DeFi and the Future of Finance

Yet so little of the infrastructure of this ecosystem has been built. We are perhaps 1%, likely less, into DeFi as a phenomenon. A burgeoning ecosystem of developers around the world is currently constructing the financial building blocks of tomorrow. At our crypto investment firm Paradigm, we often ask ourselves, if there were a periodic table of financial primitives, what has been built today, and what is left to fill in? That is the opportunity for entrepreneurs. DeFi, like the internet, will likely make financial services cheaper, faster, secure, personalized, and more. If YouTube grew the breadth of video content by orders of magnitude because it was free and easy for anyone to both create and use videos, what will DeFi do for financial products as it similarly allows anyone to create and use anything at near-zero cost? That future has yet to be written. This book provides a peek into that future, and you, the listener, hold the power to create it. Fred Ursham, Co-Founder and Managing Partner, Paradigm, Co-Founder, Coinbase, June 2021. 1. Introduction We have come full circle. The earliest form of market exchange was peer-to-peer, also known as barter. Barter was highly inefficient because supply and demand had to be exactly matched between peers. To solve the matching problem, money was introduced as a medium of exchange and store of value. Initial types of money were not centralized. Agents accepted any number of items such as stones or shells in exchange for goods. Eventually, specie money emerged, a form in which the currency had tangible value. Today, we have non-collateralized or fiat currency controlled by central banks. The form of money has changed over time, but the basic infrastructure of financial institutions has not. However, the scaffolding is emerging for a historic disruption of our current financial infrastructure. DeFi, or decentralized finance, seeks to build and combine open-source financial building blocks into sophisticated products with minimized friction and maximized value to users utilizing blockchain technology. Given it costs no more to provide services to a customer with $100 or $100 million in assets, we believe that DeFi will replace all meaningful centralized financial infrastructure in the future. This is a technology of inclusion, whereby anyone can pay the flat fee to use and benefit from the innovations of DeFi. DeFi is fundamentally a competitive marketplace of decentralized financial applications that function as various financial primitives, such as exchange, save, lend, and tokenize. These applications benefit from the network effects of combining and recombining DeFi products and attracting increasingly more market share from the traditional financial ecosystem. Our book details the problems that DeFi solves—centralized control, limited access, inefficiency, lack of interoperability, and opacity. We then describe the current and rapidly growing DeFi landscape and present a vision of the future opportunities that DeFi unlocks. Let's begin with the problems. Five Key Problems of Centralized Financial Systems For centuries, we have lived in a world of centralized finance. Central banks control the money supply. Financial trading is largely done via intermediaries. Borrowing and lending are conducted through traditional banking institutions. In the last few years, however, considerable progress has been made on a much different model—decentralized finance. In this framework, peers interact with peers via a common ledger not controlled by any centralized organization. DeFi offers considerable potential for solving the following five key problems associated with centralized finance— centralized control, limited access, inefficiency, lack of interoperability, and opacity. 1. Centralized Control Centralization has many layers. Most consumers and businesses deal with a single localized bank which controls rates and fees. Switching is possible, but it can be costly. Further, the U.S. banking system is highly concentrated. The four largest banks have a 44% share of DeFi.