DeFi makes VC gradually disappear，but when combine with Digital Bank, it may become a pivot point levering the traditional finance
The People’s Bank of China has recently stepped up the promotion of DECP, a legal digital currency. In time, it will not only replace the circulation of paper cash, but also deal huge blow and pose great challenge to third-party payment systems. In the future, the pattern of Chinese payment systems is sure to undergo earthshaking changes. Meanwhile, the release of digital currencies by the People’s Bank of China will also cultivate users’ habit of using personal digital encrypted wallets, which will promote the popularization of block chain digital assets and DeFi to a certain degree. Therefore, the GSR Matrix Fund invited several world-famous investors and technical expert to discuss whether the point of integrating traditional and digital finance is dawning.
GSR Matrix Fund Managing partner
Jackdaw Capital CEO
blockchain technology and financial technology experts
The transformation of traditional finance to Defi
Q1: How to you understand DeFi, or decentralized finance, in the teeth of storm from the traditional perspective of VC?
Ender Xu : In fact, during the decade since the birth of BitCoin, many users have been educated, especially from 2017 to 2018 when BitCoin’s price reached a peak. This attracted the attention of many investors in the world, and entered many users to the field of digital assets. I believe there may be more such chances in the future.
In particular, this year’s global pandemic dealt a huge blow to the financial sector, but investment in digital assets performed relatively well. Despite certain difficulties in the start-up stage, more and more individuals and financial institutions want to invest their own assets in the field of digital assets. But they lack a sense of security due to their lack of understanding in this field. The appearance of DeFi may make more people feel relatively safe.
DeFi is approaching traditional finance and referring to multiple standards in innovative design. But the development of DeFi from autonomy to shared governance relying on the features of decentralization and permissionless is a subversion of traditional finance and may present a completely different financial world in the future.
Bertie：Decentralized finance protocols have emerged to disrupt the legacy banking system by providing individuals — both banked and unbanked — with access to traditional financial services, such as loans, savings accounts, insurance, trading services, etc.
Through the advent of peer-to-peer networks and smart contracts, these decentralized services are capable of being completely automated and can function entirely without the need for intermediaries such as banks or brokerage firms. This is significant because it creates a transparent system that places trust in technology and not in the hands of monopolistic financial institutions.
Q2：What opportunities and challenges underlie the field of DeFi? When will it impact traditional finance and in which aspects?
Ender Xu : In the short run, if the extensible feature of layer 2 solution is achieved, or high-performance public blockchains such as Cosmos and Polkadot can guarantee the transaction and demands of DeFi on a large scale, innovative financial modes related to traditional financial securities, credit and insurance will get to bloom in DeFi.
In the long run, the improvement of infrastructure will activate more users to take the initiative to participate, but we face the challenge of security. There will be more vicious attacks caused by the mortgage of a lot of assets. Besides, there is the issue of data privacy protection. Both CeFi and DeFi have to face the issue.
According to my personal judgement, reduced non-friction experiences on the part of users, radical fall in the gas fees, full-scale improvement of security performance and relatively high return anticipation should bring huge influence on traditional finance. The logic behind is in fact the fundamental improvement and reform of infrastructure. I believe the greatest impact on financial institutions is opposition to shared governance. The true genes of DeFi are decentralized and permissionless both in terms of technology and philosophy. It takes time to change the status-quo, or gradually integrate. Traditional financial institutions may lose opportunities at this stage.
Edge Wang:Let me talk about it from another perspective. We believe there will be certain divergences in the entire financial sector in the future. Generally speaking, we would divide the financial sector into two general dimensions from the perspective of credit, one is derived from credit, or the so-called function of currency creation. This function is now generally in the hands of the People’s Bank of China and commercial banks. It involves the interests and regulatory level of our country, thereby making complete DeFi transformation or block chain transformation difficult. The other dimension doesn’t involve currency creation. Almost all financial services, such as stock transactions, derivatives, mortgages and loans, that only involve the transaction level of the industry, have corresponding plans from DeFi. Its transparency and feature of permissionless may in fact make the regulatory authorities more reassured, so will the users be, who invest with their money, as assets are locked through smart contracts, greatly reducing the likelihood of moral risks. In fact, online finance is to make such financial services civilian on a large scale, but due to the lack of transparency of the centralized systems, many moral risks occurred, preventing P2P from achieving its original aim. From this perspective, DeFi may accomplish these historical missions unfinished by the online finance and form a brand-new financial service system.
Bertie：In terms of DeFi’s influence on financial institutions going forward, I think we will see a substantial change in existing banking and brokerage services. We’re already seeing a rise in institutional custodial services — particularly in the United States which has now allowed national banks to hold crypto funds on behalf of clients. In order to remain competitive with existing DeFi lending and saving platforms, it’s only natural that these financial giants will have to reconsider their interest rate and fee structures. Barriers to entry for loans and other complicated application processes will also need to be re-addressed, to keep toe-to-toe with P2P networks.
