"Defi"

DeFi is sometimes known as “Lego money” because you can stack dApps together to maximise your returns. For example, you could buy a stablecoin such as DAI and then lend it on Compound to earn interest, all using your smartphone.

Though many of today’s dApps are niche, future applications could have a big impact on day-to-day life. For example, you will probably be able to purchase a piece of land or house on a DeFi platform under a mortgage agreement whereby you repay the price over a period of years.

The deeds would be put up in tokenised form on a blockchain ledger as collateral and, in the event that you defaulted on your repayments, the deeds would automatically shift to the lender. Because no lawyers or banks would be required, it could make the whole process of buying and selling houses cheaper.

Why the craze?

First, regulators have been behind the curve, and DeFi has been able to flourish in this vacuum. For instance, in traditional unsecured lending, there is a legal requirement that lenders and borrowers know one another’s identities and that the lender assesses the borrower’s ability to repay the debt. In DeFi, there are no such requirements. Instead, everything is about mutual trust and preserving privacy.

Regulators are having to weigh the delicate balance between stifling innovation and failing to protect society from such risks as individuals putting their money into an unregulated space, or banks and other financial institutions potentially being unable to make a living as intermediaries. But it seems more sensible to embrace change — and that seems to be happening. In July, the US Securities and Exchange Commission (SEC) made a major shift towards embracing DeFi by approving an ethereum-based fund, Arca, for the first time.

This is welcome and important, since one of the major challenges towards financial innovation is the hostile environment created by archaic regulations written for a bygone era. This has caused some DeFi projects to fail — including major ones such as New-Jersey-based Basis, which returned US$133 million to investors in 2018 when it concluded it couldn’t work within the SEC rules.

A second reason for the DeFi surge is that mainstream players are getting involved. Many high-street financial institutions are beginning to accept DeFi, and seeking ways to participate. For example, 75 of the world’s biggest banks are trialling blockchain technology to speed up payments as part of the Interbank Information Network, spearheaded by JP Morgan, ANZ and Royal Bank of Canada.