DeFi, CBDCs and Web 3.0

My perspective has been evolving as I work to build out infrastructure for “when Crypto grows up” in my new Company. I’m pleased to report that Accept Payments ( went live this month and is expanding our private rollout as we fine tune all of the CX. Thought for the day… Its about trust.. 

Thanks in advance for your comments. Merry Christmas!!

Environmental Analysis

The structure of Money and the laws under which it operates are undergoing transformational change(s). This change is not along one vector. Today bets are spread across Crypto/Defi, CDBCs, web 3, card networks, existing FIs, neo banks … etc. Why does this matter? Money is part of our social fabric; both the instrument and the system that created it must be trusted. Trust is central to our language, communication, structure of society, government, contracts, laws and relationships (see Data Tipping Point – 2018 for detail and examples). 

Tom’s Top 5 List  – Blockchain Based Innovation Impacting Financial Services

    1. DeFi/Crypto
    2. Government – New Centralized Schemes
    3. Federation – Small Communities
    4. Assimilation of new technologies by current FIs 
    5. Web 3

What is fundamentally different between these models? Trust and Control. As I describe below, each of these schemes has advantages and solves key challenges today. I believe each of these 5 will move at a very rapid pace, in different areas. My head spins daily trying to keep up.. What is real? What is meaningful? What changed?

Specialist intermediaries that connect disparate parties are at the heart of modern finance. These intermediaries bring together a range of financial market participants to connect providers of finance resources (for example savers, lenders, and investors) to those seeking financial resources (for example borrowers, entrepreneurs etc). DeFi provides a new model for both MARKET and SYSTEM to accomplish this. 

DeFi model has two obvious use cases: 1) Existing System, Existing participants – improve the efficiency of current FIs and 2) New System, New Participants (emerging markets). 

For example, the central securities depository (CSD) on the NYSE could evolve to a blockchain based record of stock transactions and current NYSE specialists adapt the blockchain and DeFi technologies to their current operations within the closed network of approved NYSE operators

Efficient financial markets develop where there is stable government, enforceable contracts and sources of capital. This “supply side” of capital sees a virtuous cycle of laws, controls (ex underwriting) counterparty trust, risk management, transparency with enforced oversight and reporting. On the demand side of capital, ineffective markets, laws and regulations, and infrastructure limits “qualified’ deployment thus limiting the market where traditional financial markets can operate. DeFi can address demand side flaws for BOTH the MARKET and the SYSTEM. 

For example, 50 yrs ago securitization enabled specialization and distribution of risk, thus improving management of bank capital (ie off balance sheet) and creating more efficient financial markets. Much of the trust in securitization was in the originator and underwriter (see related from NY Fed) as well as the Government backing the market (promise of purchase). In the US mortgage market, the US government held control as the market maker. 

New DeFi models for banking and financial services are being made along these same lines, operating with different controls and trust structure.  In DeFi, the market makers within emerging markets are: investors, impact funds and governments. These groups have a vested interest in improving access to financial services in emerging markets. 

DeFi is not just for emerging markets, but within existing financial markets. Existing FIs pour over $30B a year into innovation, unfortunately their products, processes and structures are rigid. As financial services become embedded, the world no longer wants to adapt to a bank, it must be the other way around. The systems of DeFi are open and enable a much faster pace of innovation for both closed and open networks.

Where as the definition of ISO 8583 standards in payments took 30yrs, 2 participants can agree on a message exchange set and smart contract in 1 day. 

Individuals and businesses don’t change payment and banking behavior frequently because financial markets are efficient. So what is the case for DeFi in existing markets? The rising cost of intermediation in financial systems (see blog and picture below). Mature markets have too much concentration within critical functions, which restricts smaller financial services intermediaries, and competition. This concentration is caused by increasing regulatory burdens, active defense/co-opting (of competing schemes) and ability to maintain control through high switching costs.  DeFi presents an “open switch” opportunity to smaller (regulated) market participants.

                            Rethinking Finance – Thomas Fillippon

DeFi remakes financial services on blockchain and crypto (see Wharton Article for great overview).  

For example, given Europe’s (ECB) penchant for improved bank competition (ie SEPA, PSD2, …etc.) I would anticipate an ECB CBDC in near term (if they can walk away from their past failures).  Whereas the US Fed, and associated regulators, seems fully captured by bank needs and will be a very late follower. In this way US will lead with Stablecoin’s like Paxos USDP.

CDBCs and Stablecoins are able to act within DeFi architecture to act as non-volatile instruments. Trust shifts to the issuer of the Stablecoin. This is not without issues as witnessed by Tether’s November downfall. CBDCs provide stability in value through a central bank (see my blog). But what is gained in stability is “lost” in control as trust becomes concentrated and country specific controls capture to ensure it does not represent a “threat” to traditional banking (see Facebook Diem). For example China’s CBDC has the potential to replace the USD in B2B trade flows (see blog). 

