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The author is a practising chartered accountant and an independent director on many large public companies whose views and ideas have been instrumental in framing policyMore From The Author >>
How Defi And Web 3.0 Could Shape The Future Of Finance
The benefits of decentralised finance (DeFi) has to serve all stakeholders, and all types of consumers. Else only the economically stronger section will be able to afford or access it. The DeFi community has to solve for concerns that it is striving to beat the system rather than better the system! Else regulators and governments won’t cede ground. Neither a bit, nor a byte!
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Mavericks, ideators and innovators have injected many a wonderful idea into the financial markets over the centuries. These ideas have seen prosperity of the human race, as well as its decline, and denial of the associated non-financial morality. Yet, the common aspect over these centuries has been that power in the financial markets has become more and more centralised.
During the Global Financial Crisis, not too long ago, we saw the conventional financial systems failing. These systems were not just failing themselves, but also depriving consumers and losing their trust, thereby, pressuring regulators to wake up to the realities of a broken system. To safeguard existing consumers and to preserve fiscal stability, governments had to rescue the very institutions that make the crisis occur in the first half.
This kickstarted a series of serious new ideas in rethinking our financial structures and systems. The concept of decentralised finance started moving ahead with a vengeance then. When we invest in the currently regulated traditional financial system, we are obligated and under the operational control of the intermediaries (especially the banks). Have these traditional systems solved for inclusive finance or bettering consumer interests? No, would be an understatement.
*Old finance, not been inclusive
Despite all tall claims, we have failed our global brethren. Over 1.75 billion people are still unbanked. In an interconnected world, they cannot access fair-priced credit or invest their sachet-sized weekly or fortnightly savings. Importantly, despite growth of the internet, many of them face digital-exclusion and hence, are not in the mainstream of socio-economic participation.
Many of these consumers sadly, are forced to resort to informal or over-priced pay-day loans to overcome their cash flow issues. Even if these consumers were to be banked, conventional banks might not be interested in dealing with such small ticket size consumers; or might not make adequate revenues from such an insignificant category of consumers.
Moreover, the existing financial systems are set in an ecosystem where the inter connectivity is poor or expensive. Switching costs prohibit financial independence to choose products and services that suit the consumers. For most parts of the world, the simple task of moving money from a financial institution to another seems complicated and time consuming. A wire transfer across different country markets could take a few days.
Have we ever thought of, or questioned our financial institutions? Why should it take two to three days for a stock market transaction to close, when most stock markets are digital? Why is the access fee for credit cards still expensive for vendors or merchants? Why are banks still struggling with and not willing to serve smaller entrepreneurs and businesses? Why is it difficult to understand operational silos that still exist in these entities? Why are the regulators still concerned about letting growth of FinTechs happen at a faster pace? Why does it seem as if regulators are supporting the conventional institutions, however poorly they may have demonstrated capabilities and financial impact on the society? Questions such as these are aplenty and end up pointing a critical finger at what else can be done to improve the quality of what financing can actually deliver.
*Web 3.0 and why
Web 3.0 is still evolving, as much as the innovations in decentralised finance (DeFi) such as blockchain and distributed ledgers which are its foundation. Web3 is based on the core idea of decentralisng the overall nature of the current Internet and to give equal power to all content creators.
Cryptocurrencies ‒ as unpopular as they are with many governments ‒ are a commercially prominent application of the various web3 ideas. The widespread usage of blockchain technology is just scaling slowly. Web1 had very little space for user interactivity. It was essentially readable only and with slower access. Web2 that is currently in use, gave rise to social media where users generate content.
*DeFi (Decentralised Finance) is not defiance
The basic premise of DeFi is to use the peer-to-peer interaction, and to move away from costs of brick and mortar presence or access. This fundamental promise would impact and change business models of financial institutions. Decentralised finance comprises financial applications built on blockchain technologies, typically using smart contracts. Smart contracts are automated enforceable agreements that do not need any of the existing intermediaries to execute the agreed transactions. It would simply need internet connectivity.
Most current DeFi applications have been built using the Ethereum network. With innovation in this space, there are emergent networks which could offer better speed of access, scalability at lower costs and with enhanced security. The DeFi innovators also have started addressing concerns about high energy usage, and to be more green-friendly.
Existing financial systems have intermediaries and associated inefficiencies. These come at the pain and cost to the consumers. However DeFi solves for these with its shared infrastructure and interfaces, which in turn allow for efficient interoperability. The public nature of DeFi offers security and trust, something that current institutions have failed over the years.
*Concerns will continue
Governments and regulatory institutions will continue to have their social-governance concerns, as well as the fear of ‘losing control’. These would include the following questions:
•Will any of the web3 reduce governmental control over regulating the financial institutions?
•Will decentralisation make it difficult for governments to regulate the internet?
• Will any of these technologies bring challenges of national security or cause any systemic issues?
•Will they further complicate consumer protection issues and cyber risk problems?
• Can any of the technologies be used to weaponise against the state?
The usual industry lobbying of the traditional old-boys of the centralised finance will continue. It could also use its network in the fear-mongering of what could be short-term ills of technology enabled decentralisation.
Yet pragmatic governments and proactive regulators won’t pick up the bait, even as it might seem to be an antithesis of the establishment. Rather they could use their mantle to create stronger and resilient financing mechanisms, for all. They are looking at possibilities to create a financial democracy with better chances of financial inclusion. We have also seen the fast evolving global economy when fintech companies are massively adopting cashless and virtual payment technologies. In India, the government itself has been the biggest proponent of going cashless and digital.
According to various estimates, Web 3.0 could contribute nearly $1 trillion to the Indian GDP by 2031. With over 845 million internet and 518 million social media users in 2021, India is the second largest internet user in the world. By 2040, the total number of internet users in India is expected to cross 1.53 billion and yet the overall demographics will remain and be productive with a median age of 35 years. With adequate regulatory outlook and continued support for the innovative use of technology in finance, India can lead the way to financial inclusion and impact.
The benefits of DeFi has to serve all stakeholders, and all types of consumers. Else only the economically stronger section will be able to afford or access it. The DeFi community has to solve for concerns that it is striving to beat the system rather than better the system! Else regulators and governments won’t cede ground. Neither a bit, nor a byte!