Does Amazon for financial services make sense? On combining decentralized finance with traditional finance

Recent months have seen a battle of sorts between the proponents of decentralized finance (DeFi) and the more "moderate" advocates of the status quo. Each has, of course, its reasons, and reconciling them seems difficult, to say the least. However, in practice - as also indicated by various reports and discussions - the functioning of these two worlds in isolation from each other seems unlikely.

This is a result of many factors, such as generational change, the development of new technologies, or simply different expectations of customers. Also, the approach of countries to the issue of regulation, including AML/CFT, is not without significance. But what if it were possible to combine these two - seemingly contradictory - concepts and create a new model of the financial world, e.g. with the use of digital platforms, which is discussed in one of the recent reports of the Bank for International Settlements ?

Let's start by trying to figure out why "one" doesn't like "the other." Decentralized finance, which includes not only popular cryptocurrencies, by its very nature is based on the model of "de-mediation" of transactions, that is, minimizing the intermediary steps (and costs) during the entire process of transferring funds. On the one hand, this is an expression of "freedom" aspirations assuming the escape from the "supervision" of the state, and on the other - the "demand" to reduce the cost of transactions. That is why the Peer-2-Peer model is so fashionable now, although it should not be forgotten that even cryptocurrency exchanges are intermediaries in this process and charge for it - not small - fees. At the same time, often in the context of DeFi we talk about the risks associated with money laundering or fraud (including tax fraud), which occur here more often than in other sectors. Of course, we cannot exclude the possibility that they also occur frequently in traditional sectors, but they are less frequently disclosed. I do not judge.

At the other extreme, we have the entire financial sector, which is largely based on a banking system created centuries ago. In this model, we have many intermediate steps (e.g. in correspondent banking) and costs that are generated by intermediaries. It also means - unfortunately - longer transaction processing time, which is of course derived from the fact that each entity has to go through its procedures. The infrastructures used by specific entities, e.g. payment systems, which slow down the whole process, are also a limitation. Banks are often said to be technologically immature and "expensive" - unjustifiably so for the services they provide. Obstacles here include outdated technology (legacy systems), but also cultural immaturity and resistance to change. Both yes and no. I leave this issue for everyone to judge.

At first glance, it is obvious that these two worlds stand in opposition to each other, as DeFi assumes decentralization, while traditional finance emphasizes some form of centralization or at least intermediation in service delivery. In practice, however, at least in the long run, neither of these models will hold up, although the reasons for their eventual "failure" may be quite different. This is not a thesis, but only my assumption, so if someone ever "pulls" this article to prove me wrong, please take into account that we live in times of great uncertainty.

Decentralized finance revolves around ensuring the immediacy of service delivery and minimizing the necessary steps, including system steps, required to get the "job done." In a centralized model, on the other hand, we have a number of fund transfer requirements that stem not only from the Anti-Money Laundering Act but also from other legislation and regulatory requirements covering the supervised entity. This is important because, at least for today - in principle - providers in the area of crypto trading are not subject to specific requirements (not counting, for example, the obligation to register under the AML Act). The difference is therefore significant. And yet the same rules should apply to "similar" activities - the same activity, the same risks, the same rules.

OK, but enough about differences. What can connect these two worlds? Paradoxically, or maybe not at all, the idea of digital platforms that are gaining more and more importance in our lives. Quite a lot is said and written about the potential of such platforms in the financial sector (the EBA report from last year mentions the development in the next 2-5 years), both from the perspective of service providers themselves and end-users. Platforms - by their very nature - presuppose the existence of an intermediary who takes on some of the necessary stages of service delivery. A good example here are platforms like Amazon or Allegro, which on one hand offer the possibility of searching for products and their purchase, but also the possibility of crediting such a purchase or obtaining appropriate insurance (this is what we call embedded finance).

However, there are many more possibilities. Intermediaries, both the platforms themselves as well as entities that can offer their services in both B2B and B2C models e.g. via access interfaces - API, can relieve the burden of e.g. conducting the KYC/AML process, onboarding the client (Digital ID), or concluding a contract or transaction. And all this in a way that does not disturb the whole process and positive user experience (after all, everything takes place in the background or with minimal client involvement).

Platforms can have diverse characters. We can imagine ones that aggregate various products and services and enable quick "purchase" of a product or service, but also ones that compare and evaluate. They can also connect the demand and supply side (match-making), also in the Peer-2-Peer model. All in compliance with laws and regulations (although we must admit that this is a huge challenge given the different regimes that may apply). Business models can be very diverse, as platforms can, for example, make money by providing the platform itself or charge for "specifics". We also have freemium and premium options or subscription models, which are becoming more and more popular.

Here there is a lot of room for cooperation between the supporters of decentralized finance and traditional finance. Of course, I won't convince those who opt for full decentralization and lack of intermediaries and any requirements, e.g. in the AML area, but for those who see the potential in combining these two dimensions, maybe I will. In the long run, it seems unlikely that DeFi in its current form will remain intact. For no one is going to walk away from AML requirements or income tax obligations, as well as broader and more effective consumer protection. These are objectives that the state, and therefore the regulators, must pursue. The question is how it will look in the end. A complete ban - including in the long run - is probably out of the question (even if some jurisdictions are doing it or "threatening" to do it).

Platforms combining these extreme concepts may therefore be a kind of "pact", in which each of the parties will have to sacrifice a little bit of their independence or "profits" because this is what cooperation and creating innovative and safe solutions require. After all, it's not just about profit for the entities (by the way, the costs of Peer-2-Peer transactions are not the lowest), but also about creating a new, effective ecosystem for users. Arguing about the pros and cons of each approach seems unnecessary. It's better to focus on how to use these elements for building new finances. New, secure, and stable. We need this not only locally, but globally as well.