"Fintech Can Be a 1.5 Bridge Into 2.0 DeFi:" 11:FS Co-Founder Simon Taylor

Hello Defiers! Happy Columbus Day if you celebrate.

Sharing this past week’s podcast episode, where I interviewed Simon Taylor. Simon has the rare quality of being very knowledgeable about decentralized finance but also about fintech. He is the co-founder at fintech consultancy firm, 11:FS, and he previously led blockchain research at Barclays. He also leads the excellent newsletter Fintech Brain Food.

We talked about the main trends in fintech, from b2b fintech or banking as a service, to modular banking, to how every consumer app is basically becoming a fintech company with money at the core. This was interesting to hear because it all sounds very similar to what DeFi is building and trying to achieve, and there’s a reason for that. Simon points to a world where fintech and defi start to converge. All the capital and users in the traditional finance will have to bridged into crypto at some point and that bridge can be fintech.

He argues that DeFi gets lost in the yield and savings space, but Simon’s most excited about self custody, tokenization and what happens when everything’s an asset class, from digital goods to art.

At a time when there seems to be a wall between fintech, traditional banking, and DeFi, Simon helps find the similarities among these spaces and how they can benefit from each other.

🎙Listen to the interview in this week’s podcast episode here:

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🙌 Together with Zerion, a simple interface to access and use decentralized finance, Perpetual Protocol, which provides decentralized perpetual contracts for any asset, and HackAtom V, a two-week virtual hackathon organized by Cosmos.

Simon Taylor: I was always a gamer back in the day, so I was always building different machines out of Nvidia cards, ATI cards as it was back in the day. Even 3D effects, if you go way back, that's one for the nerds. But in 2009, I started doing a little bit of Bitcoin mining on the sides, but even by then with the GPU I had, it wasn't turning over a particularly large amount versus the electricity it was costing me and quickly, I give that up and forgot about it.

In 2013, I started seeing some things pop up around this thing called Ethereum and that really caught my attention. I saw the early video from Vitalik, and just all of the announcements around it, and I realized I hadn't looked at Bitcoin properly the first time and I went back and looked at it properly, and really tried to understand it from first principles.

That's when I sort of got the bug a little bit of this was a fundamentally different thing. They were changing the nature of how value is exchanged and settled, and it could be disrupted, probably not in a five-year time horizon, but massively over a 50-year time horizon. So I wanted to understand it because it was intriguing.

“They were changing the nature of how value is exchanged and settled, and it could be disrupted, probably not in a five-year time horizon, but massively over a 50-year time horizon.”

But I worked at Barclays at the time. At Barclays, I was running the Rise London Lab, which was essentially, the startup outreach program that Barclays was running at the time. Because of this, I was able to offer space, we had an auditorium about, I think it had 200 seats in it, and I was able to offer that to the London Ethereum community. Over the course of 2014, we had Vitalik visit, we had Gavin Wood visit, and a lot of the early Ethereum community in London really use that space as their base, and it was definitely a little bit of tongue in cheek trolling of like how we're using a bank space for free to disrupt banks.

But from a bank's perspective, we were learning. We're giving you the space for free, and we got to watch all of this community developing. Depending who you speak to, there’s enterprise Ethereum, and there's ETH, and some people will view anything that is corporate as bad. But from a corporate perspective, there was a load of cost and issues inside the organization that this new technology could start to resolve, so I got involved very early.

When I went back and told the folks in Barclays what was going on, instead of them saying, oh, well, that's scary and risky, they said, okay, see if you can figure out how you manage the risks, see if you can take on the really big questions. That really led me down a voyage of discovery of how you try and make the world of law and finance fit with this incredibly disruptive, incredibly creative space. That has always been where I found myself sitting, so it's a nice place to sit.

CR: I don't know if you can condense this, but what are the main lessons that you got from that?

No Day Walkers

ST: I think the summary way of putting it is there are not many day walkers. There are not many people from banks that really deeply get crypto, and there are not many people from crypto that really deeply get banking. You can probably list maybe 100 in the world. A good friend of mine, Colin Platt is one classic example. These folks are deep in the world of DeFi at the moment, they understand it as well as anybody in the world, but they come from a capital markets investment banking background, and they see both sides of it.

Actually, I think the pure DeFi world, the pure crypto world views everything in banking as quite negative, some quite often, not everybody, but there to be disrupted. The banking world often views the crypto world and especially the DeFi world is too scary, too hard to use, never going to be regulated, we can't touch it. The reality for me is somewhere in the middle. That's the key observation.

