Decentralized Finance: The Biggest Disruptor In The Financial Industry In Decades

Table of Contents

• About Ramón Ferraz

Disruption Innovation Theory, as defined by Harvard Professor Clayton Christensen, states that disruption is normally triggered by a technological advancement that introduces fundamental change, even if it underperforms in comparison to contemporary technologies and solutions. This fundamental change attracts niche areas of the market at first, and then moves more into the mainstream, as its performance improves and becomes more widely recognized by larger market forces, eventually supplementing existing technologies.

Historically, the financial industry has remained minimally influenced by disruptors compared to other industries, enabling the very same banking institutions to retain the world ́s domination of the financial system. 

In 2008, Bitcoin and its underlying technology, blockchain, kick-started what could be the strongest disruptor to the financial industry in decades. The fundamental change that blockchain brings to the world is its ability to decentralize trust－something that was once solely in the hands of experts at financial institutions. 

Blockchain, while still in its infancy and yet to reach its fullest potential, has the power to disrupt the foundations of modern finance. In fact, there are numerous indicators and case studies demonstrating how the fundamental shift is already taking form. Let us consider the CFA curriculum to prove it.

Think about macroeconomics. Bitcoin was created as a digital currency alternative designed to replace fiat currency. More than 10 years later, however, the most prominent cryptocurrency is still quite volatile and does not meet the unit-of-account and store-of-value functions associated with fiat. Lately, however, stablecoins have proliferated, promoted by centralized and decentralized start-ups, such as Reserve and Makerdao (Dai), and even large financial institutions, such as JP Morgan (JPM Coin). In June 2019, Facebook announced a plan to launch its own cryptocurrency, Libra, backed by 25 global blue-chip companies across a number of industries, including reputable global merchants. How difficult would be for a social network with two billion global users to effectively substitute the dollar as the global standard for money? Considering it is an open-source project built towards decentralization, how long would it take for centralized or decentralized players to create savings, lending, custodial or any other financial services on top of this new money? 

This means serious competition for regulated central banks, who are currently the only parties authorized to issue currencies, and for commercial banks, who serve as the exclusive distribution partners for the central banks’ currencies.

Let's consider microeconomics. Think about companies of any kind. Often, companies are forced to think short-term, to provide their shareholders with immediate dividends, rather than thinking for the long-term to create value. Blockchain enables the substitution of margin-based economic models for incentive-based economic models, structured around native tokens. These models eliminate the traditional distinction between the owners of financial capital and the clients who execute transactions, merging them both around intelligent tokens that capture all of the value that is created. Blockchain technology also allows tokens to be the determining factor of the true value of the company, rather than using equity and shares prices to evaluate company value. 

Moving on to asset classes, cryptocurrencies are emerging as a new asset class with high volatility and low correlation compared with other asset classes. In addition, any asset class that exists today, from the most liquid to the least liquid, can be tokenized (digitized), with strong business cases serving as proof of asset productivity, efficiency, liquidity, and risk management to name a few. Currency.com has already tokenized more than 1,000 tokenized securities, including global indices, blue-chip stocks, bonds, and many others. Similarly, Santander just issued a $20 million bond on the Ethereum network; Rabobank is tokenizing SME debt; Banco Pactual in Brazil is tokenizing real estate; and others are tokenizing art, etc. Will everything eventually be tokenized? There seem to be numerous examples saying “yes.”

And with new asset classes, portfolio management firms will need to adapt accordingly, as well as their supporting services, such as the security services and custodial services. Key global players are already positioning themselves on these nascent industries, including Fidelity and NYSE in the U.S., and SIX and Julius Baer in Europe.

Disruption Innovation Theory states that incumbents, by their nature, normally ignore the disruptive forces around them, because they do not affect their mainstream user bases at the outset. By the time the disruptive force starts hitting revenue targets, it is generally too late.

It's time for financial institutions to take blockchain seriously, and embrace and lead the change. Those who do so will survive and remain competitive in the new financial landscape. Some will become new key players. Those who don't adapt will likely disappear, just as others have in other industries.

About Ramón Ferraz

Ramón Ferraz, CEO of 2gether, the first crypto-focused challenger bank, is a serial entrepreneur and former consultant with broad experience in banking strategy, open banking and value transformation. He has 15 years of experience in tier 1 consulting firms A.T. Kearney and Monitor Deloitte, focusing on the financial services and private equity industries, and has co-founded and led start-ups in the lodging and student accomodation industries.