Expanding peer-to-peer models into the wider world of decentralized finance could challenge traditional firms
Over the past two years, digital assets like bitcoin and ether have captured the imagination of investors, stoking demand for direct exposure as well as allocations to spot cryptocurrency ETFs and mutual funds. But even as crypto assets have attracted so much attention, they only scratch the surface of what blockchain technology can do to disrupt the world of investment.
“Technology in general has been chipping away at the margins of the investment business. We’ve all seen how robo advisors and even ETFs have simplified and accelerated the metabolism of finance,” says Alex Tapscott, Managing Director of the Digital Asset Group at Ninepoint Partners. “Still, I think the financial services industry has been mostly unaffected by technology compared to say, publishing or media which has been completely transformed.”
According to Tapscott, blockchain technology offers the ability to rethink many activities that currently happen within the financial industry. That thinking is best represented by decentralized finance, which takes the idea of peer-to-peer transactions from the world of cryptocurrency payments and investments, and expands it into other functions like accessing credit, trading, investing, and protecting against risks, among others.
One example of DeFi’s potential application to the current investment industry, Tapscott says, can be seen in decentralized exchanges.
While a typical exchange like the TSX, the NASDAQ, or Coinbase might rely on a central order book to act as an intermediary for transactions, decentralized exchanges operate based on smart contracts, which are pieces of software that govern direct transactions between parties based on certain rules.
“In this case, the smart contract is a piece of software that connects buyers and sellers in a liquidity pool. If one party is selling something, and there’s a buyer for what they’re selling, they can transact peer to peer,” he says.
According to Tapscott, decentralized exchanges have exploded in popularity in the digital asset world, so that on some days they actually surpass the centralized exchanges. While the concept of decentralized exchanges hasn’t been applied to traditional assets like stocks and bonds, he doesn’t see any reason why it couldn’t be.
Another potentially disruptive innovation, Tapscott says, can be seen in a new type of robo advisors that work within the digital asset space. Under that model, investors put their money in a liquidity pool, which is then invested by an app that’s programmed to seek the best returns across different markets. One notable example, YFI, has grown from zero to $7 billion of assets in about a year, which Tapscott says exceeds the growth achieved by Wealthfront in 10 years.
“I think the idea of being able to do these things without the need for banks and other financial intermediaries will eventually find its way to the world of traditional finance,” Tapscott says. “And the companies that do that will start to seriously challenge some of these incumbent institutions.”