“… the pure crypto world views everything in banking as quite negative, there to be disrupted. The banking world often views the crypto world as too scary, too hard to use…”

You can apply that to regulation, you can apply that to technology, almost any subject you want to cover. We have seen this movie before. Yes, some of the fundamentals have changed because of the new technology and the crypto-economics and everything that enables, but also, you're still dealing with humans at some point, and you're still dealing with numbers, and there are some things we've learned from the old technology that we should build upon. That sort of look at this from first principles, kind of mental model is still really, really useful. We can double click into to what that means, but I think that's the high level.

CR: Before we get into all those details on DeFi specifically and what can DeFi learn from traditional banking and vice versa, I'd love to just go deeper into just fintech itself. Because, as you've said in DeFi, we live in kind of a bubble where we're only looking at developments there and not really at what's happening beyond. I’d love to take this opportunity for you to tell us what are the major trends happening in fintech, this year, for the past 12 months that you think are the most exciting?

Because I think there's this perception in DeFi that there's nothing new in traditional banking, and that there's fundamentally a lack of meaningful innovation because the rails that fintech is building upon are really old, and so all innovation can happen at the margin. I think that's the common perception in DeFi, so would love you to answer that and maybe prove people wrong.

Banks are Struggling

ST: I don't know if I'm ever going to prove people wrong. But what I would say is fintech is enormous, and banking is really, especially in the pandemic, in a real sticky spot. If you look at the share prices of banks, they are really, really struggling at the moment. Bank's ability to be profitable is really not looking good for the next four or five years, they're really, really struggling and their business model is fundamentally troubled. Interest rates are at an all-time low, and their risk models don't allow them to lend in this market. They don't understand what good lending looks like. Because how do you lend at a pandemic? Nobody's ever done that before.

“Bank's ability to be profitable is really not looking good for the next four or five years, they're really, really struggling and their business model is fundamentally troubled.”

Banks have built their models of who they lend to based on hundreds of years of experience, and there's no map for where we are right now. You take those two things combined, and bank earnings, unless they've got a trading desk, they’re down 50%-60% from the previous year, bank losses are heading higher. So that's that side.

But then go look at PayPal, go look at Square, go look at the folks like that who have built fintech businesses, and their earnings are doing really well, they are continuing to grow. I think Square’s earnings were up 70% year over year, PayPal was up nearly 50%. These are massive, massive businesses. PayPal is nearly as big as JPMorgan by market cap, and I think Square is almost as big as Goldman Sachs. People haven't made that connection that fintech is mainstream.

That's I think threat number one. It's massive. So if it got massive, and it's now as big as the banks, surely, there's something we can learn from that. What is it that they did that the banks have not done?

“PayPal is nearly as big as JPMorgan by market cap, and I think Square is almost as big as Goldman Sachs. People haven't made that connection that fintech is mainstream.”

Start With the Market Problem

I think the banks are a little bit like the DeFi folks, especially come across, not all, but a subset, started the technology or started the business model on work back. Actually, what fintech did is they started the market problem and worked back and that's a fundamentally different space. What do I mean by that?

Square starts with we’ll help you move money, and we'll figure out how we make money later. But the first thing is, it's just too hard to get money from A to B, let's figure that out; Paypal, similar thing, and then they figure out a whole bunch of ways to layer on financial products and lending and all that kind of thing as a secondary consideration.

So they started at the customer, solve the customer's problem, and then figured out what's the tech we need and then figured out how do they make money.

Banks, the answer to the question is they make money by taking deposits and lending, but it almost doesn't matter what the question is. They know the answer.

I do find this with a subset of DeFi is that the answer is yield farming, the answer is lending, the answer, it's going to be decentralized, regardless of what the question is. We forget sometimes that there are problems in society to solve, and the things that go make it outside of their bubble, the things that make a meaningful impact on the world are the things that solve our society or consumers’ problems. Can we think about how we connect to that? To me, that's the big observation about fintech, number one.

CR: That's perfect. But the fintechs you mentioned, have been around for a while, PayPal, Square. I’d love to really, just to dig into what's new right now. What are the emerging trends? Who are the innovators right now in fintech? What are the new market needs that they're answering?

B2B FinTech

ST: Probably the hottest thing at the moment right now is B2B fintech, so this idea of banking as a service or banking platforms is probably more accurately described. So I look at companies like Synapse, Marquetta, I look at companies in the UK, like Railsbank, these are building API-first abilities to create a bank.

You go to Railsbank.com and you can create a working card, an app in a very short space of time. They provide a regulatory framework and umbrella for you to sit within, and you just need to focus on building the front end and interface with their API. Banking is becoming invisible.

“Probably the hottest thing at the moment right now is B2B fintech, so this idea of banking as a service or banking platforms.”

But then the other thing is, there's a lot more to banking than moving money around and payments in the app. There are things like preventing fraud, so a lot of users care about this. There are things like preventing fraud, account takeover, money laundering, there are things like dealing with risk, am I lending to a person that's going to be able to pay me back? So all of these sorts of things are now being built by specialists.

