In 2008, the world was struck by the Global Financial Crisis (GFC) resulting in the Great Recession which was the worst economic crisis since the Great Depression back in 1929.
Ironically, the GFC was man-made more than anything as the general consensus is that the crisis was caused by the deregulation of financial institutions in the United States (U.S) through the passing of two legislations which are namely the Financial Services Modernization Act of 1999 (FSMA) and the Commodity Futures Modernization Act 2000 (CFMA).
The FSMA effectively allowed banks to utilize their deposits for the making of investments in derivatives whereas the CFMA granted exemptions to derivative investments made by banks from regulatory oversight.
Collectively, the deregulative combination of the FSMA and the CFMA resulted in banks partaking in excessive risk-taking policies with regard to their lending practices.
When the bubble burst sometime in March 2008, it culminated in the massive bailouts for three fallen financial giants in the U.S namely Bear Stearns, Fannie and Freddie, and TARP Bank which cost a total of US$657 billion.
For the world in general, the GFC serves as an expensive lesson that self-regulation is very much an aberrant concept in the financial domain because when left on their own, those calling the shots for financial institutions tend to succumb to their instinctive greed which prompts them to abandon the notion of prudence for the sake of profit-making. Now that we know the issue, wherein lies the problem?
From time immemorial, the global financial system has operated in a centralized manner with critical decision-making powers being imposed on the central boards of financial institutions which supposedly are the most competent decision makers.
However time and again, this centralization of authority has facilitated the perpetration of massive frauds most notably the London Interbank Offered Rate (LIBOR) scandal in 2012 whereby sixteen banks including Deutsche Bank, Barclays, UBS, Rabobank, and the Royal Bank of Scotland banded together in their attempt to the rig the global financial system by manipulating the LIBOR.
It is perhaps a tad ironic that those who have been entrusted with public monies i.e. banks would resort to joining hands to concoct a scheme to manipulate the LIBOR all in the name of profit-making. If history is anything to go by, centralization is certainly far from ideal for the financial domain.
In comes decentralized finance (DeFi) which embodies the conceptual framework of Social and Solidarity Finance (SSF) to offer an alternative financial system for the global population.
From the outset, DeFi refers to an ecosystem of financial services which are provided through decentralized applications (dApps) operating on blockchain networks.
The rise of the DeFi is aptly illustrated by the fact that the total locked-in value (TVL) of the ecosystem has already hit the US$4.2 billion mark as of August 2020.
Besides its decentralized features which distribute decision-making powers among the stakeholders comprising the ecosystem, another feature of DeFi which renders it to be a preferable option to the conventional financial system is its democratization ideals which aim to promote social and solidarity practices based on reciprocal relationships to encourage the active participation of the public community as an integral part of the ecosystem.
A rising star in the DeFi ecosystem is Aave which in August 2020 pipped MakerDAO to top the ecosystem’s TVL rankings with a total TVL of US$1.47 billion outdoing stable mint MakerDAO by US$0.2 billion.
Aave’s credit market protocol which allows users to earn interest on cryptocurrencies and to borrow money using their cryptocurrency holdings as collateral has undergone an exponential growth in 2020 resulting in the price of its native token LEND having risen by more than 36 times i.e. over 3,600% in the period from January to August.
From a commercial perspective, the sky-high popularity of Aave is not too surprising as it is the first platform to include flash loans i.e. uncollateralized loan options which allow token holders to borrow from the liquidity pool without the pledging of any collateral subject to condition that the loan is paid back to the pool in one transaction block.
In line with the democratization ideals under the SSF conceptual framework, Aave is shifting to a fully autonomous and decentralized mode of operations through the deployment of its genesis governance framework which grants key decision-making powers to its token holders.
Nonetheless, Aave is not the only DeFi operator who is living up to the democratization ideals of SSF as MakerDAO and asset platform Synthetix are both developing their operations along similar lines.
With the systemic deficiencies of the conventional financial system leaving more than 1.7 billion adults of the global population unbanked i.e. without access to financial services, DeFi will pick up where the conventional financial system has failed by making financial services available and accessible to anyone and everyone who requires it.
Notwithstanding the stringent regulatory compliance obligations imposed on conventional financial institutions which resulted in these institutions having to spend a mind-blowing US$270 billion in 2018 as part of their efforts to comply with such obligations imposed on them by regulators, fact of the matter is that when it comes to money matters it is almost impossible for men to put into practice the virtue of honesty as the best policy.
Consequently, the conventional financial system is much like a ticking time bomb with its fault lines being akin to accidents waiting to happen. It is in this context that DeFi steps in to offer an alternative choice of financial system, one which is not only in line with the democratic ideals of our modern times but that is indeed the true embodiment of SSF.
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Combining his professional experience as a corporate legal practitioner with his knowledge of blockchain, Ming Sen finds it fascinating to explore the endless possibilities of blockchain particularly in the regulatory domains of the financial services and capital markets sectors.
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