Copenhagen Fintech Christmas Calendar #14: Decentralized Finance Matters
For this episode, Head of Alliances at Copenhagen Fintech, Sebastian Jensen, sat down with Søren Peter Nielsen of the Maker Foundation and Jacob Pouncey of the Nordic Blockchain Association and Saxo Bank Crypto Market Analyst to discuss why so many talk about decentralization when they talk about blockchain and what blockchain enables us to do what our current economic setup of bank-issued fiat money doesn’t.
Maker has developed the first fully, decentralized asset backed Stablecoin on Ethereum, called DAI. Using the DLT on the Ethereum blockchain allows their transactions to be confirmed by several nodes that are spread globally. On top of this, having partnered up with Danish fintech, Tradeshift, they have managed to build the world’s first self-executing smart contract. These contracts facilitate an automated, self-executing code on nodes within the DLT system, such as supply-chain contracts. The idea behind these supply-chain contracts is to tokenize invoices with data that enables to make credit assessment of suppliers and buyers in an automated way. This allows small companies with limited access to liquidity and differing credit lines from large companies to work together without running into liquidity problems. Without going to much into detail here, you can read about smart contracts and its basic functionality here.
A bit of background
The right to make money is, from a historical perspective, something that was reserved for central banks due to the power of influence connected to it. With monetary policy being a seemingly governmental matter, how does blockchain fit into this and should we buy into the offered alternative means of payment and value? Most global banks have been experimenting with Distributed Ledger Technology (DLT) for some time now, some have even launched their own Stablecoin. We are seeing central bank issued digital currencies, and even the World Bank has issued blockchain-based bonds and debt and equity are now undergoing a similar treatment. With all these big banks and financial institutions working on this issue, why do we need small, decentralized actors to provide us with these solutions?
What is it about distributed ledger technology (DLT) that makes it such an attractive alternative?
One major advantage of DLT is its traceability. In the traditional systems, the information on transactions sent from one party to another is securely stored behind the closed doors of respective financial institutions. This makes it difficult to trace transactions as there will always be an authority gatekeeping the information in a central storage. A DLT in return, is open-source and decentralized, allowing every participant of the system to participate and trace their own transactions as well as the transactions of their peers. Not only does DLT democratize the governance of transactions, it also eliminates the need for a third party governing the transaction as they will being fully transparent and immutable, reducing the possibility for fraudulent activities, e.g. double entry booking.
What about the degree of legislation?
One major question that needs to be discussed is how we ensure compliance and accountability if there is no central entity that can be held accountable for its actions. As of now, everyone can participate in creating the code, which is regulated as free speech, protecting developers of the code in their pursuit of innovation and development. Since there is no unified approach or central body authorizing transactions on the system, as of now, there exists a range of different and varying legal frameworks among countries. To both, Jacob and Peter, in order to generate trust in the technology, we need to make sure to have a global regulatory oversight in place that on the one hand provides for this freedom to constantly improve the technology, but on the other hand ensures accountability and the responsible development of code.
From a consumer’s perspective — How can I trust it if I don’t fully understand it?
To both, Peter and Jacob, this is a question of dispersion, where a basic level of trust is only possible once blockchain technology has established itself in the broader user base. As of now, the adoption curve of distributed ledger technologies is rather positioned at the stage of early adopters and innovators. However, with a decline in trust in many centrally organized financial institutions in the last ten years, we can see a trend towards alternative, more decentralized services that put the issue of trust at the center of their businesses.
What does DLT have to do with financial inclusion?
As of today, 1.7 billion people are without access to financial services. This poses a massive opportunity for DLT to capitalize on the citizens that currently don’t have the access to traditional services. If we manage to build a well-functioning technological infrastructure for DLT applications, it has great potentials to serve a currently underserved market segment. Since participation in the system does not require the access to large financial institutions but is open to the general public, the barriers of access to banking that are particularly prevalent in many developing countries could be eliminated.