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What is DeFi and why does it matter?

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As the concept of decentralized finance continues to take root, Shawn Douglass, CEO, Amberdata, outlines the implications of DeFi developments for the financial industry…

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As the concept of decentralized finance continues to take root, Shawn Douglass, CEO, Amberdata, outlines the implications of DeFi developments for the financial industry…

The term “decentralized finance” – DeFi – is seemingly everywhere these days. 

At its core, DeFi seeks to replace many of the functions performed by traditional institutions with software known as a “smart contract” that operates on a blockchain network. Today, most DeFi is powered by Ethereum. 

What makes DeFi disruptive?

In many ways, DeFi has the potential to upend the entire financial system as it is currently known. By removing gatekeepers, simplifying infrastructure needs, and dramatically reducing overhead, DeFi allows more entrepreneurs to build more ways for more people to make more money – without arbitrary barriers.

Higher yields

Because DeFi protocols are open-source software instead of a complex institution, and aren’t subject to governance like Federal Reserve interest rates, returns for staking can exceed returns on bank account deposits by orders of magnitude.

There are also multiple opportunities for arbitrage that can drive alpha for institutions. 

Transparency

Because all DeFi transactions are recorded to the blockchain, anyone can view transaction history. This transparency gives market participants the theoretical ability to fully understand the ecosystem, making it possible to identify additional money-making opportunities and, more precisely, gauge risk. 

More equitable financial services

One benefit of the anonymous and deregulated nature of DeFi is that it makes financial services more equitable by minimizing the possibility of discrimination while allowing returns-on-capital that are impossible for the average person to access through traditional finance. 

What are the challenges of DeFi?

While DeFi’s disruptive impact on financial services creates many opportunities and provides many benefits, it’s not without challenges and risks.

Lack of recourse in case of theft and fraud

The same lack of a central authority and regulations that makes transactions fast and discrimination nearly impossible also eliminates most avenues for recourse in the case of fraud or theft. With DeFi, there’s no safety net if a platform is hacked, an application turns out to be a scam, or you fall victim to phishing. 

For institutions seeking to enter DeFi, this means that they need to be extremely diligent when it comes to choosing DeFi protocols.  

Lack of regulatory clarity

While most countries have yet to implement crypto-specific regulations, institutions seeking to enter DeFi must do so while remaining compliant with broader fiduciary regulations.

The main compliance challenge is KYC/AML. While crypto is designed for anonymity, some steps can be taken to protect your institution from involvement with wallets known to be associated with bad actors. Projects can keep these wallets out by either using a blacklist of such wallets or operations on a whitelist-only basis and using an identity verification process before granting access.

How can institutions manage these challenges?

In addition to implementing robust vetting and due diligence procedures, institutions entering DeFi need to have comprehensive, granular data to power decision making. 

If you are a traditional financial institution looking to build, use the Decentralized Finance (DeFi) Primer eBook to learn about the biggest shift in the history of finance.


Shawn Douglass, CEO, Amberdata  Shawn Douglass is Co-founder and CEO of Amberdata, a Blockchain and Digital Asset Data company. Prior to founding Amberdata, Mr Douglass served as president of software and CTO at Unified, building and operating the company’s rapidly-expanding SaaS offerings in cross-platform data management, analytics, and reporting. Mr Douglass was CTO at ServiceMesh (acquired by CSC) and drove the strategy and vision of the ServiceMesh Agility Platform and contributing to IT transformation at Global 2000 enterprises. Prior to ServiceMesh, he was managing director at EMC Ventures where he led strategic investments in cloud, security, big data/analytics, and disruptive technology and business models. He has been a cloud visionary and key contributor to the emerging enterprise cloud operating model for over a decade. He has held roles as board Member, operating executive, technologist, advisor and investor. Mr Douglass is a graduate of Harvard Business School.

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