By R. Quincy Jones
The last few years have seen massive growth and adoption in the Decentralized Finance (DeFi) ecosystem. From almost nothing in 2018, DeFi has grown to more than $200 billion in Total Value Locked (TVL) across the wide variety of projects represented in the space. Ethereum alone services over 4 million users, seeing a whopping 8x growth just in 2021.
The fervor surrounding DeFi is unmistakable, with young investors rushing in, fueled by the storied success of their peers and many others scrambling to make sense of what this all means for the future of finance. But while its success has been remarkable, DeFi’s failure to assimilate some of the more attractive attributes of traditional finance has so far prevented it from truly penetrating the mainstream. Take fixed interest rates, for instance — a virtual non-entity in DeFi. Retail lenders and borrowers seek out fixed interest rates to build wealth steadily and predictably over time. The floating interest rates of DeFi eschew this approach to investing in favor of a more “wild west” environment that, while filled with earning potential, is far too volatile for the appetite of the average retail investor.
There are also issues surrounding liquidity, collateralization, and security. Even though these assets have massive potential for returns, moving them around and converting them to different products can be complicated, and investors may run into multiple stumbling blocks. Not every digital token can be sold directly for any other. Furthermore, concerns surrounding hacking, scams, and digital theft have yet to be fully addressed and remain a key stumbling block as DeFi pushes to make inroads into the mainstream investing landscape.
NFTs: The Unexpected Solution
When most people think of NFTs, they probably think of newly-minted bitcoin billionaires spending $250,000 on a picture of a cartoon ape. Indeed, 2021 saw NFTs become a hot-ticket item, primarily in the more speculative worlds of artistic and promotional goods collecting. That being said, the underlying token standards provide the raw canvas for more elaborate financial products to be designed and released into DeFi. This is because NFTs can take any type of information, be it an image, a 3D model, a document, literally anything, and give it a form of tangibility by making it cryptographically unique and identifiable from any other batch of data. The encoded information cannot be altered or accessed by anyone who doesn’t hold the correct cryptographic keys.
NFTs are not limited to vaguely defined crypto assets. They can come imbued with specific properties concerning their functionality and built-in value. For example, existing financial products can be tokenized on the blockchain via this technology, providing a new means for investors to access a wider array of options than ever before.
Tokenized financial instruments can further be used in DeFi as collateral to secure loans. The instrument’s newfound stability through tokenization makes it infinitely more attractive to lenders compared to other digital assets, and so its function as collateral takes on more weight and introduces further possibilities.
DeFi’s cover protocols, which provide insurance to investors who have been rug-pulled, exploited, or whose investments suffer a cyber attack, can also include financial NFTs as part of their compensation mechanisms.
The process of tokenization can be applied to commodities, property transactions, loans, Index funds, almost anything. Doing so can help bring in mainstream institutions who will find themselves better-equipped to operate in suddenly familiar territory.
Even contracts themselves can be tokenized, with the holder being able to show ownership of a given agreement made between two entities. These types of partnerships would be unfalsifiable and completely enforceable via the underlying network, which could be revolutionary for how financial deals are made moving forward. In essence, this opens up a whole new world of possibilities for handling both data and collateral.
NFTs provide the vehicle to deploy an array of new products, payment rails, supply chain systems, and other features that will propel DeFi towards a mainstream future.
The Dawn of a New Type of Trade Finance
Although modeled after legacy financial vehicles, financial NFTs bring all the promise that comes from being hosted on a blockchain. This means they can be trustlessly verified to represent their underlying resources, are transferable all over the world in seconds at relatively little cost, and are safe from most forms of fraud, forgery, and theft. In almost every respect, NFTs can help DeFi become safer, more efficient, and more accessible than traditional finance.
Moreover, NFTs hold great promise in the area of supply chain management, helping consumers certify the provenance of goods and services. By using NFT tagging, a product’s entire history through the supply chain can be traced from source to sale, with every step along the way being automatically and immutably recorded.
In trade finance, where supply is often bogged down by stringent regulatory frameworks, NFTs can help companies deliver products faster while slashing costs associated with supply-chain inefficiencies such as fraud, human error, and a surplus of intermediaries.
Ultimately, through its potential to help create new products and protect the interests of investors and companies, NFTs may very well hold the key for taking DeFi to the masses.
About The Author
R. Quincy Jones is a XDC Foundation developer, who on behalf of the XDC Network is building new standards and applications for the XDC Network. With over four years in cloud development, and a growing following on YouTube: CoinClubCrypto, Quincy is well-suited to break down the fundamentals of blockchain-based technologies for general audiences.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.