Cryptocurrencies and DeFi as seen by “traditional” finance. Part 1

Sometimes I catch myself thinking that for a long time, I have been analyzing the cryptocurrency industry from the “inside”. Yes, it is very convenient: you know and understand everything; you are immersed in the processes and see their internal dynamics. But it also leads to certain distortions of perception. We shouldn’t forget that people on the outside view everything completely differently.

And now we are not even talking about the end users of crypto and DeFi – we already understand quite well how their thinking evolves. We are talking about professional financiers working with fiat money, about bankers. The author of these lines had a chance to spend an unusually long time talking to several bankers to assess the evolution and current state of the cryptocurrency market, the stablecoin phenomenon, and the prospects for DeFi (which turned out to be especially painful for them).

So let’s try and look at the world of cryptocurrencies through the eyes of fiat bankers based on their own financial market research.

It’s only the beginning

Even those bankers who say that “there is no alternative to fiat money” in their speeches and articles privately admit that this can be one of the most exciting new markets – digital assets and companies that use them to create fast and easy financial applications that do not require trusted third parties. Moreover, bankers are well aware that digital assets are not payments in and of themselves. It is an entirely new computer paradigm: a programmable computer available everywhere and to everyone that belongs to millions of people all over the world at the same time.

The market value of the digital asset ecosystem is over $ 2.1 trillion (exceeding the GDP of Italy or Canada). There are more than 200 million cryptocurrency users worldwide, and the daily transaction volume is about $ 125 billion.

Despite rapid growth and market value at the level of some of the largest public companies in the world, financiers recognize that the digital asset ecosystem is still in its infancy. Currently, a new type of finance based on blockchain, digital assets, and applications is just beginning its long journey.

At the same time, banking experts consider digital assets and blockchain to be software. They specifically notice an architectural shift in how the technology works – the move to distributed consensus. Anyone on the network can install an application that provides consistency and trust. It’s an early trend, and money turned out to be the simplest use for blockchain.

But digital assets are much more than a form of currency. It is a new monetary system that liberates people from the central bank and government control. They also get criticized as a threat to economic stability and the ability of governments to collect taxes and prevent illegal activity. The next wave of digital assets is decentralized finance (DeFi) systems. Further down the list, you get loans, insurance, real asset ownership rights, unique digital goods (NFT), online corporate structures (decentralized autonomous organizations or DAOs), and so on. The point is, today’s “fiat” bankers are conscious of it being the primary trend in their world in the next 20 years.

Digital assets are also fundamentally changing the structure of user and stakeholder incentives. Before, the word “online” meant a company website or an open-source software project like Linux, without a connection to money.

Now, however, anyone can build thousands of online collaboration systems, no need for a real company. This is decentralization – imagine a social network where the more you use it, the more of it you own. Bankers speculate that the early forms of digital finance we see today are likely to mature within the next five to ten years.

That being said, today, with a market value of $ 2 trillion and more than 200 million users, the universe of digital assets is already too large to ignore. Crypto-based digital assets can form an entirely new asset class.

Venture capital investments in digital assets and blockchain technologies amounted to $ 17 billion in the first half of 2021 alone, which is much more than last year’s $ 5.5 billion. This creates a new generation of companies working with digital assets, new applications in various industries, including finance, supply chains, games and social networks.

Of course, professional financiers (judging from my experience with them) are especially impressed with DeFi as an ecosystem that allows financial products and services (such as lending, borrowing, insurance, and trading) to be used without relying on traditional financial institutions. DApps can provide financial assistance to many of the more than 1.7 billion unbanked people worldwide. You only need simple smartphone apps.

No escaping the regulators, but there is a silver lining

At the same time, bankers perceive the world of cryptocurrencies as a kind of “Wild West”. And they pay attention to state crypto regulation. And while they disapprove of China or India – countries which banned the crypto trade, they are comfortable with the future of the digital asset industry staying within government policy.

According to market participants, regulatory uncertainty is the biggest short-term risk for the cryptocurrency sector. Nevertheless, regulation can stimulate more active investor participation in the long term after the “terms and conditions” for digital assets are established.

Despite potential regulatory hurdles, financiers are optimistic about the long-term outlook for the digital asset ecosystem while they see it go mainstream. They expect significant growth as digital asset use evolves beyond valuing only Bitcoin into an industry characterized by product innovation, clarity of regulation, increased institutional participation, and widespread adoption.

The financial world is optimistic about digital assets as a new environment – with distributed ledgers at its core – rapidly emerging with the advancement of decentralized software “native” to the Internet. Applications built on this new software architecture grow much faster than previous technologies.

Bankers obviously see that digital assets are still mainly used for speculative trading. However, they understand that thousands of companies are already entering the ecosystem of digital assets, providing support for infrastructure, marketplaces, and applications. The combined market capitalization of publicly-traded digital assets exceeds $ 130 billion. Digital asset-related M&A jumped to $ 4.2 billion this year, up from $ 940 million in 2020 and $ 2.5 billion in 2019, indicating a dynamic and growing industry.