Everybody talks about, oh, well, the technology in banking is really, really old. Well, actually, there is now a fintech B2B supplier that does just about everything a bank does, and you can basically build a bank out of Lego bricks. You can construct a bank out of all of these newer suppliers and get to market a lot faster.

There's a really interesting company called hummingbird.co, built by the team actually, who was originally at Circle and built out their compliance program. So that team’s spun out and with the learnings that they have from the crypto world and being in the startup world, basically figured out how do we take and productize this thing and make it available to the rest of the market? That Lego version of banking is a realistic thing at this point. I think that's super exciting.

“That Lego version of banking is a realistic thing at this point. I think that's super exciting.”

Imagine, if you're going to found Square today, you could actually, instead of just doing the peer to peer app, you can build something quite complete. I know where DeFi is going is like unstoppable Lego bricks. These may be more stackable Lego bricks, but at the same time, I think that's super interesting trend to watch.

Generally, there's a third trend as well. So one is big, two with modular, three, everything is becoming fintech. It was Matt Harris at Bain Capital Ventures, who said fintech is becoming the fourth platform of the internet. First platform was the internet itself, the second one is cloud, the third one is mobile. He's saying that financial technology is as big and as important as the first three, which I think is huge. Of recent, Andreesen Horowitz have said every company will become a fintech company. This is major VCs are now baking their theses around finance will start to get embedded, the finance will appear at the point of need.

As an example, a company like Shopify helps you build a website. It helps you take payments on that website. It helps you manage logistics. They'll also lend to you, and they'll also give you an expense card to run your day-to-day business. So they’re not a bank, but they do financial services, and increasingly, that's where banking sort of needs to go. It needs to disappear and be provided by people who are solving your broader problem at least. So one, fintech is big; two, it's modular; three, everything is fintech.

“[Banks] needs to disappear and be provided by people who are solving your broader problem at least. So one, FinTech is big; two, it's modular; three, everything is FinTech.”

CR: Leaving out the big part, the modular part and this idea that money needs to be ingrained in the way the internet works, that's exactly what DeFi is going for and people building in DeFi perceive that DeFi’s edge or advantage. The fact that it can be open source and composable and people can build on top of each other and use each other's pieces, and at the same time that this base layer has money built into it. These networks are made to transact and to transfer money from point A to point B unlike the internet protocol that we're using today. So it's interesting to see you talk about, non-blockchain fintech and these are the same traits that you're seeing.

Merging DeFi and Fintech

ST: I think that's super interesting, because I've been a big believer in convergence for quite some time, that the macro trends will come together, that DeFi and fintech will sort of find its middle ground. You can see the early stages of this in, again, Square Cash, allowing you to buy Bitcoin, but also Robinhood and Revolut.

Fintech, it's sort of moving to where Coinbase and some of the wallets were four or five years ago. Actually, why doesn't that come together? The interesting thing, depending on where you're standing, there's either an on-ramp to crypto, or an off-ramp from the old world of finance, but all of the capital and all the users are in the old world of finance, for me, that's going to have to be bridged at some point.

“…all of the capital and all the users are in the old world of finance. For me, that's going to have to be bridged at some point.”

Now, you can build an alternate universe and grow that alternate universe to a certain size and scale, and maybe you never have to bridge the two, but I would imagine at some point, you're going to have to. DeFi probably has quite a ways to run before it has to really be backwardly compatible in any way, shape, or form. But fintech actually becomes an interesting bridge in sort of 1.5 technology, if DeFi finance 2.0, it becomes a really nice space where it's sold for consumer problems, it's sold for business problems and market problems, and it's really deeply understanding the customer.

It would quite happily work with better rails if somebody could provide them. Why it doesn't surprise me that Jack Dorsey spending so much time looking at Bitcoin and crypto, and they have Square crypto and kind of that whole Blue Sky initiative, because they are really trying to look for tech upgrades and rails upgrades, because most of the financial services stuff was kind of built in the 70s. But there's probably more value for financial services businesses dealing with that just because of the scale and the money involved. But if you're a fintech, that inflection point is going to come.

CR: What value do you think DeFi can bring to Finance 1.5 and vice versa?

Beyond the Petri Dish

ST: There's an interesting question: when does a stablecoin become more efficient as a way of moving money than the existing rails? What people often forget about the ways of moving money around existing rails is the scale involved. So whilst the individual fees of it costs $40 to send something or it costs via a remittance platform seem really, really, really expensive, you've got to remember that those rails sometimes are the same rails that are often used to move millions, if not billions of dollars in a single transaction and trillions in a given day. So it still absolutely dwarfs all of crypto. I know we get excited by market cap, but market cap is a false number, look at volume. You look at the actual trading volume in crypto, it's still incredibly small compared to the global economy; growing, not insignificant, exciting, but incredibly small.

