Welcome to Invesco’s new series of articles, looking at the evolving themes in digital assets and investment management. In it, Dave Dowsett, Global Head of Innovation and Emerging Technology at Invesco, with contributions from Ashley Oerth, Senior Investment Strategy Analyst, explore the growth of Decentralised Finance in asset management, how this is possible, and what the potential implications are for the industry.
Decentralised finance or “DeFi”, may be a familiar term in the context of cryptocurrencies. It may even spark thoughts of crypto speculation and arcane workings of code. Yet what truly underlies DeFi is a trend that is reshaping how people think about and structure the financial economy more broadly.
The idea is to take traditionally centralised aspects of traditional money management such as decision-making authority, settlement, and recordkeeping and to introduce a decentralised approach. The goal being to reduce the potential for fraud, abuse, and corruption, and increasing efficiency and access.
DeFi accomplishes this by using a decentralised database technology, commonly referred to as blockchain. This technology makes it possible for users to access different types of financial products and services without the need to go through an intermediary, such as a centralised institution.
In traditional finance (or “TradFi”), participants rely on institutions and intermediaries in global financial markets for the issuance, trading, banking, and settlement of investments. DeFi introduces a shift in the trust mechanism to blockchain technology which introduces public verification of transactions, leading to greater transparency, efficiency, and speed.
In general terms, the advances in technology don’t change what’s happening - but how it’s happening it. For example, research from major central banks has highlighted the potential for blockchain-based transactions to accelerate payments and security settlement.
Another anticipated upside of decentralisation is increased matching of buyers and sellers. Not only that, but it should also allow greater depth and access to capital markets (as new liquidity sources are opened) in equally secure and trusted manners.
With all the buzz and recent headlines in this space, it’s no surprise some are left wondering what it means to participate in a so-called “trustless” system.
These systems achieve consensus through code and cryptography rather than relying on institutions to process and settle transactions. In other words, “trustless” systems disintermediate trust and distribute it across network participants.
Without sacrificing data privacy, a single version of irrefutable truth is recorded that can be inspected by selected parties but cannot be controlled by any single authority. The ledger ensures traceability, and the encryption layer has the promise of leading to better cybersecurity protections for capital markets participants.
Since the inception of stocks in the 1600s, advances in technology have progressively enabled the movement from paper shares to electronic trading to T+2 settlement1. The 2000s saw an acceleration that reshaped the industry from trading floors to electronic trading portals. It also brought increased data frequency and availability, and high-frequency execution speeds.
Now in the 2020s, blockchain offers the ability to record the ownership of assets in a publicly accessible, decentralised record. This “tokenisation” allows for the recording of ownership of any asset, whether it’s tangible/physical or intangible/non-physical. If an asset can be owned and has value to someone, it can be offered as a token and then be incorporated into the larger asset market.