DeFi Beyond the Hype, Wharton, May 2021

Closed Networks and Communities

Small communities (think Venmo/Cash App) maintain financial connections within the context of a use, geography or affiliation. 80% of transactions within these systems are “on us” as in a closed network. Members are buyers and sellers, senders and receivers that retain a balance for transacting in the community. Citibank’s success in Global Transaction Services (GTS) is similar. They operate in over 130 countries, most for over 100 yrs. It is how governments and businesses exchange funds. Small communities don’t need a public blockchain, but only one trusted by the community. Story:

I had a very good friend working at a new “high speed blockchain” start up and called me for an intro to PayPal. I told him PayPal doesn’t need a public blockchain for its crypto efforts, PayPal merchants and consumers only need to trust a PayPal crypto token for “on us” (private blockchain). This is similar to the US bank system 200 yrs ago. Back then the US Central Bank didn’t print money, but rather it was the local bank, as 99% of transactions in a community were local. This community trust model is replicating itself (and is core of what I’m doing with my Acc3pt Payments). 


DeFi has the potential to reshape governments and societies as it enables trust and exchange of value based upon a distributed immutable ledger. This ledger can operate without regard for an understanding of the parties, the health of the intermediary, or the laws/boundaries of  governments. Trust is in the technology, open access, defined rules and distributed nodes. Value is not defined by Government monetary policies, gold standards, FX markets or assurance of repayment, but by scarcity. Enforceable contracts do not depend on geography or legal regime. 

I’m a big fan of DeFi. Why? 

#1 The world’s financial system has NOT done a great job at serving 6 billion of the world’s 7 billion people. As such I’ve been fortunate to work with many great people at the Gates Foundation, Omidyar Network, Elevar Equity, Quona and others who have a mission to change this.  

#2 The cost of intermediating financial services is going up ( see my blog). Proving that modern finance is one of the few networks in the history of man to grow LESS EFFICIENT over time. 

#3 Transaction Costs define the operating model. The economic theory behind this is laid out by nobel economists Oliver Williamson and Ronald Coase in Transactions Costs and Nature of the Firm. As discussed in Collaboration and the Sharing Economy, a reduction in transaction costs is leading to fragmentation of previously integrated companies (ie specialists win). Bundled services and products thus become easier to create as the specialists can assemble more quickly. 

#4 Money is embedding in process and our daily lives, yet banks still believe we need to adapt to them with the core constructs of banking similar to what it looked like 500 yrs ago. 

#5 Macro economic: Excess cash looking for risk today, the emerging markets have the need. The cross border channels, governments, enforceable contracts, access to legal system, and other traditional “infrastructure” in these emerging markets is broken. 

What is DeFi?

IMHO Matt Harris of Bain has done the best job of outlining what the future of DeFi looks like (see Medium post). In a perfect world without regulators, governments, existing banks, new market dynamics, traditional modes of work and consumption,  nor concern for changing consumer behavior ingrained for 10,000 yrs.. do I think pure DeFi will ever happen? no way… it is far too threatening to existing political structures. 

Note: The Block is the industry’s premier source of all information on Crypto, DeFi and industry investment. Also see “intro to DeFi” this medium post is fantastic. 

The core of DeFi is Blockchain. Blockchain enables a federation of trust and new forms of enforceable contracts. In this world, the need for trusted banks dissolves as managing risk and storing value is distributed across unregulated specialists. The trust construct is remade, shifting from the bank entity to: oracles, smart contracts, decentralized exchanges, scarcity, open systems and distributed ledger. 

Areas of Focus

DeFi has two obvious use cases: 1) improve the efficiency of current FIs and 2) emerging markets with ineffective capital markets, systems, governments, laws and enforceable contracts. Within the first use case, the trust structure is not changing and DeFi is deployed to remake processes among existing participants in a “closed market”. In my opinion this is the fastest growing deployment in the US, with focus in capital markets and some commercial banking. The potential value unlocked surrounds speed and efficiency.

The emerging market track is much more revolutionary, with global societal impact. Today modern financial services does an adequate job of servicing 1B of the planet’s 7B people. DeFi is a model that can serve everyone. The relative stability of this structure could insulate participants from the gyrations experienced in Turkey, Venezuela and now Brazil. The ability of money to operate independent of control would diminish the role of governments and their controls in policy and taxation (thus actively defended, as exemplified in China’s crackdown this year).  The primary shortcomings of DeFi surround: 1) the volatility of Crypto Currencies 2) the ability to interoperate with traditional banks and 3) trust/certification of Oracles and decentralized exchanges. These issues can be managed, for example stablecoins in place of Crypto and regulated banks (or Central bank) operating on DeFi Networks (example Equador). 

