The metaverse and Web 3.0 have established themselves as hot topics within the fintech space, but something that has not been spoken about as much is the next evolution of decentralised finance (DeFi). DeFi 2.0 promises a decentralised financial infrastructure with the addition of easily accessible liquidity, something that is severely lacking in the traditional finance space.
Rachid Ajaja is CEO and co-founder of AllianceBlock, the company aiming to bridge the gap between decentralised finance and traditional finance. With a deep-rooted understanding of traditional financial institutions, Ajaja spent six years as a quantitative risk analyst at Barclays Investment Bank, BNP Paribas, and Moody’s Analytics. A serial entrepreneur with a passion for modelling, analytics development, quantitative analysis, and data science, for the last decade Ajaja has been developing and implementing models and methodologies to help organisations with forecasting and risk management.
During his tenure as a senior AI research scientist his work received accolades from VINCI, where he was commissioned to orchestrate the ambitious ‘smart highways and smart cities’ project, combining AI and blockchain.
Using his expertise in the area, Ajaja spoke to The Fintech Times to discuss how companies must address certain areas before the large adoption of DeFi 2.0 can take place:
Traditional financial infrastructure is the foundation that underlies a whole system of connected institutions, information, technologies and rules and standards. It enables financial activities like trading, asset allocation, portfolio management, lending, borrowing and more. In recent years, the arrival of DeFi has been contributing to the creation of a more inclusive and collaborative global economy.
The first wave of DeFi solutions created the foundation for a new era of finance. The advent of DeFi 2.0, the second generation of DeFi protocols, which aims to correct the problems of the first iteration of innovation, aims to make this a reality. DeFi 2.0 promises a decentralised financial infrastructure with the addition of easily accessible liquidity, something that is severely lacking in the traditional finance space. Before this vision can be fully realised, the industry needs to create the right building blocks and address its most pertinent technical issues. The following are the five key areas the industry needs to focus on.
Having the infrastructure that enables projects to easily build solutions on top of existing DeFi offerings readily and accessible is essential. As it stands, projects looking to update and change lending, borrowing and trading solutions predominantly have to do so through smart contract developments, which can be a lengthy and complex process. Providing a framework allowing them to bypass these processes and quickly react to issues or developments will help to promote the positive growth of the space.
As an industry in its infancy, DeFi still has few standardised processes and widely adhered-to standards. Outlining these is essential for bringing about DeFi 2.0. In traditional finance, standardised procedures help to create seamless, quantifiable processes that are easy to understand and follow. An example of this is the FIX protocol, a solution that helps trading companies exchange information between broker-dealers and clients in a streamlined, universal way.
In DeFi, NFTs are showing great promise as a means for setting clear standards for the decentralised financial infrastructure of DeFi 2.0. They hold potential as a foundation on which to build standards for financial products and instruments for both DeFi and TradFi. NFTs will play a huge role in bringing standards to the space over the coming years through their ability to reduce reliance on middlemen by inputting standards into a single immutable digital token.
Execution and liquidity
Access to liquidity across the DeFi space without the risk inherent in automated market making is not something that exists yet. Decentralised exchanges (DEXs), which cut out the middleman and use Automated Market Makers (AMMs) to match trading pairs, are one of the most utilised technologies to come out of DeFi’s first wave. However, there are over 100 DEX solutions in operation today, resulting in a highly-saturated market. What’s more, many of these are forks of established platforms, which in simple terms, means they are variations of existing offerings.
Unfortunately, these existing offerings are plagued with issues of impermanent loss, wherein liquidity providers risk incurring losses if price changes occur after assets are inputted into a pool. Slippage, wherein the difference between the expected price of an order and the price when the order actually executes, is also a key issue. The DeFi community is working hard to address these issues, which are essential to bringing decentralised trading and automated markets into the mainstream.
To truly open up liquidity across DeFi markets, the industry needs interoperable, multi-chain and decentralised bridges that connect networks and bridge data in a seamless and secure way. This will allow for the essential flow of capital across different channels. It’s important that these solutions retain the core trustless ethos of the industry, meaning they should not have to rely on intermediaries or individual parties in order to function. They should also be universal so they do not silo individual solutions to individual problems, as has historically happened across DeFi. There is a lot of promising work being done across the space to improve the efficient transfer of liquidity in DeFi, which provides a lot of hope.
For DeFi and TradFi players alike, it is a massive undertaking to traverse cross-border regulation as it applies to global networks. They must act in accordance with the most up-to-date regulations of the different jurisdictions they are operating in. Regulators are increasingly making moves when it comes to digital assets, making the global landscape increasingly complex to navigate day by day. To truly bring DeFi to the mainstream and give institutional players access to the massive opportunity it has to offer in a secure and compliant way, regulatory compliance rules engines will be essential. Innovations like these ensure automated validation of transactions and compliance with varied and complex regulations.
KYC, KYT and identity
It’s no secret that crypto’s traditional characteristic of anonymity is one of the key reasons why many traditional institutions are cautious towards this asset class. Know Your Customer (KYC) and Anti-Money Laundering (AML) checks are essential for verifying the legitimacy of who one is doing business with and ensuring that they are compliant with relevant regulations. From TradFi’s perspective, it is also extremely time-consuming to comply with the manual KYC/AML checks that their systems haven’t been quick to update to keep up with technological advancements. With the adoption of DeFi and automated transactions, Know Your Transaction (KYT) processes need to be deployed in combination with KYC and AML to ensure that monitoring and due diligence happens across all touchpoints.
An increasing number of individuals are looking to decentralised technologies as a means for protecting their data, privacy and security and to improve on outdated TradFi processes. New decentralised identity solutions are helping to solve this issue by allowing people to give access to their personal information in order to comply with KYC checks. There is then a possibility for the user to revoke access.
Addressing these five key issues will enable DeFi 2.0 to become a reality, creating a new financial infrastructure that both TradFi and DeFi players can benefit from. Many of DeFi’s issues today are complex and nuanced. Thus, they require extensive innovations and consideration as we move into DeFi 2.0. Only then will DeFi be fit to contribute to a more inclusive, collaborative global financial system.