them.
And a key tenet of DeFi is “no clawback” so if you make a mistake you don’t get to say, “oops, can you return that please.”
Then again Clawbacks don’t always work now, as Citibank found out the hard way with their $500 million accidental wire transfer.
One of the many DeFi reported benefits is about reducing fraud because you are trusting the code not fallible humans. DeFi’s track record on fraud reduction is spotty at best. Don’t get me wrong the current system has plenty of fraud too. No one wants a repeat of 2008 which was made worse by fraud and general shenanigans within the current rules. But we can not ignore DeFi fraud.
“between January and April,(2021) $156 million was stolen in DeFi-related hacks, according to CipherTrace. DeFi fraudsters stole an additional $83.4 million.” from a CNBC.com report on DeFi
So do we abandon DeFi because of fraud, no but I am also not sure that Mark Cuban’s reaction is correct either. Mr Cuban lost money in a DeFi token called Titan from Iron Finance. It went from $64 to $0 in about 24 hours. Many speculators guessed this was a “rug pull” scam. A rug pull being where an unscrupulous set of developers set up a DeFi project, collect money and then disappear with the actual funds and never build the DeFi protocol or tokens.
Mr. Cuban immediately called for regulatory oversight of crypto tokens and DeFi which I understand but might cause as many problems as it solves and is literally the opposite of DeFi. I do think it is worth studying the question of how to ensure folks do not get bamboozled as we move to a DeFi system.
Finally let’s look at smart contracts which is how DeFi often works. Whenever I think about Smart Contracts I think “programmable money” and I got that from the Ethereum.org website. Another great resource for you to checkout.
As you look at this stack of DeFi you can see that it is built on the Ethereum network. The Smart Contracts or logic of the programmable money lies in the application layer. Also it is worth noting for the bankers and corporates out there there are tools for KYC and Identity.
Smart Contracts will contain all the Terms and Conditions. Think of them as the ultimate <if, then> implementation. If <a happens> then <b happens>.
I worked on a proof of concept years ago with a Smart Contract that was for cotton shipped from Australia to China. Using IOT sensors within the bails of cotton, the sensor would transmit its’ GPS position and also read for humidity. the Smart Contract allowed for when all 5 transmitters arrived in Shanghai, a signal would indicate they arrived and then further the humidity indicator would show a low humidity rate ensuring no water damage.
If <sensor count=5> and <sensor GPS=Shanghai> and <humidity <12%> then <release $500> from Account A to Account B.
Clearly I do not write Smart Contracts for a living but you get the idea.
It is about meeting agreed upon conditions to ensure that the value exchange occurs with no intermediaries. Could someone manipulate the sensors, yes of course they can.
So can we get rid of all intermediaries overnight with DeFi, I think the answer is simply, no.
But can we add efficiency and reduce transaction costs while also reducing latency the answer is YES.
Personally I am excited about the future of finance being decentralized, I welcome DeFi.
