Among all the headlines and discussions about cryptocurrencies and NFTs, a separate form of disruptive technology is gaining momentum that has as much or more potential to impact our current financial models: distributed finance.
Decentralized finance, or DeFi, refers to decentralized peer-to-peer financial transactions and services that operate without an intermediary, such as a bank or financial services company. It is a technology-fueled philosophy that allows companies and groups of individuals to rely on software algorithms instead of intermediators or regulators to govern transactions, all based on the idea that you no longer must have a centralized exchange.
DeFi applications, platforms and DeFi protocols allow people to lend or borrow funds from others, speculate on price movements on a range of assets using derivatives, trade cryptocurrencies, insure against risks, and earn interest in savings-like accounts.
Max Carnecchia, CEO of Mitek, explains in his latest Forbes article that “Diving deep into the world of DeFi requires learning a whole new language, but at its core, the goal of DeFi is to claw back fees and improve investment yields by eliminating the infrastructure cost of traditional financial services.”
DiFi currently is emerging within the world of crypto, primarily Ethereum. While it is still largely of interest to early adopters, as it evolves it has the potential to gain wider acceptance and take a broader place within more mainstream financial services portfolios.
High risk, high reward?
Demand for decentralized financial projects and services is soaring. According to ConsenSys, in Q1 of 2021, the DeFi ecosystem included an expansive network of integrated protocols and financial instruments worth more than $53 billion USD. A March report in Forbes puts DeFi’s capitalization at about $74.8 billion.
“The total market capitalization of the world’s stock markets is around $90 trillion,” says Kenneth Rapoza, who covers global business and investing in emerging markets for Forbes, says in the report. “The total market capitalization for cryptocurrencies, of which almost all of it is Bitcoin and Ethereum, sits at more than $1.4 trillion. DeFi’s market capitalization is around $74.8 billion.”
However, one serious block to broader adoption beyond the world of cryptocurrency: at present DeFi lacks many of the basic safeguards companies and consumers have come to expect, such as any type of regulation and, in the U.S., FDIC protection. This is by design, part of DeFi’s philosophy of decentralized exchanges that reduce or eliminate the cost of transactions by eliminating intermediaries.
One way to establish decentralized trust: identity verification
Despite DeFi’s commitment to eschewing traditional forms of intermediation, to succeed, all financial transactions require mutual trust. The question, for these types of developing financial systems, is how to reliably establish peer-to-peer trust.
One way is through identity verification.
For example, Mitek already has customers that are using DeFi, but these companies are putting guardrails in place to protect those on both sides of a transaction. They make sure people’s identities are real and that they can pass a credit check. They confirm that those making loans are not criminals or unscrupulous operators.
Accurate identity verification is central to an ability to identify and prevent fraud. Even in a DeFi environment – especially in a DeFi environment – both sides have to know for sure who they are doing business with and trust that any transaction will proceed as agreed.
As DeFi continues to evolve, chances are good that systems will need some version of decentralized identity verification in order to thrive.
Learn, analyze, prepare
Now is the time for businesses across the global economy to investigate how DeFi may impact market segments going forward. By staying alert and preparing now, businesses will have the opportunity to catch the crest of this financial innovation – and even help shape it.
New technologies are almost always disruptive. They can be unsettling, as well as energizing. For those going into it with a clear understanding of the risks and rewards, the development of DeFi products and services is exciting.
At Mitek, we believe whole new markets are likely to emerge that we can’t even imagine today.