Q3：Which factors will play an important role in making investment decisions? What do you think are the reasons for more traditional VC to invest in DeFi field?
Bertie：It is important to remember this is a relatively new concept, and due diligence is still paramount. For instance, we have all seen the success that Uniswap has had and then equally the now evidently unsustainable Sushiswap token phenomenon. DeFi has a place in this current economy and it’s the VC’s job to vet the projects, both for themselves and for others looking for fiscal leadership, to ensure we don’t see a repeat of the 2017 ICO bubble.
Main Factors currently in what will make a traditional VC invest in DeFi is calculated diversification. Understanding we stand on the precipice of fiscal change, economically, politically. Trust is becoming increasingly valuable. DeFi poses an intelligent solution.
Ender Xu:Traditional VC investment would weighed industry, teams and business modes more heavily, investment institutions that focus on block chains and digital economic filed like us will also consider the economic scale and community participation of projects, but recently, we find that DeFi has subverted traditional VC and investment institutions focusing on this field like us, since entrepreneurs and innovators don’t need you at all. Inventions may have been made before their appearance is discovered. What is the reason behind that? It’s difficult for CeFi’s project team to make a quick cold start from financing, development, marketing to market making. While DeFi prompts innovators to realize quick cold-start through the close combination of AMM, yield-farming and project start mechanism without high operation costs. This makes it impossible for VC to capture DeFi projects, so VC may disappear. So where are we heading? Is there any chance yet? First of all, at least, the information in the real world is asymmetric; secondly, most people need time for a full and thorough understanding; in the end, many investors don’t have time for cognition and comprehension, and yield rate only needs to be created by professionals. The business world is truly becoming more and more flattened and democratic. At the current stage, VC may become the best aggregator of investors and project sides, while improving mobility by participating in mining equally like anybody else. My personal investment logic in the field of DeFi is technical innovation, business logic and algorithm models of projects. For example, CheeseBank protocol that I’ve been following these days conforms to my investment standards in determining the feasibility of projects.
The Cheese Lending Protocol currently shows me the new possibilities of future DeFi Lending with the creative mechanism allowing LP token as the collateral. This not only promotes fund flow, and fully taps into the value of users’ assets, but also provides the entire ecology with more advanced mobility.
If only mainstream currency types as collaterals are supported, such highly liquidity assets of currency types can cash in at any time, even be used to buy other assets as basic currency type. Therefore, pledging and loaning with such assets in fact lower their own liquidity (since the pledge rate is generally 70+x%, obviously lower than the original assets). Therefore, these people are not in need of mobility, but seeking interest arbitrage by revolving pledge based on the logic of rise in the price of tokens. For the whole market, the overall liquidity is actually contracted, and the risks are increased, comprising an unhealthy pattern. The significance of DeFi platform is to serve as an advanced liquidity system, discovering people in need of mobility and providing them with mobility, so as to create greater value.
One of the groups in real demand of mobility is DEX market-makers. They can gain profit from market-making after providing DEX with funds, but the voucher of the liquidity pool they get (LP) is a kind of assets lacking mobility — — underlying assets, right to earnings and all other rights are deprived after selling in the secondary market. Therefore, their liquidity terminates due to market making. The only solution is to allow them to pledge and loan with LP, similar to the model of pledging with stocks and real estates: assets, rights and interests are still theirs, but there is new liquidity gained, enabling them to further invest in other assets, and redeem assets simply by paying interest. This is a real model that improves liquidity. Cheese Bank detects such an opportunity, therefore, I propose it as a case here and look forward to their subsequent development.
The next morning star of DeFi: Digital Bank
Q4：How do you look at the saying that DeFi may create a killer application in the banking sector? What chemical reactions do you think there will be by combining decentralized finance and banks?
Edge Wang: I believe digital banks will play an important role in the future development finance system like a bridge. First of all, the present traditional assets such as bank deposits in dollars and euros hope for some investment or at least value maintenance and appreciation channels given the huge goofing around, zero interest rate or negative interest rate in the world, even if the annualized yield is 2%. But in traditional financial system, due to the limitation of region, geography and economies, it is difficult for assets and capital to freely circulate around the world, therefore making it impossible to reach this goal. DeFi world is, however, characterized by free circulation worldwide without boundaries, and the ability of achieving higher yield rate.