“What people often forget about the ways of moving money around existing rails is the scale involved (…) It still absolutely dwarfs all of crypto.”

So most of the game in financial services, actually, the value add is at the margins. The way you stuff a lot of these problems is with accounting. So you start getting into things like netting.

Netting is an idea. So when you net off transactions, basically, what you're doing is you're pushing it up to a layer two, but you're doing it with a spreadsheet, or some other technology, rather than doing it with an actual messaging layer. So let's say bank number one and bank number two, may be doing millions of different transactions between each other every single day. Rather than trying to keep up with all of those transactions on 1970s technology, what they'll do is they'll just get to the end of the day and they'll figure out what the difference is and then if bank number one net owing bank number two money, they just move the net value, they just do one single transaction for the net value; it's layer 2 scaling for banking. Layer 2 scaling has been around as an idea for decades, it's not a new thing.

What I think is interesting about financial services is you see that it has emergent properties, and people don't recognize the similarities between the two, and actually, layer 2 scaling is netting, netting has layer 2 scaling, it's just using different technology. But actually, netting is incredibly powerful in the financial system, it doesn't solve all of the world's ills, but it is incredibly powerful. There are ways you can dramatically reduce costs without necessarily changing the technology.

“Layer 2 scaling has been around as an idea for decades, it's not a new thing (…) There are ways you can dramatically reduce costs without necessarily changing the technology.”

For example, a company like TransferWise, they're able to reduce a lot of the hidden fees and remittances around the world to be competitive with anybody who's got a stablecoin offering, because they now have volume and they have a number of users. Now, would they want to be users of a stablecoin platform? Yes, maybe one day, but for most of their customers, those users couldn't use the stablecoin, so they've got an adoption problem. The on and off ramp then becomes really important to a company like TransferWise.

This is why I think in order to really get adoption, we have to understand these 1.5 areas and how would we get this beyond the petri dish? How do we get it beyond this is a really niche way to speculate and really niche asset class? It's a really niche way to buy an option on the future. Bitcoin is arguably become digital gold, somewhat mainstream in that sense. It's used in 401Ks, like that's lovely. But what other problems we could actually solve with this stuff? That's where it gets much more interesting.

CR: What do you think are the main problems that DeFi can solve for the everyday person right now? You mentioned, stablecoins, and I guess that solves the problem of having cheap international transfers, to me, that's one thing that it definitely does better, maybe savings anywhere, like getting a dollar-based account or curious what your thoughts are on?

Modular Rails

ST: I mean, it's modular rails. How do you make the rails of financial services modular and Lego? How do you make them compliant? That's going to be a controversial opinion, because different countries have different laws and rules. You might not agree with one country's you might agree with another's or you might just think rules are bad, period.

“It's modular rails. How do you make the rails of financial services modular and Lego? How do you make them compliant?”

But go back to first principles. Why did those rules get put in place in the first place? It wasn't because, in my opinion, it's not because there's an evil shadow, a second world government that's trying to control our lives, it was actually much more to do with trying to keep up with some level of public opinion. It's an imperfect system democracy, but ultimately, regulators are there to prevent buy things from happening. They may not be succeeding. There may be a million things wrong with it. But why is it there? Understand why that thing was put into place in society in the first place.

There are a number of things that we could do, if we got really creative to start to solve some of the reasons. I'm trying to send money from A to B, I sent it to the wrong person, what happens now? I didn't mean to, I had a fat finger. Think about your grandparents using this stuff. Unfortunately, not everybody is tech-savvy, and the problem with being your own bank is you can have your own bank robbed.

I think there is a perception in crypto and in DeFi to a certain degree that, well, if I'm sophisticated enough to kind of run this rat race and be okay, then everyone else should be, survival of the fittest, which is fine. But you're never going to scale that thing, you’re never going to change the world with that perspective. So there are a number of good wallets that are building better user experience, that are trying to bring in the mainstream with DeFi savings as people are calling it.

I don't know if that's the right approach. I think getting a different marketing for what that asset class is and understanding why it works. But let's just step back and go to what problems in society need to be solved. If we had sort of composable financial services rails, I think that's a really interesting conversation to have, to which I don't know the answer, but that's why I find it so exciting.

“There is a perception in crypto and in DeFi to a certain degree that, well, if I'm sophisticated enough to kind of run this rat race and be okay, then everyone else should be survival of the fittest. But you're never going to scale that thing, you never going to change the world with that perspective.”

CR: So to you, you're not sure what exactly are the big use cases or problems that DeFi can solve, but that the answer lies in this composable finance that it has the potential to build?

