How Defi can Accelerate Global Economic Recovery

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Coinmonks

7 min readJun 28, 2021

Modern Buildings In City Against Blue Sky

The global financial crisis of 2008 came as a result of excessive risk-taking by banks. Governments were forced to bail out the banks to prevent further consequences and attain stability. The crisis exposed the flaws of the traditional financial system and identified the need for improvements in the system.

The Great Reset

After the global financial crisis in 2008, governments and central banks in major economies made a resolution. They decided that never again would they allow the banking system to threaten economic and social well-being.

Today, they have not fully followed through on this pledge. They now need to risk destroying a durable and sustainable recovery from the disastrous economic effects of COVID-19. Perplexed by how the public sector stepped back to allow finance more room to work, some countries have gone ahead to compete to become bigger global banking centers. However, they did this without considering the size of their real economy.

Following the pandemic, the World Economic Forum (WEF) came up with a plan called “The Great Reset.” It is aimed at a complete transformation of the global economy. The idea is that there is a need for society to respond to the economic issues caused by the pandemic and anticipate further challenges related to climate change. According to the World Economic Forum, it is an opportunity for recovery.

Why Defi?

Decentralized Finance (Defi) is an ecosystem of Decentralized Applications (Daaps) that provide financial services which are built on distributed networks that do not have a central government authority. They are based on Decentralized Autonomous Organizations (DAOs), which are mostly community-led. That is, no individual governs the organizations, rather they are governed by the community members.

Banks play an essential role in the present financial landscape. Banks are the major players of the financial industry. They facilitate payments, accept deposits and offer credit to individuals and businesses. The total capitalization of the top 10 banks as of 2019 was $2 trillion.

Capitalization of Top 10 Banks — Capitalization of top 10 Banks

Defi aims to build a more functional financial landscape enabled by blockchain technology. Three major aspects of the banking system will benefit from adoption of blockchain technology. They are payment and clearance systems, accessibility, and transparency.

Nevertheless, cryptocurrency has a role to play in the recovery from the effects of the pandemic. Presently the number of (Defi) Decentralized Finance platforms make finance more accessible and efficient for their users. The decentralization, transparency, openness, and speed of these platforms could play an important role in lubricating the global economy.

Economic implications

In the earlier innovations, easy and cheap access to activities fueled a round of overproduction and overconsumption. Sure enough, Wall street’s credit and leverage factories flooded the housing market and other sectors with new financial products that had few safeguards. In order to ensure quick endorsement, lenders initially relaxed their standards and offered mortgages that required no documentation of creditworthiness from the borrower.

By the time governments and central banks noticed this, it was too late to take action. A financial implosion followed that almost caused a great global depression and forced those in charge of policymaking to rescue does who had created the problem by their reckless behavior. The policymakers introduced several measures to make banks less risky. They increased the capital buffers, improved supervision, and outlawed certain activities.

Internet first, global first

Part of the secondary effects of the Coronavirus pandemic is that people are getting accustomed to making transactions online as against physical visit to the banks and other financial institutions. Many find it more convenient to access critical financial infrastructure without being physically present.

In addition to this, financial institutions and businesses are looking to cut down on costs because they have been hit financially as a result of the pandemic. In a bid to save costs, they look to the greater efficiency provided by digital platforms. This is a huge driver for adoption.

There are indications already that financial institutions are interested in utilizing blockchain technology to enhance their operations. A study from the business insider magazine in December showed that 66% and 56% of financial institutions identify payments and securities settlements as the two use cases major use cases for blockchain-based technology.

A similar development service indicates that a growing population of businesses and freelance workers want access to real-time payments and finance. In other words, there is already growing demand for the kinds of services that cryptocurrency-based financial products can deliver. Given that much of the world is already experiencing an economic downturn, it is likely that the demand will increase in the coming months. Again, there is an increased intolerance for the challenges in the existing financial system.

Drivers of adoption

In the short term, it is unlikely that crypto-based financial platforms and products will do much to help the global economy. However, in the long term, there are likely to be reforms in the financial industry. A lot of activities are already ongoing with respect to Central Bank digital currencies and with respect to regulation.

For instance, China is in the process of releasing its Central Bank Digital Currency (CBDC), the digital Yuan. Countries in the Eurozone are following the trend.

Barriers to Adoption

Experts are of the opinion that lack of regulation is one of the reasons why the majority of organized institutions have refrained from participating in cryptocurrency. As soon as there is adequate regulation, we are likely going to see more adoption from corporate organizations.

By their nature, cryptocurrencies are not bound to any country borders or specific agencies within the government. This nature poses a challenge to policymakers who are accustomed to dealing with clear-cut definitions for assets. As a result of this, they are unresolved questions relating to the regulation of cryptocurrencies.

In addition, there is some measure of confusion about the classification of cryptocurrencies. For instance, the Commodities Futures Trading Commission (CFTC) treats bitcoin as a commodity while the Internal Revenue Service (IRS) treats it as a property.

The unique characteristics and global portability of cryptocurrency present another bottleneck for regulators. There are broadly two types of tokens traded on exchanges — utility tokens and security tokens.

Utility tokens serve an underlying purpose. They are used to reward behavior and used as incentives for the champions who contribute to and support the organization. On the other hand, security tokens represent equity or share in the organization. They can also be used to cast votes for decision-making in the decentralized organization.

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