This is the first of a two-part series about what could be one of the most disruptive — and promising — transformations of modern finance in the 21st century.
The story starts with Decentralized Finance (DeFi). As we wrote one month ago, it has the potential to ...
- Re-engineer or displace the banking and brokerage industries ...
- Remove the middleman from most financial transactions, and even ...
- Replace custodian banks.
That’s one hellova big step beyond the simple store-of-value use-case of Bitcoin.
But for those who just want to zero in on its most essential element, I like to call it “Non-Custodial Finance.”
Why Replacing Custodians Would Be Revolutionary
There are roughly 500 billion non-cash financial transactions per year in the world today.
And virtually every one of them needs custodians — the institutions that hold and safeguard the world’s financial assets, either in physical or electronic form.
When you put money into a mutual fund, for example, who holds that money? A custodian bank.
When that mutual fund buys billions of dollars of stocks, bonds or options, who holds those securities? Again, it’s a custodian bank.
Even foreign governments need a custodian to hold their U.S. Treasuries or other assets.
It makes sense. Someone, somewhere, must stash this stuff. And they’d better be strong enough to withstand debt disasters, market crashes or global panics.
But are they, really?
And what about bankrupt authoritarian governments that try to restore their own finances by confiscating other people’s wealth?
The big idea of DeFi is to build a system that does not rely on the ability of custodians to withstand those kinds of shocks.
DeFi could be the basis for stock exchanges ... commodity and futures markets ... foreign exchange markets, credit markets and much more.
All using Distributed Ledger Technology. All without custodian banks. And all with automated, built-in mechanisms to liquidate assets as needed to make sure they’re always fully collateralized.
The Big Missing Link
Trouble is, this new world of finance will not be possible without one key ingredient: a stable unit of account.
In other words, a standard, relatively fixed, monetary unit everyone can use to measure value.
People need to know how much stuff is worth. That stuff must include anything and everything people buy, sell or own. And that measure of value can’t be gyrating wildly by the day — let alone by the minute.
In that scenario, no financial system, new or old, can exist.
No one could afford the risk of buying or selling anything. Not stocks or bonds. Not real estate. Not mortgages. Not insurance contracts. And certainly not high-stake assets like many financial derivatives.
Today, the U.S. Dollar is the World’s Dominant Unit of Account.
The dollar’s relative success is linked to the fact that the U.S. has the most highly developed financial system in the world.
And on the flipside, the failure of economies like Venezuela — with virtually nothing resembling a viable banking system — is linked to the fact that its currency is so extremely unstable.
This same fundamental linkage between stability and success will also hold true for crypto and DeFi.
They have nowhere near the stability needed to serve as units of account.
Bottom line ...
It will not be possible to build a DeFi-based, non-custodial global financial system until and unless there’s stable unit of account that all participants can rely upon.
Enter the DAI Stablecoin
The DAI Stablecoin could be a key to this emerging new space; and, despite some challenges, it could help unlock the full potential of DeFi.
In part two of this series, we’ll explain why.
Juan Villaverde is an econometrician and mathematician devoted to the analysis of cryptocurrencies since 2012. He leads the Weiss Ratings team of analysts and computer programmers who created the first-of-their-kind Weiss Cryptocurrency Ratings.
Image Sourced frin Pixabay
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