Secondly, the products or agreements in the DeFi field can only use purely digital assets, since only digital assets can act on intelligent contracts, therefore, it is difficult for investors of traditional financial products to participate in DeFi. Digital banks are able to connect assets in the real world, including the currency assets and other assets that can be pledged such as gold and real estate in the traditional banking system, with the digital asset world as they offer digital financial services such as exchanging for digital currencies or buying digital assets facing traditional groups or assets, so as to become an important path directing traditional users and old money towards the digital world and new money.
For example, if our digital banks convert investors bank deposits into stable currencies on the block chain with the approval of regulatory institutions, or allow investors to pledge traditional assets such as gold and real estate to generate stable currencies, which can enter DeFi through individual investors or professional digital funds and participate in the deposit, interest-bearing, pledge, loan, assets insurance, and transaction exchanges among other various financial services herein with clearly visible investment and yield, the yield at the current stage is obviously higher than that of the absolute majority of traditional financial products, while risks are relatively controllable.
Bertie：I think when DeFi and digital banking come together we’ll see a banking system that runs completely autonomously — without people, without bank branches, without lengthy application or legal processes. A system where smart contract functionality will allow anyone with a smartphone to instantly tap into a wide range of financial services 24/7, 365 days a year.
We have been working closely with the Valens Bank Group to formulate concepts and anticipate future products/services that will remain relevant and valuable in future evolutions of traditional banking.
Ender Xu: Why would we lay out in the digital bank, since we found digital currencies would gradually become an investment choice for users, but it takes time for more users to understand and enter the industry. After the popularity of DeFi, however, finding a combination of technologies and philosophy for us, which can be totally autonomous and decentralized, users may feel more reassured in handing over their assets for you to manage at such a moment.
So what kind of role does digital banks play? A guide and attendant, allowing users to enter the field seamlessly.
Q5： Now the focus of the existing products in the DeFi field is how to enter the quality mainstream tangible assets into the rising DeFi field. What are the advantages of digital banks compared with the existing products of DeFi?
Edge Wang:I believe digital banks should have huge advantages in this aspect, as licensed exchanges in the field of digital assets or other institutions that can issue stable currencies like USDC or GUSD all turn up with identities similar to currency exchange institutions of exchanges, applying for regulatory licenses in all countries to issue stable currencies. From the perspective of digital banks, in turn, digital banks have naturally been qualified to operate licensed bank transactions all round the world, making it possible to connect with the digital assets field by simply adding the condition of permission to issue stable currencies. It is obviously a non-financial institution, or a financial institution with narrow business scope, boasting much greater advantages in doing this. Other transactions such as assets pledge are pretty easy to be realized, since this is also allowed in the business scope of banks, much easier than accessing to this transaction by a purely digital asset institution.
Ender Xu: Products such as MakerDo are a universal currency for those native digital assets users (and investors with digital assets) in a DeFi (decentralized finance) wold. Therefore, their limitation is actually the overall currency value of their existing digital assets. Current digital banks and funds are exploring how to link the huge tangible assets and old money outside DeFi to a freer and fairer DeFi platform through compliance. I believe only with the appearance of such products can DeFi’s world atlas become strong enough.
Q6：Yield-farming has gone viral from the beginning, and now everyone has become relatively stable in mood. After this hot-button issue, what do you think will be some new development directions in the future decentralized finance?
Edge Wang: As to yield-farming, it has indeed played a huge role in the hot trends of DeFi in short term ,since there was a huge rise in the price of tokens of early-stage yield-farming, bringing significant wealth effect, and promoting the popularity of DeFi. Therefore, many people don’t think this pattern is sustainable and they even believe DeFi will decline as a result.
In the long run, in fact, yield-farming is a standard mechanism encouraging users and communities, therefore, it will continue in the future, only it is difficult for frequent big price rises, and price fluctuation may become a slow and normal process. This is a little similar to the mode of a start-up company inviting its users to use its products and then sending them some stocks. In fact, such modes exist in companies in Europe, North America and Japan. Although DeFi protocols are not made with companies, and token governance is unlike the governance of stocks, the market price will return to relatively basic value logic in the end, without affecting the sustainable development of DeFi.
Ender Xu: I believe the future development will become more democratic and flattened in terms of philosophy. Just like what I shared just now, VC may disappear. You have to participate in projects offering liquidity to get tokens. For example, the Cheese Bank that we think highly of recently match our philosophy. We’re willing to join hands with it and offer subsequent digital bank cooperation services to it. But it doesn’t provide us investment opportunities because of it, and we can only get Cheese through providing the platform with mobility like any other ordinary user. The future will become more and more obvious in the future, and the determinant factor of long-term development of projects will no longer be the support of financial institutions and large amounts of capitals, but whether it can truly meet the anticipation of users and the market in a real sense. We look forward to this more democratic financial world and are willing to be an ordinary participant, witnessing the dawning of this era together.