Lost in Yield

ST: The answer lies in there somewhere. I get excited by direct custody. This is the idea that a financial institution could custody their own asset. Why is that important? Well, today they're relying on custodian banks and a number of other intermediaries and you create a lot of efficiency there in world trade. Tokenization is super, super interesting, especially if you can make everything tradable.

I get excited by what happens when everything's an asset class. How do you create rule sets around that though? As people talk about the metaverse in gaming quite a bit about, how do we make digital goods and art really, really tradable with the NFT space? Again, all very, very interesting.

I think, DeFi gets lost in yield, savings and kind of that space, but from a mainstream perspective, where's the value going to be? I think it's going to be solving problems in either the gaming space, in the tokenization space or both. So there are some other perspectives out there. But I just don't know what's coming first.

CR: It's all so new. I mean, super hard to predict, obviously. So you've touched on the roadblocks to get there, to get DeFi to mainstream, and regulation is a big one. These adoption on-ramps is another one. Can you talk more about these roadblocks? I guess, particularly interesting is regulation from your perspective since you know more about how that works in traditional banking, how do you think DeFi can bridge that?

Banking Regulation Opportunity

ST: Let's start out how does regulation work in traditional banking. Because my answer is not very well, unfortunately, and I think this is a huge area of opportunity for DeFi and for crypto more broadly.

This isn't all the fault of the banks, but regulation is typically passed by countless regulators in countless countries. If you're a global bank, you have to figure out what to do with that regulation. So what will happen is when a new regulation is produced, banks will put a policy owner in charge of that, and it might be the anti-money laundering policy on or maybe the cybersecurity policy. But somebody has this thing called a policy. A policy is a written document that basically contains the internal rules that the bank will apply whenever dealing with this subject or this area of risk.

Then what happens is, auditors come in and audit the bank to make sure that that policy has been followed, and then put in a series of processes and committees to make sure that's happening. Sometimes that's managed by spreadsheets, sometimes it's more automated, but quite often, what you're finding is that when banks don't have a system that can already do it that’s been around for many, many years, for example, something that works when you go and try and buy something with Visa or MasterCard from a website that has been put on a blacklist somewhere, Visa or MasterCard can automatically reject that, or your bank can automatically reject it. So there are some things that are automated. But there are some other things that just fall into a queue for a person to review, and then figure out what to do with it, or even to take to a committee and figure out what to do with it.

So point number one is, I don't know how effective regulation is, it's certainly the least worst option to date and it's good thing that it's done, but I don't know how effective it is.

DeFi Helping Reduce Risks

What could we do about it is a good sort of second question. Because there's a real move in fintech at the moment, there's a subset called RegTech, which is regulatory technology. How do we use data to start driving some of the decisions and some of the risks that are around financial services? There are risks like credit risk that is, can I afford to make this payment, that DeFi can potentially help settle? Because we've got a shared record, we know exactly where those tokens are held. Am I going to be good for it, or am I not good for it.

Settlement risk; will I get paid? I'm going to put my name up for this transaction, I'm going to send you the goods, but am I actually going to get paid? Well, again, DeFi can potentially really help with both credit risk and settlement risk. Can I afford to pay? Will I in fact, get paid? DeFi can play some interesting roles there. I think it's probably non-controversial to a DeFi community that well, you get that out of the box. That's kind of what it does.

“DeFi can potentially really help with both credit risk and settlement risk.”

But then I look at companies like Chainalysis and Elliptic and others that are now increasingly the crypto forensic companies that are coming to DeFi and trying to prevent financial crime risk, prevent money laundering, and that is a little bit more controversial, I think in some areas of crypto. Because it's like, well, no, now we just bring back the state and the government. But I step back to why is regulation there. What's the first principle we're trying to solve for?

I think at some point, there has to be an acceptance that the world is not me, I am not the world. My worldview is not shared by everybody outside of the window. So why were these rules put in place? What is it that society wanted at the time? Is that fundamentally different from first principles? What can we solve? What are these risks? I'd go down sort of the major risks that financial services think about from, can this customer afford to lose the money that they’re borrowing? Are they good for paying it back, so affordability? Is this somebody that is not dealing with the proceeds of crime, or is not financing terrorism, or is not potentially arms dealing?

There are some folks in crypto who are genuinely like, I don't care. But guess what, most of the world does. I think, actually, how do you solve those problems with these Lego bricks becomes a really, really interesting question. So I guess to summarize, stem back to why regulation exists, and then figure out if there's a better way of solving those problems that society has with the new tools that we’ve got.

CR: No, it's definitely interesting. I think, it's a really hard problem to solve in DeFi, because I think some of the basic principles around it are made to go against blocking people getting into these applications. It's meant to be open finance, everyone can access it, it's a decentralized public network. I'm not sure how these companies can balance those two visions, because I agree for DeFi to be used more broadly, it needs to deal with those questions.

