Cryptocurrencies and DeFi as seen by “traditional” finance. Part 2

    27 Nov 2021

    We continue to describe the cryptocurrency industry through the eyes of “traditional” financiers, primarily bankers. As it turned out, they are not as blinkered as we used to think. Moreover, they can reasonably assess the prospects of a decentralized financial world.

    Crypto is turning corporate

    As the digital asset ecosystem grows and more people get involved, regulations intensify. This means digital assets are nearing the end of their “Wild West” days, and corporations are increasingly inclined to consider adding digital assets to their balance sheets. Others may want to join the digital asset ecosystem (and blockchain technology in general) to make their businesses more efficient.

    Here we should mention a recent study by Bank of America, which looked at 161,000 income statements from Q1 2009 to August 2, 2021. It showed an all-time high interest of commercial companies in digital assets.

    Corporations already take for granted that digital assets make it easy to transfer value and make payments. They also work in real-time and bypass the middleman (or at least make the transaction less cumbersome by using something like a crypto exchange).

    It is also clear that the development and deployment of digital assets will be led by Millennials and Gen Z. The generations that grew up with the Internet expect online transactions to be seamless and digitalized, without excessive steps and intermediaries.

    Sticking with the Bank of America’s data, 14% (21.2 million) of the US adult population own digital assets, and another 13% (19.3 million) are planning to acquire digital assets by the end of 2021. The average age of these potential buyers is 44; 53% of them are women.

    Research shows that female company leaders are less likely to ignore digital assets and are actively exploring this technology and ways of applying it.

    Bitcoin is in the lead, the value of altcoins growing

    Finance people look at the numbers and see that Bitcoin has more than doubled its cost from the 2017 peak. The individual adoption rate has also increased significantly, as it remains the most valuable digital asset.

    At the same time, there are now over 11,500 altcoins (or tokens), although many of them don’t have a clear use case. Digital assets that enable the creation of a platform, as the iPhone did for applications, are the most valuable. Blockchain-based apps raise huge amounts of money. Such areas as decentralized finance, digital identification, and supply chain tracking using blockchain are developing rapidly.

    Unsurprisingly, however, most financiers are naturally drawn to stablecoins. They are perceived as a means of eliminating volatility in crypto transactions, a store of value, and a medium of exchange (used as money). For financial market professionals, stablecoins are a “grey zone” between fiat and digital currencies, which could further accelerate the adoption of the latter.

    They also recognize that many stablecoins are not actually backed 1:1 by US dollars. Instead, they partially use reserves, such as commercial paper or corporate debt, to generate additional profit for their creators. This, in turn, produces the risk of forced liquidation in case of uncomfortable market conditions or a broader market correction.

    CBDC and NFT

    The other big thing for traditional finance representatives is the central bank digital currencies (CBDCs). No one even says “if they happen” anymore, only “when they happen.”

    Bankers see the inevitability of the transition to digital assets. And given the success of stablecoins, different nations are preparing for the evolution of money – the emergence of “cash 2.0”. It is currently reflected in central banks of countries which account for more than 90% of the world’s GDP exploring the potential of using CBDC.

    The three major world currencies – dollar, euro, and yuan – are actively moving towards introducing the CBDC. China is leading the way: they are already testing the digital yuan and preparing its full launch in 2022 for the Winter Olympic Games in Beijing.

    There is also a flip side to this heightened attention: governments and regulators worldwide have stepped up efforts to restrict digital assets as their adoption and use grows. Some of the critical issues governments and regulators are focusing on relate to AML/KYC, mitigation of potential bank run-offs, taxation, and liability.

    And this is where “traditional” financiers conclude that digital currencies, issued and managed by the central bank, will solve these problems while keeping the country’s monetary policy under control. Based on personal experience, I can say: if there is a mutual misunderstanding between crypto enthusiasts and adherents of traditional finance, it lies in their attitude to CBDC.

    Non-fungible tokens (NFTs), on the other hand, were definitely a surprise for everyone. Their meteoric rise and inexplicable backing in the form of incomprehensible digital art baffled both conventional finance experts and people with significant experience in digital assets. NFT sales rose to over $ 3 billion in August 2021 (although the market has cooled slightly since then), up from $ 250 million in 2020. It is driven (but not explained) by demand from corporations, celebrities, and other individual investors.

    The recent sales of such NFTs as a simple image of a black background with a few words of text has made people with financial backgrounds seriously worried about increased risks in the sector. (To put it extremely mildly).

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