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  • - [Narrator] A rapidly growing financial trend

  • is attempting to turn traditional banking on its head.

  • It's called decentralized finance, or DEFI.

  • And it promises to bring digital banking

  • for cryptocurrencies to the masses,

  • but with no middlemen and almost no barriers to entry.

  • - So in the last 18 months,

  • this idea has really mushroomed within the crypto market.

  • - [Narrator] Estimates vary,

  • but a conservative one says the total value locked in DEFI

  • reached $114 billion in November this year.

  • And while that's just a fraction

  • compared with traditional banking, DEFI is growing quickly.

  • It has increased more than 1,200% since June, 2020.

  • Here's why some are calling DEFI the Wild West of finance,

  • where investors are entering uncharted territory

  • to take on big risks for the chance of even bigger rewards.

  • When we talk about DEFI, we're not talking

  • about a specific financial product or service.

  • - DEFI is just the next iteration

  • of this grand experiment in cryptocurrencies,

  • which is basically just to recreate

  • the financial system in a digital online format.

  • - [Narrator] Paul Vigna has been reporting

  • on the equities market for almost 25 years,

  • and has been covering cryptocurrencies since 2013.

  • - Anything you could do at a bank or a brokerage

  • is handled rather than through an individual

  • and a corporation, it's handled through a computer program.

  • - [Narrator] You can think of the emergence of DEFI

  • like this, a dusty town in the wild American West,

  • where there's no sheriff, no bank, and no cash.

  • Here at the local Trading Post,

  • people can trade and lend goods,

  • and do pretty much anything else normally done at a bank.

  • It isn't owned by a single person or entity.

  • And unlike traditional finance, trades that happen here

  • are verified out in the open where everyone can see.

  • For example, one type of transaction

  • that takes place at the Trading Post is lending.

  • To ensure the trade,

  • the borrower gives collateral for the loan.

  • The lender then earns interest off this deal

  • in the same way a bank would.

  • Transactions like this are all recorded on a public ledger

  • that everyone can see.

  • In the world of DEFI, this ledger is called a blockchain,

  • which is a network of computers

  • built to store and record transactions.

  • - Every computer on that network

  • has an identical copy of that ledger,

  • so that all of the data is open, all of it is public.

  • - [Narrator] This is different

  • from a traditional stock trade, which works like this.

  • - I have a broker, the other party has a broker,

  • the company has an institution

  • that keeps track of the stock itself.

  • All these different middlemen,

  • all these different intermediaries have their own ledgers,

  • have their own internal databases

  • where they're recording the transactions.

  • A blockchain takes care of all of that

  • and does it in an open way

  • that anybody can track the progress of that trade.

  • - [Narrator] Most DEFI services

  • run on Ethereum's technology,

  • which also hosts the cryptocurrency Ether.

  • It's one of the most commonly traded cryptos in DEFI,

  • along with stablecoins, digital assets,

  • which are pegged to currencies, like the dollar.

  • The DEFI services run on the blockchain,

  • similar to how apps run on your phone.

  • And the mechanism that allows them to work

  • is called a smart contract.

  • - Smart contract as an idea have been around for years.

  • It's another app that is focused on a bank-like service.

  • So all it's really doing

  • is taking all the parameters of a trade

  • and sticking them into fields and automating it

  • and then monitoring it.

  • - [Narrator] Smart contracts

  • are designed to give DEFI transactions

  • more transparency and security.

  • - And because all the parameters were being inputted

  • into a program, ostensibly it's more secure

  • because there shouldn't be any real debate or contradiction

  • about the terms of the service.

  • - [Narrator] Despite this layer of security,

  • decentralized finance carries a lot of risk.

  • In many cases,

  • the people facilitating DEFI transactions are anonymous.

  • This has caused fraud to become rampant.

  • A poorly created smart contract could have loopholes

  • that allow scammers to steal

  • or other design flaws that affect the value of assets.

  • Another risk is security.

  • And because most DEFI services aren't insured,

  • if a platform fails or is hacked,

  • millions of dollars can be on the line.

  • - The problem is that you may not know

  • who wrote the program.

  • You may not know how secure the program itself is.

  • That's a significant, significant risk

  • that you really can't overlook.

  • These DEFI protocols virtually once a week,

  • there is a problem with one of them.

  • - [Narrator] So far this year,

  • investors have lost about one and a half billion dollars

  • to DEFI attacks, hacks, and cons.

  • And in this Wild West of finance,

  • regulation is still virtually non-existent,

  • though, that could change.

  • Here's the chairman

  • of the Securities and Exchange Commission

  • speaking with The Wall Street Journal about DEFI.

  • - But if this field is gonna have

  • an ability to move forward,

  • it's gonna be inside some public policy framework

  • and inside some sort of regulatory perimeter.

  • Look, folks have already been hurt in this field.

  • - [Narrator] While decentralized finance is risky,

  • many think the potential benefits are worth it.

  • - The benefits are an ability to make money.

  • You are either lending out your cryptocurrencies

  • and you're getting interest paid back on that,

  • and that interest can be anywhere from 5% to 20%,

  • even more.

  • You can be a passive investor and earn money on an asset

  • that you were probably storing in a wallet

  • that was doing nothing.

  • The other benefit is you can borrow against your holdings.

  • A lot of these services are being used

  • as a way for people to get a bigger pool of cryptocurrency

  • to go through a bets out into the derivatives market.

  • So it's a way for you to turbocharge

  • your cryptocurrency gambling habit, essentially.

  • - [Narrator] If DEFI continues growing,

  • it's likely that regulations will be imposed

  • to smooth out its rough edges and reduce risk for investors,

  • which makes sense.

  • Even in the wildest of Wild West towns,

  • a sheriff eventually showed up to lay down the law.

  • (light music)

- [Narrator] A rapidly growing financial trend

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B1 US WSJ narrator finance cryptocurrencies cryptocurrency smart contract

DeFi: Crypto’s ‘Wild West’ of Finance | WSJ

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    Kelly Lin posted on 2022/09/18
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