DeFi : Before the blockchain, Without Regulation, No Future..

Believe it or not, the blockchain age is America’s second foray into decentralized banking (DeFi). Long before blockchains, the United States was the last major industrial country to create a central bank. The Federal Reserve System was formed in 1913, more than a century after the Bank of England, and other major European countries already had their own central banks. Even though, the Fed was formed unwillingly following a series of financial crises.
Prior to the founding of the Federal Reserve, banking in the United States resembled the “Wild West,” with no regulation and no lender of last resort. As a result, a crisis at one bank might swiftly spread to others. The Federal Reserve was established in response to a highly leveraged short squeeze that went awry, rendering the financing business, the Knickerbocker Trust, illiquid. Knickerbocker’s failure triggered a larger stock market crash and a wave of bank runs.

Will Banks Prepare for a DeFi Future?

As in 1913, the notion that regulators had a role to play was not universally accepted. The argument was the same then as it is now: bank crises are terrible, but they are a type of market discipline, and crypto ecosystems, because they lack central banks, provide a better level of discipline and performance.

Cryptocurrency was meant to be superior to nineteenth-century banks. The tremendous openness enabled by blockchain technology should have shown which funds and organizations were operating on the margins, vulnerable to dangerous goods. Four factors conspired to make it difficult for a transparent, disciplined market to arise.

Four elements

First, numerous firms and protocols have begun to combine on-chain DeFi with uncontrolled off-chain centralized financing (CeFi). Instead of obvious and transparent on-chain components, the trail ends in off-chain assets.
Instead of explicit and visible on-chain components, the trail stops in off-chain assets that are unknown or, worse, committed to many owners. If an asset is pledged as collateral on-chain, others may see it. If the same item is pledged off-chain, a company’s obligations may be significantly more than what can be determined by looking at on-chain data.

As a result, if the company does not provide such information, judgments based on on-chain data would be dangerously incomplete. Some of this was obviously fraudulent. Much of it was proof of how poorly certain businesses scaled, as they neglected to separate money or manage their own operations. Some of the largest bankruptcy are unlikely to be completely publicized for many months and looked into it for us to find out

The development of the DeFi industry is critical since it is the future of banking.

Second, transparency has limitations. It’s great that completely decentralized and on-chain solutions can be read by end users. That does not imply that end consumers comprehend what they are purchasing or how to assess the risks. Only a small percentage of cryptocurrency consumers have the technical understanding (let alone the time) to properly comprehend the most sophisticated DeFi protocols. In summary, like in conventional banking, end users or depositors are scattered, and these institutions lack the monitoring competence to adequately discipline them.

Not only are most users unprepared to grasp protocols, but there can be no “flight to quality” without strong benchmarks and other quality criteria for financial services both on-chain and off-chain Banks must meet liquidity and capital quality requirements set by regulators, and the results are made public.

Finally, in the short run, markets are not rational. In the first half of the cycle, in early 2021, a speculative frenzy carried everything skyward, and despair drove individuals to sell swiftly in the subsequent drop, which began in November 2021 and lasted most of 2022. While logic may win over time, investors may not always act logically. The automated and networked nature of DeFi may also hasten the panic.

MakerDAO is an excellent example of a highly well-governed DeFi system that survived the worst of this crypto winter with little harm.

Maker, a DeFi loan system that issues the DAI stablecoin, only momentarily decoupled from the dollar and swiftly recovered. CeFi enterprises that have aggressively courted regulators and auditors with an eye on the long term are another type that has fared well. The reporting rigor necessary to obtain a Big 4 audit or to go public on a US stock market is a strong motivator for firms.

The development of the DeFi industry is critical since it is the future of banking. And banking crises cause far more systematic economic damage than other industrial concerns. The objective of financial systems is (or should be) to channel capital to enterprises that make investments, hence driving economic productivity and growth.
When they quit working, the impacts ripple throughout the economy. The 1907 financial crisis in the United States resulted in an 11% loss in industrial production and a 26% drop in imports. By contrast, this is roughly the same degree of decrease that occurred during the 2008 global financial crisis.

While the severity of financial crises did not differ much before and after the establishment of the Federal Reserve, the frequency did. Banking crises and panics struck the United States in 1819, 1837, 1857, 1873, 1884, 1893, and 1896, and virtually all of them resulted in recessions. However, there was just one significant crisis in the twentieth century: the Great Depression.

Thus far in the twenty-first century, we’ve also experienced one significant catastrophe, the Global Financial Crisis, albeit its impact was considerably less than that of the Great Depression, owing to then-Fed Chair Ben Bernanke’s vision and ideas.

The lessons for blockchain business ecosystems are abundantly obvious: Government-backed insurance schemes and fiat currencies founded on professionally operated central banks have no future unless they embrace regulatory compliance. Even the best-run businesses will be unable to absorb practically any amount of acceptable risk necessary to provide a reasonable return or multiply the value of capital. And without that, DeFi has no genuine future.