Every significant transformation comes with a new toolset, one that is always surprising at the time and obvious in hindsight. If we look at the past few years, we can notice that events around Bitcoin (BTC), the Black Lives Matter movement, climate change and GameStop — to name a few — are individual vectors of the same movement that highlights the need to refine inefficiencies of current systems and drives solutions led by an aggregation of individuals with a collective belief.
This follows the recent events in which certain users were unable to access platforms such as Reddit, Parler and Robinhood. Although these practices are commonplace in traditional internet and finance within a narrow context, we also need to consider the possible implications when we take a broader perspective of access restriction in other areas of our society.
In the example of Robinhood, what was brought to light is a currently established process that can make it difficult for brokers to handle an urgent request for an increased amount of collateral by clearinghouses. A sufficient collateral amount is necessary to settle trades, and since Robinhood and some other brokers didn’t have enough cash, they had to restrict buying high-flying stocks like GameStock. To ensure similar occurrences won’t happen in the future, perhaps brokerages should have higher margin requirements. Another thing that came to light is that brokers like Robinhood, E-Trade, TD Ameritrade and others engage in a practice called “payment for order flow” that enables commission-free trades for their users but also, at least in theory, could lead to a conflict of interest with a broker’s best execution obligations. The practice was restricted in the United Kingdom, and according to the CFA Institute document, this removal of potential agency conflicts should lead to more efficient order-handling practices and a more competitive market for retail-sized orders.
In the meantime, while these practices might be required and well-thought-out, if occurrences like the GameStop event prove to be more than just a momentary anomaly, we might presently be witnessing the need for the emergence of a profound change in the financial system. Decentralized alternatives such as decentralized finance and the subset of DeFi decentralized exchanges play an important part in this broader transformation. As financial technology companies make it easier for consumers to participate in financial markets, DeFi and DEXs are aiming to take that progress further by working on tackling the inefficiencies of centralized markets. And in some ways, this generation of DEXs may become the new Robinhoods.
Can DeFi and DEXs refine traditional finance?
In 2014, Bitcoin Foundation’s Harsh Patel published a paper titled “A block chain based decentralized exchange,” outlining how code, not institutions, could manage the trading market. The idea wasn’t new, but it came at a time when crypto markets were facing difficulties. Mt. Gox, along with many other centralized crypto exchanges, met its demise between 2011 and 2014 through hacks and loss of its users’ assets.
To avoid the flaws inherent in centralized crypto exchanges, a number of entrepreneurs sought to launch DEXs, supporting what would come to be the core values of DeFi: transparency, unfettered access to markets, and the option to participate in decision-making in the platforms they use through ownership of governance tokens.
Early DEX protocols functioned by utilizing smart contracts to facilitate cryptocurrency trading in direct peer-to-peer transactions. However, challenges, including lack of liquidity and poor user experience, prevented DEXs from becoming viable platforms for users. Today, iterative and innovative DEX protocols have made considerable strides to overcome those challenges and are shaping up to have trading interfaces familiar to traditional markets. For example, traders today can buy crypto with card and bank account balances directly with fiat on/off ramps that convert fiat to cryptocurrency and vice versa.
In addition, soon-to-launch DEXs will introduce features intrinsic to traditional markets such as market analytics, and trading tools like liquidity charts, trading volume and order book depth. These functionalities provide users with objective real-time data and insights into the trading landscape.
DEXs that utilize automated market makers — like Uniswap or 1inch — generate an equal playing field for all participants. There are no brokers, clearinghouses or centralized market makers; trades are settled peer-to-peer or peer-to-protocol without arbitrators, except those codified by smart contracts. And critically, there are no different sets of rules for different groups of players.
Access is also improved. Whereas in traditional markets, it can be difficult to gain entry due to the complex requirements for accreditation, a typical DEX requires little to no private information from the user. These standards offer a measure of privacy protection that otherwise isn’t guaranteed when handing over your personal, identifiable information to a centralized broker. However, this may change with more Anti-Money Laundering laws coming to DeFi and the regulatory environment remaining uncertain. But, teams are working on solutions to address both the compliance requirements and an individual’s desire for privacy, which enables users to retain full ownership of their assets and identity rights, and grants specific permissions to businesses to verify their identity.
Where are we heading?
Granted, innovation and regulatory frameworks around DeFi and DEXs are still in their early stages of development, and we need to make sure that they will indeed better the current systems, rather than do the opposite. We also need to ensure that the retail participants of financial markets have the necessary financial education. With that, DeFi and DEXs carry the potential to allow various participants unfettered access to the world of asset exchange — and not just for traditional blockchain tokens but also for public equities, commodities and derivatives.
What is clear is that we need to build more constructive frameworks so that we can move a few steps closer toward a more just, better-functioning world — be it through the development of decentralized alternatives or the refinement of the current systems. Perhaps this is one of those moments in human history where the interests of the people, and not the status quo, will define the future.
Update: This article has been updated to clarify that the GameStop event takes place within a broader context of changes within society.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.