The Future of Finance is Decentralized

Why DeFi will eat banks, fintechs, and CeFi from the ground up

This post originally appeared in The Defiant on Thursday, September 10, 2020.

Last Wednesday, something big happened in the world of finance.

Daily trade volume on Uniswap (a decentralized crypto exchange on Ethereum) eclipsed Coinbase (a centralized crypto exchange) for the first time in history.

Less than a year ago, a majority of investors and people thought automated market makers (AMMs) couldn’t scale—arguing that high slippage on larger trades would make large trade volumes impossible.

Well it turns out that crypto is a retail (not institutional) led market—at least currently—and the long tail of demand for crypto assets is a lot larger than people initially realized.

Bigger than Uniswap

What Uniswap’s flippening of Coinbase represents is much bigger than Uniswap however—it represents an accelerating shift away from centralized to decentralized financial systems broadly, and it’s starting in crypto.

Eventually, Uniswap’s flippening of Coinbase will happen across a number of other financial products like derivatives (e.g., FutureSwap), options (e.g., Primitive, Opyn), loans (e.g., Aave), payments, and so on.

Financial services has been going through a multi-generational process of decentralizing up and down the stack, starting over 20 years ago with the Internet.

Pre-Internet Era (1472-2000)

Before the Internet, the financial system was a vertically integrated oligopoly controlled by major financial institutions like Citigroup, J.P. Morgan, and Goldman Sachs—many of which are still dominant today. These companies ran the entire financial stack—from the lowest level infrastructure (e.g., settlements) all the way up to the end user interfaces: personal bankers, branches, and ATMs. (Remember those?)

Note: I headed Citigroup and Citi Ventures’ (the bank’s corporate venture investing and innovation arm) efforts in crypto, Bitcoin, and blockchain from 2014-2017 before joining IDEO to start its crypto fund and startup studio.

This vertically integrated financial system lasted for a very long time (hundreds of years) as it took million of dollars and decades to build and provide financial services. As a result, banks were extremely profitable, and many of the world’s most talented minds aspired to work on Wall Street.

Post-Internet Era (2000-2020)

But in the 1990s, something new came into the world: the World Wide Web.

Slowly, then suddenly, it became much easier, cheaper, and faster for people and companies to build and deploy web-based services in the areas of e-commerce, media, and information technology—giving rise to companies like Amazon, Netflix, Google, and Facebook. Instead of taking millions of dollars and years, it took hundreds of thousands of dollars and months to build and ship a new web-based service.

For a while, the web focused on digital content, media, and information and avoided heavier-weight industries like healthcare, enterprise, and finance.

But when cloud computing (via AWS in 2006) and mobile apps (via Apple in 2007) arrived on the scene, creating and deploying a web or mobile service went from hundreds of thousands of dollars and months to a few thousand dollars and weeks. With these new superpowers, startups could now enter industries previously unassailable like financial services. Nearly 10 years later, fintechs like Square, Ant Financial, Stripe, and Robinhood have massively disrupted the traditional financial services industry (and will continue to do so).

However, when you take a wide view, fintechs have predominantly innovated and created value at the ‘interface’ and ‘application’ layers of the financial services stack. At the end of the day, Stripe, Robinhood, SoFi, Wealthfront, Venmo, PayPal, and all other fintechs still run on legacy financial rails and infrastructure on the back-end like Citigroup, J.P. Morgan, and Wells Fargo.

Paradoxically—even with fintechs—money and value still flow and settle through today’s financial system in the same way a paper bill did hundreds of years ago—just faster and digitally. For example, Venmo simulates real-time, peer-to-peer money transfers, but once a user tries to take money out of Venmo, funds move through the legacy ACH system as a normal bank transfer, which could take several days to get into their bank account for use depending on the user’s location. (And Venmo only works in the U.S.)

How has that fundamentally changed the financial system?