Responsibility of Building

ST: That's exactly what they are, they’re questions. I don't think there's anything fundamentally wrong with more open more transparent financial services, and money movement and value movement. I think you have to go long and far to find somebody who disagreed with it. But how do you prevent the financing of terror or human trafficking? Do you want to prevent it?

If the answer to that is, well, I'm just building these rails, well, recognize that you're splitting the atom and that could go both ways. It could have massive consequences. I think it's a tad naive to suggest what I'm just building the technology and somebody else will deal with the consequences later. There is a responsibility of building some of the technologies. Maybe it's not quite the same people. Or maybe it gets solved later as the thing scales. Maybe it's not solved in the rails itself, it's solved by the apps or the end-users. Maybe the assets get adopted, baked in, who knows? There are so many possible answers, but I think it's interesting to play with the question.

CR: Totally. I think having this big piece missing is still decentralized identity, or just an identity that fits into DeFi. Because once you have that, you can trustlessly start to segment applications based on users. If you have a decentralized credit score, maybe that user will be able to access some financial DeFi services that others can’t. If you have some sort of verifiable record of where that person got their money from, without having a centralized entity have to tell you, that's maybe a DeFi way of doing that, but we're still missing that piece.

Decentralized Identity

ST: It's a very hard problem to solve. I know the work of the Sovereign Foundation, and the works of Evan M. and many, many others are trying to solve this. But I'd agree decentralized identity is the Higgs boson of the global financial system. You figure that out when everything else makes sense. It's also the hardest problem, like the Higgs boson was. It's such a multi-layered, complicated problem, complex problem, that it's not going to be solved overnight.

“Decentralized identity is the Higgs boson of the global financial system.”

But I do sometimes worry that in the DeFi space, we go with decentralized identity, we’ll solve that. Actually, if you can solve that you do a lot better financial rails, you build better everything.

I think fundamentally, we make the social contract between people and each other, people and country, people and state. Because right now, the legal definition of identity in most countries is when a sovereign nation points at a legal record and a photo of an individual and says this face represents this number on our records that was in fact born in our country or immigrated at this point in time, the definition of identity is centralized itself. Yet the UN under Sustainable Development Goals and many others are quite open to alternatives to how we can manage some of that risk.

There's nobody standing in the way of decentralized identity. What people are standing in the way of is saying, there is no role for centralization in the future. Actually, if a very large trader or company or some other entity wants to point at something else and say I trust this thing that should be within their remit to do that, and that thing could even be a country. But actually, if that orients more around the person and their digital identity, then that can be super interesting, and doing so in a privacy-preserving way would be phenomenal.

Actually, probably the biggest pushback you get is from big tech, because of their business model would be broken under that model. From a bank's perspective, they would quite like digital identity, they would especially like decentralized identity, because so much of their cost and risk is wrapped up in not knowing who their customer is.

If you could say that personally identifiable data is something that banks A don't have to hold anymore, and B, they could dramatically reduce their risk of money laundering and dramatically reduce other risk in the process, that's not the handoff. Because if you look at the fines that the banks have gotten, it's all been about anti-money laundering rule breaks, which is they didn't know their customer. Even though they might have got a passport and try to find out who the person was, that system is just so unbelievably broken, and it's not privacy-preserving, and it's ineffective. Fix that and then you fix a whole bunch of other stuff, and I think you can do so in a way that's privacy-preserving.

CR: We're finding the same thing we did with Layer 2, here’s another bridge between both worlds and how big banks would also find decentralized identity useful. I hadn't even thought of that. For any genius listening right now you need to solve this problem right away, seems like everyone is going to use it.

ST: I think often people see, and it's very easy to paint banks as the villain, but they forget that that's a legal entity with more than 100,000 people inside it, all with their own lives and complexity, and sophistication, and worldviews, and politics and sports teams.

The problems are very, very similar. I'm a big believer in first principles thinking. Actually, by understanding another worldview, you can identify those first principles much easier, which is why at the start of the conversation I mentioned, day walkers are rare. Because when you see both worlds, you can't help but see the similarities, and you kind of want to keep showing the other side the similarities. Basically, that's what I really enjoyed it.

CR: Talking about big banks, there's always this question in DeFi of, will they start to offer DeFi products? Will they start to compete with DeFi protocols at some point? Or will it be DeFi will start to eat away at their market cap? Where does that competition happen?

ST: I don't think in the next five years, maybe not in the next 10 DeFi will eat into to their market cap. Fintech is eating at their market cap and the market itself is eating at their market cap. So understand that everything that surrounds the bank, look at them as they are rather than from a position of DeFi, and I think that's probably an important perspective to take.

