By Eric Dong, CEO and co-founder of Themelio
Over the past two years, DeFi (decentralized finance) applications have ushered in a revolution regarding how we collectively view and interact with money, creating a democratized and transparent financial playing field for all. No longer are we solely dependent on centralized banks and government entities, as decentralized alternatives have successfully blossomed across the realms of banking, lending, insurance, exchanges, and more.
In stark contrast to traditional finance systems, DeFi markets never close and are open 24/7 to anyone worldwide. Transfers of funds happen nearly instantaneously, and users have total autonomy over how they decide to spend or invest their crypto assets. DeFi also provides investors with high-yield investment opportunities that were previously only accessible by financial institutions. These are just a handful of reasons as to why DeFi became as popular as it is today, and it still has plenty of room to grow, with roughly $230 billion TVL across all of DeFi.
Coinciding with the rise and success of DeFi protocols, was the surge in popularity of USD-pegged stablecoins, such as DAI, USDC, and Tether. These stablecoins are typically collateralized by audited reserves of fiat currency or short-term securities.
Throughout the first half of 2021 alone, over $100 billion worth of stablecoins were transacted. As the name implies, these types of assets provide a safe haven of stability in the broader, more volatile crypto space, serving pivotal roles as sources of liquidity across decentralized crypto exchanges (such as Uniswap).
With the rapid rise in stablecoins, centralized banks have naturally begun to explore creating their own stable digital currencies (CBDCs) or centralized bank digital currencies. The Chinese digital yuan is leading the pack to be the first to go to market, as they plan to fully launch their CBDC to their population of over 1 billion people in 2022.
The larger question is, how will these two types of stablecoins co-exist, and how will the looming regulatory landscape affect USD denominated stablecoins? SEC Chairman Gary Gensler recently likened stablecoins to “poker chips” in the “Wild West Crypto casino,” and it appears that wide-sweeping regulation of the space is indeed inevitable.
In addition to regulatory pressure, the mere existence of CBDCs may pose an existential threat to DeFi stablecoins, as they have several advantages baked in that their decentralized counterparts lack. CBDCs could easily automate the collection of taxes from countries’ citizens, which is something DeFi stablecoins obviously aren’t designed to do.
CBDC’s would also have compliance and KYC checks built in from the outset of their creation, as by their very nature, they’d have to comply with all government regulations and financial governing bodies. For these reasons alone, the use of CBDC’s would be a no-brainer for financial institutions over their decentralized counterparts.
This highly insightful report on the intersection of DeFi and CBDCs from McKinsey and Company makes some highly astute points around the broader, unforeseen societal impacts that the co-emergence of CBDC’s and DeFi stablecoins may have:
To what extent will physical cash still be used—and accepted—in society? In what medium of value will employees and bills be paid? Through what means will commerce be conducted, particularly if digital currencies issued on public distributed ledgers lower the cost of hosting accounts and speed payment delivery, and to what extent could a single digital currency emerge as a global currency? To what extent will citizens resist the full traceability of payments? And to what extent will citizens be comfortable obtaining familiar banking services—such as high-yield deposits, collateralized lending, working capital, and payments services (all available in DeFi today)—without reliance on a traditional bank? And finally, how quickly will we see innovation in blockchain protocols (e.g., proof of stake) that dramatically reduce their environmental impact?
Despite all of the many uncertainties outlined above, combined with the looming threat of regulatory pressure, I do believe there will be a future where DeFi Stablecoins and CBDC’s can coexist and thrive together in their respective lanes. DeFi stablecoins provide a decentralized alternative to centralized CBDCs. Due to the very nature of decentralization, it's difficult to restrict the use of DeFi stablecoins, which gives them staying power by default. Second, crypto lobbyists and politicians are working together to determine regulatory policies that provide room for innovation, but also put a cap on the "Wild West" ethos and protect investors/traders. The latest crypto hearing on Capitol Hill that gathered top crypto companies and congressmen proved that both parties are working together to determine a future that works for both DeFi and central banks.
Lastly, digitized fiat currency fits our increasingly digitized world, so CBDCs are bound to continue to grow in popularity, but the world in which they emerge will be a hybrid one where both centralized and decentralized options will serve their own distinct purposes in this paradigm shift.
All of this is to say that I believe there will be room for all types of these digital currencies to thrive and coexist in the future: including a mixed bag of fiat-pegged stablecoins like DAI or USDC, non-fiat pegged stablecoins like MEL, and CBDC issued from a central bank. The next several years will be pivotal for DeFi and the future of the global economy as a whole.
About the author:
Eric is a computer security researcher and entrepreneur. Growing up between China and Canada, he is passionate about technology that enables a more open, decentralized, and secure Internet. He is the founder of Themelio, a new public blockchain designed to achieve unprecedented security, stability, and immutability. He also created and single-handedly runs Geph, a VPN project focused on defeating censorship in regions like China and Iran.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.