Understanding DeFi: an interview with Lex Sokolin

understanding DeFi

The following article is an adapted transcript based on the audio recording of Season 2, Episode 7 of the Mr. Open Banking podcast. The audio version is available here.

Lex Sokolin is a futurist and entrepreneur helping to usher in the next generation of financial services, contributing thought leadership articles to publications such as The Wall Street Journal, the Economist, and Bloomberg. He also speaks regularly at industry conferences. Lex is also the host of SIGNAL, a podcast aiming to empower the technology ecosystem and share inspiring stories about the future of finance, crypto, and the Web3 world.

Previously, Lex was the Global Director of Fintech Strategy at Autonomous Research. Prior to that, he was COO at AdvisorEngine and CEO of NestEgg Wealth.

He’s also held several roles in investment management and banking at Barclays, Lehman Brothers, and Deutsche Bank. He holds a JD/MBA from Columbia University, as well as a B.A. in Economics and Law from Amherst College.

As the head economist of Decentralized Protocols at ConsenSys, Lex is an expert on DeFi, crypto, and fintech. In his current role, he focuses on protocol crypto-economics, digital assets, public and private blockchains, and as we discussed in the most recent episode of the Mr. Open Banking podcast, decentralized finance.

The rise of digital currencies

In case you haven’t heard, there’s an entirely new economy being built right under our noses. No, I’m not talking about fintech, digital banking, or even open banking, although it does play a role. These are mere background noise by comparison.

This brave, new economic world doesn’t run on dollars or pounds or rubles or yuan. It is open to anyone from anywhere and is fundamentally immune to corruption. And it doesn’t need banks — not central banks, local banks, investment banks, or any other kind of banks. Not the kinds we know today, anyway.

I’m talking about the world of cryptocurrency, entirely digital currencies, not backed by any state, which now have a combined value of over two trillion dollars – that’s trillion, with a T. While this still only represents about 0.5% of the roughly 400 trillion that is global wealth, the fact that there even is an alternative to the current system is something entirely new.

For those who think crypto is only about currency, think again. While that was true in the early days, more modern crypto-currencies aim much higher, providing programmable open platforms to build the financial instruments of the future.

These new tools aim to recreate and radically improve the centuries-old systems we have today, a movement that has come to be known as decentralized finance, or DeFi.

On this episode of the Mr. Open Banking podcast, Lex helps decipher the newly emerging world of DeFi, exploring its history, how it builds on top of crypto, its relationship to open banking, and its role in the even grander transition to Web 3.0.

The crypto ecosystem

Lex mentioned that many people today may still have the wrong idea about crypto. In reality, he explains, it’s an industry that’s anchored in hundreds of millions of people around the world and billions of assets from the largest financial institutes.

The real meaning of the word crypto is short for “cryptography,” which refers to complicated math that ensures privacy and security regarding sharing information online.

“Invoking this idea of mathematics and software and technology that is meant to give sovereignty and privacy and dignity and respect back to people when they are out there on their own in the digital world, surrounded by algorithms run by large corporations. You know, I think that’s the soul. That’s the Promethean fire of this industry.”

Lex explains the reasons bitcoin has captured people’s attention so strongly in recent years, noting that it was the first-ever digital asset. Bitcoin was the first breakthrough, but there has been a second that’s now causing the crypto renaissance in 2021.

He explains that not only can you not place a digital commodity onto a chain, but you can add computation as well. It’s possible to design software that can run on any program that is run by machines and decentralized nodes all over the world and syncs together on an agreement of shared truth.

Through this system, they can build software machines that are actually digital markets that can encompass any asset class, exposure, token, or object.

“And so, we’ve had this, again, a combination of being able to write software, which means transforming financial markets and media markets and the economy in general on top of these digitally native and scarce tokens, which essentially are absorbing the human economy into a new realm.”

This feature, as Lex explains, is commonly referred to as “smart contracts.” Cryptocurrencies that adopted smart contracts, like Ethereum, could be programmed; programmed to execute whatever behavior the coder wanted, automatically.

Suddenly, crypto-assets didn’t have to just sit there, like a pile of gold — they could be moved and worked, like a stock or a loan. This led to an explosion of new applications built using smart contracts, all of them decentralized across the blockchain, hence the name decentralized applications, or DApps.

It is these DApps that have formed the early fabric of an entirely new financial system. Far from being limited to digital currencies, DApps enable crypto to mimic easily the financial products that exist in traditional markets today. And then to build upon those products in ways that the existing systems simply couldn’t manage.

Some even believe that this digitally native system of value exchange will play a pivotal role in the evolution of the Internet itself, as it transforms into Web 3.0.

The emergence of these new tools, and the communities surrounding them, has been dubbed decentralized finance, or by its all-too-fitting acronym, DeFi.

Understanding DeFi?

The short answer to this question is decentralized finance — an umbrella term used to describe finance platforms that don’t rely on traditional systems like banks or brokerages.

If you’re looking for the long answer, we’ll have to take a closer look at traditional finance systems, the rise of cryptocurrencies, and the open banking revolution that’s happening globally.

Lex simplifies it: DeFi is a way for people to build financial instruments in a way that is radically different from how the financial backend of the industry is today. He calls it the first real breakthrough for the manufacturing side of the finance business as it allows global innovators to write open-source software to sell financial instruments digitally.

Essentially, DeFi is democratizing access to the type of machinery that used to only live within the investment management or capital markets or depositing large banks of the world. But Lex notes it’s not only about the usage — it’s about the community working together to innovate and improve on the software much more quickly.

“Just as an example, the value in DFI over the last year and a half has gone from $500 million to something like $75 billion. Today there is over $110 billion in stable coins, you know, and so there is a very large portion of the world which is engaging with these financial constructs as part of their regular portfolio.”

DeFi and open banking

Lex believes open banking and embedded finance are fantastic steps towards better user experiences, fostering competition, and allowing consumers greater access to their own data. According to Lex, open banking is the crowbar that separates manufacturing from distribution, allowing these wholly new DeFi products to be delivered to customers right alongside the old.

He describes DeFi as the manufacturing side of finance. Creating financial products in a way that is markedly different from the ivory towers where they are made today, aiming to replace existing players with something open, distributed, and continuously improved.

All at once, the monetary gymnastics that was once reserved for central banks and hedge fund managers is available to everyone.

Will this end up with the old and the new happily getting along, customers mixing and matching them as they please? Or will the new economy overtake the old, perhaps even replacing it altogether?

No-one knows.

As Lex says, “the best we can try is to do and bring it to bear.” Learn more about Lex and his work at https://consensys.net/.

Visit Mr. Open Banking @ http://mropenbanking.com.

To listen to the full podcast episode and subscribe via your favorite player, click here.

If you missed the first season of the podcast, click here.

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Head of Open Banking - Eyal Sivan is the Head of Open Banking at Axway, where he is responsible for positioning Axway as the number one thought leader and integration solution provider in the open banking space. As a member of the elite Catalyst team, he brings a high-degree of specialization in API and microservices technologies within the FSI sector and how they accelerate digital transformation.

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