The biggest hurdle. Beyond control, the ability to track exchange of money is core to 100% of tax revenue. While governments will be hard pressed to stop individuals from operating in shared ledgers or holding crypto, they are well placed to manage the “switches” converting value to fiat currency or regulated companies. Thus CDBCs have developed to co-opt the DeFi Trust and Control model… CDBCs modernize the money (like crypto) but place the central bank as the key switch. 

Thus my current projections

  1. US will have success in DeFi with Stablecoin. It will be regulated. The US will also be the home base of most new DeFi companies.
  2. Emerging markets will seek to operate in “pure DeFi” with the most significant progress of any near term opportunity (relative to current capital flows/consumer products). Emerging markets will allow this DeFi model to improve trade and investment flows into their market.
  3. Europe’s PSD community will prompt action on an ECB CBDC and will evolve more quickly than US.  There will be a 20 yr evolution of SEPA into a DeFi structure with regulation.
  4. Chinese CBDC presents near term threat in B2B trade flows with over $2T at risk in next 2-5 yrs. This will have large policy implications (ie USD hegemony as commercial currency). We should not under estimate how fast these flows will change. China has the ability to serve as the market maker underwriting the risk and THE SOURCE of goods subject to new payment flows.

Investor View

Investors are looking to assess impact on existing FIs and also identify how these new systems will enable new capital flows.  As of the end of 2021… Don’t go selling your bank stocks just yet. Traditional Financial Services are regulated, transparent and efficient with highly capable. In most countries financial services attract top talent from today’s universities, and 99% of the world’s capital. Investment is finance attracted to environments with enforceable contracts, known risks, with standards in membership (ie auditing, capital requirements) and operating rules. 

This year over $30B of venture capital flowed into Crypto/DeFi.  The DeFi companies today are creating the infrastructure for the next 500 yrs of financial services. It is very exciting to see the quality of talent and the diversity of ideas contributing. However, as a former banker and pragmatist I don’t see DeFi taking over the world (yet). None of these new systems presents a near term risk to existing FIs, nor have they unlocked the “next Brazil”. The bets this year are on the systems, people and companies that will be successful in making this happen

The challenges faced by DeFi are not technical, but political. Disintermediating either Government or Financial Services can land you in jail. How will a new world order based upon DeFi co-exists with today’s existing financial services structures and central banks? How will it overcome the walls set by governments? Money drives control, power, commerce, government, society..  

Web 3.0

A topic for a future blog, but for today it is important to note that Web 3.0 is about decentralization, a great blog covering the relationship between DeFi, Crypto and Web 3.0 was written by my good friend Mike Dudas last week. Decentralization requires trust. 

For example in one of my Web 3.0 patents Graphical user interface for object discovery and mapping in open systems – US20180096417A1  Dr Cook and I saw search evolving away from Google and to a federated network of mobile devices. If you searched on “best red wines” you would care more about the top results of your 100 closest friends (red wine loving ones) than what Google provided. How do you share value across this network? How do you manage trust?  

I discuss this trust topic more in The New Economy: Small Wins (2016 one of my longest blogs). Value exchange and creation is the core of governmental, economic and societal structures. Open is a great technology model, and a very very poor business one. Why? See open banking open payments and trust networks (2021)

Comments appreciated

Post Script – Perfect DeFi

 This blog is written to my friends and former colleagues. I’m glad others find it useful, but please  remember my audience before flaming me. I make this point given the tremendous passion surrounding blockchain, crypto and web3. I’m outlining my questions and thoughts to people that know me. 

Will the “perfect DeFi” world ever happen? Imagine a world where there is no local knowledge and trust is perfectly distributed. Everyone knows what everyone else holds and what value they create. This would be a terrible place to live.. Perfect transparency is not a feature of a society that values rights and beliefs. No open system can maintain anonymity. As the digital advertising world shows, for every effort to anonymize there is a matching effort to de-anonymize. 

For example, If your employer pays you in bitcoin, and you pay in your local pharmacy with bitcoin you can get a very narrow view of who works at Company X, shops at CVS in midland. Eventually your value store becomes known. This is what happened to IP addresses in the advertising age. 

Its all about Trust.. 

2 thoughts on “DeFi, CBDCs and Web 3.0”

  1. There’s a lot to unpack here, so I can’t really do it justice. However, I think you do a good job at the end of pointing out the risks and obstacles to DeFi, Web 3, etc. What I like to call the “monopoly on the use of force” problem. Governments can put you in jail if you do something they don’t like, and that’s a hard problem that I don’t know has a solution. You have to think about how to overcome this problem, not go full speed ahead and hope a solution will present itself. Sanctions are a principal tool of geopolitical conflict, and anything that evades the control of SWIFT or central banks will be seen as a threat to national security. Beyond fostering innovation, why should governments allow this to happen? Once criminals and rogue states start using these tools (and they already are), governments will start to outlaw and restrict them. It has happened with every major financial innovation in my lifetime, and as long as we live in meatspace, it will continue to happen. Evangelists need to be engaging with governments and regulators much more seriously.

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