I was recently requested to comment on a few trendy topics, here is the gist of it.
What are the use cases for DeFi (Decentalized Finance) in the Metaverse? First off, the metaverse hasn’t waited the birth of DeFi to move large amounts of money. Credit cards loaded with down-to-earth US$ cash are more than enough to purchase digital goods for gaming items, and NFT collectibles. However, as the asset base of digital assets grow in the Metaverse, some digital financial engineering might come in handy.
Whether you think about real estate in Decentraland, or art collectibles, there is a case for structuring financial products around it. The same way Yieldstreet, a private credit broker founded by Milind Mehere, provides crowd-sourced equity or debt financing on the back of real assets, you could provide a margin loan on top of a portfolio of NFTs. The smart contract will execute the commands like clockwork.
This has also happened all the way around, where MakerDAO is providing funding to tokenized SPVs that contain real assets, whether it is real estate or trade financing. Although the DAO-driven due diligence is lengthy, and the volumes are quite small, this is DeFi converging to real-asset financing.
Crypto regulation in the US and its likely impact? US regulators worry quite rightly on financial applications they can’t control, and are actually controlled by a few large players. As crypto grew to a $2TN market cap, DeFi needs to come clean on better educating users, simplifying protocols, and introducing clear risk management gauges. The focus of the regulator on stablecoins is explained by the fact that this is the “safe asset” of DeFi, the same way money markets are in TradFi. Typically, stablecoins are plenty, whether it is the 1-for1-fiat-backed such as USDC, or the algorithmic such as DAI & UST. Fair to say that some are more prone to de-peg than others. Whereas this distinction is priced in the crypto market, the regulator would like to establish standards, which is clashing with the permissionless nature of DeFi.
More compliance toward traditional security rules is probably inevitable, and DeFi players are preparing for that. Some are ready to set sail offshore in crypto friendly jurisdictions, which applies to the hardcore defenders of decentralization. Some are forking part of their protocol into a compliant package: Aave created a permissioned environment, where KYC&AML are required between participants. I see a net benefit coming from a long-term convergence, as DeFi inevitably becomes mainstream.
How are the risks evolving within DeFi? Hacks and rug-pulls are overall decreasing as a % of overall assets and transactions within DeFi and NFTs. As major protocols arise, their means to reinforce their code grow as well. As everywhere, the smaller nascent players probably have a higher chance of default overall.
Ethereum and other L1 blockchains? Ethereum is by far the leader. For example on Curve Finance, $20BN out of $25BN TVL are on Ethereum. For existing users, it’s highly likely that their assets are on the main chain, and transaction costs make it difficult to move them across elsewhere. Secondly, some chains have great promises, whether they are the fastest, the more algorithmic, but are lacking the primitives to attract the first non-native users. No liquid staking, no leveraging capabilities, no AMMs. Imagine an amusement park with your favourite theme, with only 25% of the rides opened. It’s great but it’s no fun.
What’s the future of DeFi for banking? Banks are converging to DeFi, will-it or not. Remember Jamie Dimon, JPM’s boss, who came quickly from “bitcoin is worthless” to “we have to give our clients a legitimate access to crypto” should they desire it. The banking focus is rather on on-ramps than crypto degen activities though. For example, Morgan Stanley led a $48M round in Securitize.io in Jun21 to develop tokenized offers of real assets. Whether it’s the future or not is left to your judgment, but these investments will force some convergence, and nourish the flows to crypto-related businesses.