DeFi is a Better Version of Finance
There has been a lot of talk about the applicability of DeFi in replacing the traditional banking institutions. However, in understanding how that might happen, we wanted to look at the conditions that DeFi would need to overcome in order to do so. Specifically how should we think about liquidity?
First, consider the practice of buying and selling a house. A home owner can set what ever price they want to their house. However, if there are no buyers for that house, we can definitively say there is no market and therefore the house is illiquid. Instead, additional factors such as school districts, “comps(or similar houses for sale),” lot sizes, house condition, age, last sale price and a myriad of other things are considerations for setting the actual price. In effect, these factors are the basis for determining the speed at which the house is able to become liquid or not.
Using this example we can define three factors that define asset liquidity.
- Market: If a market is over restrictive or insufficiently small, then there really isn’t a market at all for that asset. An asset that is unable to be sold because there isn’t a buyer (or enough buyers) is an illiquid asset. The number of buyers for that house needs to be sufficient in order for the desired price to be attained.
- Price Factors : Price and liquidity is inversely related. Going back to the housing example, if a house isn’t able to be sold, the seller ends up lowering the price of a house to a point that it can be sold. Inversely if the price of the house keeps going up for no reason, then we can reasonably say there is not going to be liquidity for that house.
- Time: Most companies that sell products often take a delayed approach in collecting their accounts receivables. Thirty day invoices, sixty day invoices and so forth are common terms. However, during that waiting period, the accounts receivables can be sold to obtain immediate funding. Therefore the liquidity of assets is actually related to the time of funding recovery.
Exchanges and Banks
The ability to exchange goods/services and receive a fair price for them is central to the flow of money. No matter if it is a gold exchange, a foreign exchange or a futures exchange, all types of exchanges share the following two characteristics.
- First, a large enough market must exist. There must be sufficient number of participants in the market for orders to take place.
- Second, the price must be transparent. If someone sees a price and they want to sell it, the mechanisms and processes are in place that allow for them to quickly close their position and get their money immediately.
Banks, financial institutions and insurance companies act as an exchange where buyers and sellers can come together. More importantly, these institutions are able to provide immediate liquidity. That access does come with stipulations. For example a financial institution can exclude anyone from receiving the credit required to buy a house based on their personal profile and more ominously, prevent them from ever entering the market — which invariably reduces the overall liquidity of the entire market. How these profile assessments are done is usually in the form of a black box with very little transparency.
Transparency Leads to Liquidity
If banks and financial institutions are the gatekeepers to traditional liquidity, we can argue that DeFi is actually better than banks in providing transparent liquidity.
With DeFi, the market is completely transparent. Every transaction that takes place upon a smart contract is certain and open. It does not require a financial statement to gather information on the current financial status of a transaction. Rather, anyone can have open access to the same type of information without an intermediary. This in turn increases credibility as all participants has an incentive to trade, therefore increasing the overall liquidity of the market. If a person wants to buy, they are able to do so. If the person wants to sell, nothing is stopping them. Hence, transparency is a big part of liquidity.
An investment that you made is open to yourself and to the entire market. All traders who partake are also transparent, which de-incentivizes anyone from secretly manipulating the market to their benefit. Everyone is equal. Because no IDs and personally identifiable information is exchanged, markets are not able to restrict an individual based on PII attributes. This is transparency at its core and in turn, a more freer exchange of liquidity to everyone in the market.
Borderless Mobility
Our money is usually locked in multiple financial institutions and is often inaccessible at the exact same time. You may have some of your money split between banks A and B. Part of your income could be used to pay for insurance stored in insurance company C. Lastly, you may have money being used in stock exchanges so that you can purchase stocks D and E. While technically this is your money, you can’t access it immediately.
This problem simply doesn’t exist in DeFi. You can escrow funds through a smart contract, buy financial assets, and even purchase assets from multiple exchanges at any given time. These smart contracts allow for the existence of exchanges, lending/borrowing, derivatives and insurance but with the added ability to use the funds for transactions on multiple exchanges without having to hop across different intermediaries. In addition, funds can also be transferred between markets such as loans and derivatives insurances without any additional steps.
In effect, this enables capital efficiency and promotes competition amongst different markets such as transactional fees and product prices. In general, DeFi promotes liquidity and promotes the willingness of market investors. This is the benefit of DeFi through borderless liquidity.
DeFi is a Better Version of Finance
We’ve discussed how DeFi encourages liquidity in the market, but how does it benefit society as a whole?
In the discussion above, we’ve determined that improved liquidity benefits finance. In prior generations, raising money across borders was a heavily scrutinized activity and mainly available to larger enterprises with credit. Often times financing was through the issuance of bonds, stock or a company had to IPO — typically activities that SME’s are not immediately qualified for.
With the global credit gap at over $2.5 trillion dollars, based on calculations by the IFC, DeFi provides opportunities for SMEs who would fall through the cracks in traditional finance. Rather, DeFi allows these SMEs to prosper and provide additional liquidity into our society.
Ultimately, the goal of NAOS is to provide opportunities for companies who fall through the gap while closing the overall credit gap. We seek to leverage the potential of DeFi, lessening restrictions and allowing the community to make decisions that will benefit everyone. We are creating a natural market for the community. In doing so, we are doing our part to provide increased liquidity.
About Coffee Shop DAO
At Coffee Shop DAO, we are placing our bets that we can be the ones to incentivize users from traditional institutions to take part. By tokenizing high quality real world assets that are safe, secure and fully insured, our team is focused on easing the high technical cost of entry for institutions and corporations alike. Ultimately our goal is to allow off-chain asset originators to easily bring their loan requests to the community and enable crypto lenders to fund these requests by offering attractive guaranteed yields. There’s more to come as we are working our way to launch. We invite you to check out our lite paper on Medium or DM us on Twitter
