DeFi, Open Markets, and the Future of Finance

Community Team
November 11, 2020

In early June of 2020, the cryptocurrency industry erupted with activity surrounding a number of new protocols offering ‘Decentralized Financial Services’ also known as DeFi. From decentralized lending, to exchanges, to yield farming: DeFi has rapidly grown in previous months with billions of dollars in value locked on different protocols.

In parallel to the many new decentralized financial protocols and services being created, traditional finance has also embraced a number of innovative digital financial initiatives. Central Banks—from Europe to Korea to China to the United States’ Federal Reserve, have started to thoroughly experiment with ‘digital currencies’, while private investment banks and large corporations have started to take tokenization and decentralized payment systems more seriously. In short, 2020 has been a breakthrough year for the Decentralized Financial Revolution undergirded by distributed ledgers, and cryptocurrencies.

Like other technological revolutions of the past, the DeFi revolution holds the promise of seamlessly applying a new technology to a different service or sector in order to make it more efficient, accessible, or rewarding. This has begun, in earnest, across lending platforms, exchanges, and cryptocurrency protocols. Yet, it is only just beginning, for traditional financial markets and prediction markets. Why does this matter, and what is the promise of open-markets?

Traditional Financial Markets: What Do They Offer and What Are Their Parameters?

Traditional Financial Markets offer investors, retail traders, and firms the ability to use their money to invest in government bonds, commodities, derivatives, and currencies, among others services like spot markets, medium term loans, and long term trust-funds.

In the past half a century, traditional finance has evolved to offer a wide array of financial services and products on top of these markets—from derivatives on core commodities like oil and gas, to complex financial instruments like Bespoke Tranche Opportunities—financialization has become commonly applied to the industrial world. In the context of a state and the development of an economy, financial markets provide governments and firms with very useful services:

  • To Use Money More Productively: Via personal loans, housing loans, credit opportunities, and spot-markets for firms and other financial service providers.

  • To Properly Evaluate Certain Companies or Assets: Via trading among professional analysts and investors interested in the future potential of a firm or service.

  • To Provide Liquidity and Credit to Companies and Traders: To support new investment opportunities, infrastructure development, and firms looking to expand.

Altogether, the existing financial infrastructure provides stakeholders with a number of opportunities for spending or receiving money in the form of loans, shares, or voting rights. And while these services are accessible to many people, they are also characterized by certain key parameters:

  • Centralization: Clearing houses, exchanges, private investment banks, or financial services companies operate as ‘middle-men’ between ‘buyers’ and ‘sellers’. They effectively set the rules of trading, the types of services offered, and the clients they allow their customers or partners to interact with.

  • Accreditation Requirements: Participating in existing financial services requires certain certifications or accreditations: From the FINRA Series 7 exam, to specific qualifications and exams for becoming Commodity Trading Advisors (CTA’s), Certified Financial Technicians (CFT’s) or Certified Market Technicians (CMT’s).

  • Strict Market Schedules: All centralized markets and exchanges that operate around the globe function according to an ‘open’ or ‘close’ schedule during which times services can be traded, purchased, or granted. Outside of these times the markets are effectively closed.

  • Geographical and Jurisdictional Differences: Different regulatory regimes across different markets, host different products, financial tools, and requirements for investors or companies. There is no standard model from which a certain asset or commodity can be purchased. Each region of the world differs in their focus and offering of financial products.

  • User Requirements: Whether it be a credit score, a certification, your social security number, or your loan history, access to financial services is stipulated upon a central entity evaluating an individual customers’ application for a particular product.

The revolution in decentralized finance, provides a number of alternative financial opportunities that circumvent or streamline many of the existing bottlenecks found in the parameters of traditional finance: This is the essential context for understanding the future of Open-Finance and the markets they will inhabit therein.

DeFi and Open Markets: What Does the Future Hold?

With distributed ledgers, a new financial revolution has begun - this time by groups of node operators participating in the validation process of open and distributed cloud platforms. Decentralized Finance, or DeFi as it has been labelled, refers to permissionless platforms that offer market trading, lending, and prediction services in a decentralized manner - most commonly undergirded by a cryptocurrency.

The advantages that DeFi possesses over traditional finance are numerous, but primarily center upon expanding or improving the limitations that traditional finance suffers from:

  • Open and Decentralized: Network rules allow for anyone with sufficient funds to access the protocols and make use of the services. There is no formal barrier to entry, nor is there an authority capable of banning participation.

