Sat. Nov 20th, 2021

Facebook and Microsoft Corp.’s stuffy corporate idea of the Metaverse — think virtual offices packed with creepy Dorian Gray-like avatars — is nowhere near as dystopian as the cryptocurrency-fueled metaverse that already exists today.

This latter realm is the real head-spinner, as my Bloomberg News colleagues recently depicted. It’s a place that runs on decentralized finance (DeFi), a hi-octane $100 billion web of largely unregulated platforms that lend and exchange crypto for fees.

It’s a place where parents fret as their kids pocket real money on blockchain games like Axie Infinity; a place where virtual museums display art sold by real auction houses for eight-figure sums; a place rife with inflated prices, insider front-running and myriad frauds and forgeries. It’s a place where, for every interesting financial innovation, there’s a hack, rug-pull or wipeout just around the corner — the Squid Game token is only the most recent example.

The question now is how much longer this place, where real and virtual fortunes are made and lost, will stay a Wild West. Probably not very long.

We know from history that speculative frenzies have a habit of eventually fading, while rules and standards are never too far away from fast-growing financial technology. There was a time when peer-to-peer lending and instant online payments weren’t as supervised as they are today, for example. Regulators are already taking a closer look at DeFi.

In supervisors’ sights are crypto assets like stablecoins, which are managed algorithmically to avoid wild fluctuations in price. These serve as the fuel for some of DeFi’s raciest projects, like locking up crypto in trading pools offering ludicrous (and short-lived) 1,000%-plus annual yields, but also some of its most bank-like ones. These might involve an issuer buying real-world loans and bonds, backed by consumer debt or real estate, and securitizing them as tokens on the blockchain offering 5%-10% yield. (The issuer gets more crypto in return.)

You can glimpse the opportunity for old-school finance here: More automated and transparent processes, with fewer middle-men, might save money and help avoid the kind of shenanigans that led to the collapse of financial services company Greensill Capital.

But the reality today is that even these DeFi projects still come with significant risks. Sift through the fine print and it’s clear that a lot of things could go wrong. The counterparty chain is complex — one offering, for instance, features an India-based entity, connected to a Delaware-based entity, connected to a pool of crypto assets managed by another entity.

The more bank-like the DeFi project, the more likely it is that bank-like rules, and costs, will follow. On top of regulation, regular banks — so-called “TradFi” — are wading in. French bank Societe Generale SA is proposing to refinance a tokenized portfolio of covered bonds by borrowing from a DeFi platform. It would be the first such move by a major lender, and a sign the financial sector would rather co-opt than be disrupted by crypto-anarchy.

Read more.

 

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