Are they going to compete with DeFi? Well, just taking JPMorgan coin, the guy behind that only has now gone to Goldman, they’re definitely taking it seriously. I think they're interested in tokenization, but SEC Jay Clayton said, they're really, really open to tokenization of any asset.

That if you read between the lines, the regulator is not the bad guy here, they're just given a set of laws to try and enforce some rules that somebody else thought were important. But tokenization itself of existing asset classes is really interesting. Tokenization of new asset classes could be one to watch

But actually, I look at what just happened with Kraken getting their banking license. Or I look at the idea of the OCC in the United States coming out and saying there's no reason why a bank can't hold crypto on its balance sheet as being real signals of where this could go. I think from a big banks perspective, there's no reason for them to move first because they are very, very risk-averse.

DeFi Innovators

But I look at companies like Fidelity and others slowly adopting Bitcoin and they'll come in. So you're looking at, I don't know if you’ve ever seen, it’s not the hype cycle, it's the early adopter cycle, which it looks like a hill or bell curve. On the first 2.5% of users, which are probably the people who are in DeFi right now, they're the innovators, they get to anything first, and they really, really will just be right in there. I'd say DeFi is in that 2.5% if that is maybe even smaller than that this point.

Then the next thing is the early adopters. This is about 12.0-12.5% of all users generally. I'd say, crypto is probably at early adopters. It's not quite at the next stage yet, which is early majority, which is kind of the middle of your bell curve. After early majority becomes late majority, laggards and so on. I would imagine that Facebook now, for instance, is now in the laggards, pretty much everybody has it, and the innovators have long since left it.

You see this cycle of adoption for any technology, and DeFi is squarely really, really, really early on, but Bitcoin might be just nicely crossing the chasm. There's a really good book actually called “Crossing the Chasm”, which is basically all about this idea from that sort of early adopter into early majority. That, if you wind the clock forward 5, maybe 10 years, that's where DeFi starts to go in some form or shape.

CR: We're starting to see the very first tiny steps from big banks, but there's still a long way to go before there's really an actual crossover from one world to the other one. From the DeFi world, what would you be the most excited to see as it starts to become mainstream? What are the biggest opportunities there when looking at what's missing in fintech? What are some of the roles that DeFi can fill?

Key to Mainstream

ST: Everybody thinks the answer to that question is yield. I come back to first principles. Part of the reason the yield is so great is because it's a thinly traded asset in banking terms, which means there's not a lot of money on the line, and it's kind of all super, super early.

If you look at the trading of any asset, when it's this early, you see exactly the same as happening in DeFi, albeit with not the same level of creativity. I'm not convinced that that yield by itself is the answer. I think the answer might be somewhere else, which is, again, look at fintech and look at what they want from better rails, more modular rails, and let's take on some of the big questions around why does regulation exist in the first place, what's the DeFi equivalent to that? Do we need that thing?

Because if we want it to cross the mainstream, why did regulation emerge in financial services in the first place? What was it about users that necessitated the invention of this thing we call regulation, and what's the DeFi equivalent of that? To me that is the key to going mainstream. It's why with a non-profit hat on, we founded Global Digital Finance, which is creating codes of conduct for any business or organization that's involved in crypto to adopt a code of conduct.

“What was it about users that necessitated the invention of this thing we call regulation, and what's the DeFi equivalent of that? To me that is the key to going mainstream.”

The idea of that code of conduct is to say, hey, we understand these are the regulations, here's how we're going to act to try and fit within at least the spirits of those, if not the letter of the law. A lot of businesses are doing that on a voluntary basis. I'd love to take that to the next stage, which say, how does this technology help us do that? How does it help us prove we're being ethical, fair, transparent? I think that's the underlying aim here. People want ethical, fair, transparent finance, this was really drawing people to it. How do we demonstrate that? How do we solve some of those problems?

CR: Huge questions. To start wrapping up, I want to talk about this important topic which we haven't really touched on, governance, and having users actually own and participate in the products and applications that they're using. I think maybe you'll correct me and say there's something like this in fintech or in big banks. But to me seeing what's happening with this latest wave in DeFi where protocols are distributing their native token to every single user, like what happened with Uniswap, to me was fascinating. They retroactively airdropped UNI token to every single person who had once used the protocol and they have a stake in their protocol and are able to participate in decision making and earn a tiny piece of revenue. Do you think that might be another way that DeFi brings people in, because it seems so different from what fintech is offering?

Draw of Governance

ST: There's a thing called crowdfunding. What happens there is a fintech business, so there's a number of them in the UK that have done this. Companies like Revolut, Monzo, and many others have invited their customers to become investors. Now the key difference is, those customers bought shares, so they weren't gifted shares, they weren't given the shares. So there is something different there. But the other thing you see quite often in customer acquisition is that companies will give you $10 to $100, sometimes $200, to switch to them.