While fintechs have taken full advantage of the distribution capabilities of the web, insights from social network data, and user experience improvements from mobile, many of the banks and financial institutions from hundreds of years ago are still in control of the financial system.

That is until cryptocurrencies and blockchains came along.

CeFi Era (2010-2020+)

With the introduction of Bitcoin (2009), Ethereum (2016), and other Layer 1 crypto protocols, two important things could now happen in the financial system that weren’t possible before.

First, value can natively flow and settle globally, instantly, and cheaply across these decentralized financial networks without financial intermediaries like banks. And second, these decentralized financial networks are open source fintech platforms that anyone can build on top of—and therefore create centralized (and decentralized, but more on that later) financial applications, services, and businesses with. No bank API keys are needed. Coinbase (2012), BitMEX (2014), Anchorage (2017), and Binance (2017), are all examples of crypto-enabled, centralized finance (CeFi) businesses built on base layer decentralized finance protocols like Bitcoin, Ethereum, and others.

But it’s not just crypto startups like Coinbase or Anchorage. Traditional financial institutions and fintechs like Square, Fidelity, Robinhood, and Revolut are building new products and businesses on top of DeFi protocols too.

Coinbase is now worth $8 billion (at least) and is preparing to go public. Square’s bitcoin trading volumes and revenues are hitting new all time highs, creating a new source of growth for the company and its shareholders. CeFi is just getting started and still has so much more room to run.

But amidst CeFi’s steady growth, something else is happening in the background that’s even more interesting and fundamentally disruptive to financial services long term.

DeFi Era (2020-2030+)

Starting in 2020, decentralized finance (DeFi) applications and services like Uniswap (implemented as autonomous, permissionless smart contracts on Ethereum) took root and started moving all the way up the financial services stack as their capabilities and end-user experiences rivaled—and in some cases were superior to—existing CeFi alternatives like Coinbase.

Instead of a few thousand dollars and weeks to build and deploy a CeFi service, you can now deploy a DeFi service onto Ethereum in days or even hours with just a couple hundred dollars. On top of that, DeFi services take full advantage of the openness, composability, positive network effects, and continuous innovation of all existing DeFi protocols like Uniswap, Aave, and yearn.finance, as well as all future DeFi protocols to come.

The user experience and capabilities of DeFi are now starting to exceed those of CeFi companies like Coinbase or Binance. This explains why Uniswap eclipsed Coinbase. For retail users, Uniswap is not only easier, faster, and cheaper, but it also has more assets, control, options, and integrations. Put simply, Uniswap is better than Coinbase. And because Uniswap is an open DeFi protocol, it becomes more capable and gets better faster than Coinbase or any other centralized exchange as new cryptoassets and DeFi protocols come to market.

Over time, DeFi will continue to improve and move further and further up the stack, eating CeFi, fintechs, and traditional finance in the process. CeFi will always have a role but an increasingly smaller one as CeFi will win in particular markets and scenarios in which factors like regulatory compliance and connections to the ‘real world and economy’ are important, as those things will not be easily done on chain. But over the span of decades or generations, these scenarios will become more infrequent as the world shifts to the new-to-world experiences and economies that DeFi enables.

To be clear, the financial services industry in the midst of a multi-decade process of decentralizing. Though it may be well past 2040 until your primary bank account, credit cards, mortgage, student loans, investment portfolio, and retirement account live on DeFi networks, I believe it will eventually happen—slowly, then suddenly.

And as I discussed in an earlier blog post, DeFi doesn’t need to go mainstream for a while for it to make a big impact and be highly valued in the near to medium term.

Generational Impact

For the first time in over 500 years, our generation has the opportunity to architect a new financial system that is fundamentally more open, free, and fair for everyone in the world—not just for the people who can access or afford it today.

That is incredibly exciting.

It’s also an enormous privilege and responsibility to do what few before us and few after us can: to make a positive change at a societal and systems level that will last for many generations to come.

If you’re working on a DeFi (or CeFi) project, reach out. I’d love to learn more and see if I can help.