This latter realm is the real head-spinner, as my Bloomberg News colleagues recently depicted. It's a place that runs on decentralized finance (DeFi), a hi-octane $100 billion web of largely unregulated platforms that lend and exchange crypto for fees.
It's a place where parents fret as their kids pocket real money on blockchain games like Axie Infinity; a place where virtual museums display art sold by real auction houses for eight-figure sums; a place rife with inflated prices, insider front-running and myriad frauds and forgeries. It's a place where, for every interesting financial innovation, there's a hack, rug-pull or wipeout just around the corner - the Squid Game token is only the most recent example.
The question now is how much longer this place, where real and virtual fortunes are made and lost, will stay a Wild West. Probably not very long.
We know from history that speculative frenzies have a habit of eventually fading, while rules and standards are never too far away from fast-growing financial technology. There was a time when peer-to-peer lending and instant online payments weren't as supervised as they are today, for example. Regulators are already taking a closer look at DeFi.
In supervisors' sights are crypto assets like stablecoins, which are managed algorithmically to avoid wild fluctuations in price. These serve as the fuel for some of DeFi's raciest projects, like locking up crypto in trading pools offering ludicrous (and short-lived) 1,000%-plus annual yields, but also some of its most bank-like ones. These might involve an issuer buying real-world loans and bonds, backed by consumer debt or real estate, and securitizing them as tokens on the blockchain offering 5%-10% yield. (The issuer gets more crypto in return.)
You can glimpse the opportunity for old-school finance here: More automated and transparent processes, with fewer middle-men, might save money and help avoid the kind of shenanigans that led to the collapse of financial services company Greensill Capital.
But the reality today is that even these DeFi projects still come with significant risks. Sift through the fine print and it's clear that a lot of things could go wrong. The counterparty chain is complex - one offering, for instance, features an India-based entity, connected to a Delaware-based entity, connected to a pool of crypto assets managed by another entity.
There also appears to be limited legal recourse for investors, and little power over issuers, who earmark the proceeds for general funding of "business operations." If something goes wrong with the algorithmic management of an event like a loan default, there don't seem to be many answers.
The more bank-like the DeFi project, the more likely it is that bank-like rules, and costs, will follow. On top of regulation, regular banks - so-called "TradFi" - are wading in. French bank Societe Generale is proposing to refinance a tokenized portfolio of covered bonds by borrowing from a DeFi platform. It would be the first such move by a major lender, and a sign the financial sector would rather co-opt than be disrupted by crypto-anarchy.
Whether directly or indirectly, sheriffs are moving into town.
Now, to be sure, the cavalry is still playing catch-up, and the ingenuity of fraudsters is still very much on display; the philosophy driving today's dabblers should remain "buyer beware." This is the Wild West phase of DeFi after all, fintech consultant Peter Lugli says. "I wouldn't bet the farm; maybe the sickly horse."
In the meantime, the corporate world's interest has been piqued. Even Facebook, which is in the regulatory spotlight, is chasing its own stablecoin ambitions with a pilot digital-payments project in the U.S. and Guatemala. Maybe the irony is that, in the future, those stuffy Metaverse offices envisioned by Mark Zuckerberg will end up being backed by metaverse money - half-real, half-virtual, but fully regulated.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. Lionel Laurent is a Bloomberg Opinion columnist covering the European Union and France.
Published : November 07, 2021
By : Bloomberg