There are parallels, but it's not owning a piece of that thing. But I'm at a loss to see why that drives mainstream by itself. I can see why for the true believer, having a piece of it is super important and what it means from a principle standpoint.

I would point you to annual general meetings of Shell. If you have Tesla stock, chances are it's held by somebody who's held by somebody who is held by somebody else. But you can and you are within your legal rights to make a vote on every single thing that comes up, most of, you never will. It's a little bit tricky. It's a little bit hard. Granted, the user experience can be better, but for the most part, people don't care. They want number to go up. It's similar in DeFi, there are some people that really, really care about the governance, then everybody else wants number to go up. So recognize the user behavior as well.

I think people get lost in the beauty and forget the ugly reality sometimes of how these things exist. People are lazy, and will want things to be a little bit easier. I don't think everybody will want what the early adopter wants. It's an interesting question. Will shared ownership help? Maybe.

“People are lazy, and will want things to be a little bit easier. I don't think everybody will want what the early adopter wants. It's an interesting question. Will shared ownership help? Maybe.”

Then you can imagine, like if we're building the future of the internet infrastructure, and the more equitable ownership of that is great. But then a bit like democracy, how many people will actually go out and vote? How much will that capital get aggregated by middlemen who do that voting on your bill? It's hard to get away from some of the first principles and some of the emergent principles of human psychology.

CR: No, for sure. I think as early as governance and token-based voting is, we're already starting to see that shift with delegated votes. Protocol politicians, people getting control of tokens and voting for others.

ST: You’ve recreated the maze. It’s a better, more efficient maze, arguably, potentially more transparent. But it's a similar maze. This is the point, right? We're recreating the maze, but we think we invented a thing. Not everybody thinks he invented the thing, but there is definitely a width of that. What if we look at the old maze and go, okay, we’re recreating some of this, but what are we taking and what are we not? I think, if that's done intentionally, it needs to get a bit more interest.

“You’ve recreated the maze. It’s a better, more efficient maze, arguably, potentially more transparent. But it's a similar maze. This is the point, right? We're recreating the maze, but we think we invented a thing.”

CR: I’d love to hear your opinion on the ability to fork a protocol. You have this open-source code, and I guess, an advantage of DeFi and Web 3.0 is that unlike in Web 2.0, you have the ability to replicate exactly the same protocol, except change the things that you don't like.

Dark Side of Forks

ST: I'm going to play devil's advocate for a second and then I'm going to take the hat off. Let's say I was a state-sponsored actor or terrorist organization, and I had understood and infiltrated the crypto community, and I was proficient with memes, I could potentially create a fork of a DeFi protocol and get the community really, really excited by it to aggregate a lot of capital inside of this platform that it can be moved around without a lot of regulatory oversight.

It's quite interesting to me that Chainalysis and Elliptic and others have started to look at this space. Now, I don’t think that's happened with any of them, but the risk is there. Though there’s unlimited clean energy of splitting the atom, there’s the atom bomb side that I think sometimes we’ve just got to remember.

But that said, to the broader point about forking protocols, general, I'm a fan of open source, and I'm a fan of it if somebody else is doing it better. But why are they doing it better? How do we think a little bit broader about? Are we forking it for the sake of it? Or is this a real meaningful upgrade? Or does it matter to the DeFi community, which is incredibly small and meme driven?

CR: I love how you pointed out that they'd have to be proficient in memes because that’s definitely a case. Memes are driving liquidity in crazy ways.

ST: Find yourself in emoji and you’re good to go in DeFi…

“Find yourself in emoji and you’re good to go in DeFi.”

CR: Exactly. Alright, that's a great note to end this on. This has been so interesting. I love seeing the parallels between both worlds and what they can each learn from each other. So thank you so much again, Simon, for joining me.

ST: Camila, thank you so much for having me. I hope the audience has enjoyed this and it's given a fresh perspective. Generally, love what the DeFi world is doing, so keep being awesome, keep innovating. Thank you, I'm enjoying watching along.

The Defiant is a daily newsletter focusing on decentralized finance, a new financial system that’s being built on top of open blockchains. The space is evolving at breakneck speed and revolutionizing tech and money. Sign up to learn more and keep up on the latest, most interesting developments. Subscribers get full access at $10/month or $100/year, while free signups get only part of the content.

About the founder: Camila Russo is the author of The Infinite Machine, the first book on the history of Ethereum, and was previously a Bloomberg News markets reporter based in New York, Madrid and Buenos Aires. She has extensively covered crypto and finance, and now is diving into DeFi, the intersection of the two.