  • Anonymous: Users transact using their cryptographically secure wallets, represented most frequently with an alphanumeric hash. On NEAR an account ID can also be used, however, there is no requirement for user identity. As such, access to protocols, loans, services, or credit is not based on a credit history or score: Individuals have the opportunity to start fresh.

  • Interoperable and Timeless: On most DeFi protocols, the rules of the network determine network access for different products or geographies. Listing a product on a Decentralized Exchange, or creating a market on an Open Market platform is simply limited by the creators ability to develop or integrate their product onto the protocol. Once a product has been added, it is accessible to anyone else, from any location, at any time.

  • Secure / Incorruptible: The rules of the platform are coded into smart contracts. As such influence over the protocol can only happen through community governance processes. As such, DeFi protocols tend to be both more secure from fraudulent behavior (i.e. a loan will stay locked until it is paid off), as well as incorruptible from nefarious actors (i.e. fixing markets is hard when changes to the protocol would require a protocol vote).

With these advantages, the Decentralized Finance Revolution has taken off in the cryptocurrency industry, and is poised to enter the mainstream in the coming years. Due to the value proposition and scope of services DeFi offers, Dan Morehead, CEO of Pantera Capital, stated "It's much more likely that the entire DeFi space goes up 100x over the next five years than Bitcoin.” Not only does DeFi offer revolutionary services within the cryptocurrency industry, but it also has the prospect of disrupting traditional financial services with more efficient, accessible, and open product and market offerings.

What’s Next: The Value of Open-Market Protocols

To date, the DeFi revolution has witnessed a surge of interest in lending platforms, stable coins, and special assets: From liquidity mining, to wrapped bitcoin (wBTC) to yield farming, daring crypto enthusiasts have been able to experiment with open-financial services with both great risk and reward. Nevertheless, there is still one very valuable yet obscure area of the DeFi revolution that is only just starting to blossom: Open-Prediction Markets.

Open Prediction Markets refer to market platforms that allow any person to create a market on any question or future event. This market can then be bet on or invested in by anyone else, from anywhere in the world. In context, Decentralized Finance has made Open-Market Protocols capable of offering such services possible for the first time: Whereas previous attempts have been centralized, shut down by governments, or unable to scale, open-market protocols built on distributed ledgers are a radically new form of financial innovation poised to disrupt multi-trillion dollar futures markets, emerging industries, and the rapid interest in superforecasting.

Open Markets Offer Disruptive Financial Innovation:

  • Market Creation on Any Service, Product, or Question: Open Markets allow professionals, firms, governments, and even students to easily open up a market on the future status of any product, service or question: Not only does this encompass the multi-trillion dollar market infrastructure from traditional finance - from commodities prices to derivatives on company decisions - but it also includes completely new forecasting markets on important geopolitical and scientific questions.  

  • Market Access to Anyone and Everyone: Open Markets guarantee market access to anyone able to connect to the internet and create an account on the protocol. This means that the barrier to entry is removed, and access to making trades, predictions, or receiving services, is available to everyone willing to put money where their mouth is.

  • Secure and Scalable Infrastructure for Sustaining and Settling Multi-Billion Dollar Markets: With rapid improvements in the technical design of distributed ledgers, it is now possible to trade on open markets for fractions of a cent, with settlement times between 30 minutes and 24 hours, and protocol capacities to transact up to 80,000 transactions per second. For the first time, the technical infrastructure is in place for open-markets to sustainably handle billions of dollars at a time.

  • Built in Governance and Dispute Resolution Mechanisms that can be Solved on a Protocol Level: Most importantly, Open Markets are commonly managed by an inbuilt governance and resolution mechanism, denominated in a cryptocurrency of sorts. This ensures that decisions about the protocol are taken in a decentralized and transparent fashion, so that markets cannot be corrupted or unduly influenced by shadow stakeholders.

The ultimate value proposition of an Open-Market is its capacity to decentralize access to predictions and investments on futures, in a secure, accessible, and scalable manner. With existing markets valued at trillions of dollars across industries and services, it is clear that the pinnacle of the DeFi revolution will take place with the inauguration and adoption of Open-Markets for settling value. As the next financial frontier, the time to start creating open-markets has arrived.