A Glimpse Into The Future

As we crash headlong into the 2020’s, the tumult we’re experiencing is making it clear that significant change is coming. The unrest, the cataclysmic disasters, and the energy of the population all point to a desire and a need for changes to our system, if for no other reason than making it possible for them to survive the coming storm.

One area in particular seems to be in desperate need of a radical upheaval: the world of finance. As more and more people in the younger generations begin falling through the cracks and a select few scions gobble up the majority of the wealth in the world, the financial system sits poised to be accessible only to an untouchable class of wealthy elites, out of reach from the filthy hands of the pauper masses.

Luckily for those of us not lucky enough to be born in the privileged classes, the delicate position global finance sits upon is also ripe for the destruction of its old and unwieldly bastions to make room for new growth. Advances in technology have allowed for huge strides to be made in decentralized finance (DeFi for short), a new method of asset ownership and distribution that has the potential to democratize the financial system and allow wealth-starved millennial and younger generations to gain access to wealth-creating assets.

There are limits and stumbling blocks to the burgeoning new markets emerging from the Bitcoin and cryptocurrency explosion of the 2010’s, but that is to be expected of an entirely new system springing up from the confines of potential. As the technology advances, so too will the possibilities expand outwards from their current confines.

To get a quick glimpse at what the future will bring, we can look to the prognosticating from crypto industry experts like Roy Learner, who recently wrote a medium post on what changes he sees in the coming year. With new services and trends emerging, decentralized finance as a whole will be shifting and adapting to take on a more concrete form, crystalizing as a real competitor to the current financial system.

To address DeFi’s current roadblocks to mass adoption, Learner identifies 6 main issues that prevent the system from rivaling its legacy competitor:

1. Availability of fiat on/off ramps
2. Scalability/high gas costs
3. Lack of financial privacy
4. Lack of ID/credit scores leading to over-collateralization requirements
5. Smar contract/technical risk (and lack of insurance)
6. Friction around UX/UI

In the near future, Learner is confident that 3 of the 6 primary issues will be fixed – scalability, UX/UI (user experience and user interface), and fiat on/off ramps (ability to transfer crypto into various currencies). The other 3, namely credit scoring, financial privacy, and risk, are still a ways off from being solved.

Much of what Learner predicts revolves around collateral, or the amount a person must put up to receive a loan through the DeFi system. Collateral rates for loans in the system are at or above 100%m meaning those looking for a loan must have the same amount (or more) to offer as collateral, as cryptocurrencies are volatile to the point that any loss or gain in value of the crypto being borrowed could lose the lender a significant amount of money.

“Given the inherent volatility of crypto collateral, collateralization ratios will always need to provide a meaningful buffer as the underlying can move significantly before a liquidation can occur.

While I believe 2020 will see some improvements, I think we are still at least a couple years away from the decentralized identity and credit scoring primitives that would make undercollateralized loans a reality.”

It isn’t all bad news, however – he believes that interoperability, or the ability to exchange one cryptocurrency for another, will be accomplished within the year. This will allow the use of Bitcoin as collateral in the DeFi network, which will significantly open up the system to new investors looking to use their current BTC holdings to purchase assets.

Ethereum will also solve its scaling issues, as gas costs fall significantly in the wake of the ZkRollup and the recent Istanbul hard fork. The new protocols allow for a much greater level of traffic at a fraction of the price, without the need to expose the transactions to hackers as it goes through custodians, which are often the subjects of hacks.

While many issues are being solved thanks to new technological advancements and changes to protocols, the primary issues relating to risk and collateral remain. There are some steps being taken to reduce the risk and collateral needed, as Learner notes here:

“My gut is that we’ll begin to see centralized providers implement a hybrid model that utilizes a combination of traditional credit scoring data and alternative data sources to offer undercollateralized loans. My money is on Calibra eventually leveraging FB’s massive data set to offer loans to thin-file applicants.

However, in the meantime, the introduction of less volatile collateral such as treasuries, fiat-backed stablecoins like USDC, gold, tokenized real estate / invoices, etc. hold promise to incrementally lower collateral ratios.”

An interesting point about utilizing real world assets that lack the volatility of crypto currencies is made here, as there are intensive efforts being made to tokenize as many of these assets as possible. One company, RealT, is leading the way in the DeFi real estate market and has managed to convert $1.6 million worth of real estate into crypto-backed security tokens.

RealT itself is working on its own road blocks, introducing a number of different Ethereum-based software packages to streamline the user experience and make purchasing their security tokens easier and safer. They’ve integrated services such as Uniswap, MakerDAO, and Balancer, and are in the process of integrating new DeFi services such as Monolith, which provides a debit card that you can use that utilizes your DAI instead of money from your bank, Aave, a lending platform, and Compound, which is used for tokens.

Developers in the blockchain and crypto world are working furiously to expand the current perimeters of DeFi, and this breakneck pace is needed. 2020 has proven that our current system is teetering on the brink. Without the breakthroughs and innovations in the burgeoning tech sector, the future looks very dicey indeed.