Every significant transformation brings with it a new set of tools that is always surprising at this time and obvious in retrospect. Bitcoin (BTC), climate change, and GameStop are examples of how mass actions are pushing for dramatic rather than evolutionary action. We can also see that these are single vectors of the same movement highlighting the inefficient parts of the legacy system and the solutions driven by a collection of individuals with a collective belief.
What is so striking, but not unexpected, is that some of these events highlighted the opacity of centralized systems. They follow the recent trend from companies like Reddit, Robinhood and E-Trade to restrict user access to entire platforms or certain functions. The GameStop episode showed how centralized systems can control trading processes and unjustifiably disadvantage private investors in favor of older institutions. In particular, it has brought to light a surprising amount of collateral requirements placed on brokers – like Robinhood – by clearing firms. The reason for this was to maintain a sufficient margin.
Connected: The GameStop story reveals the regulatory paternalism and true value of DeFi
Another thing that came to light is that brokers like Robinhood, Fidelity, E-Trade, Charles Schwab, and TD Ameritrade have a much-discussed practice called “payment-for-order flow” and Running can lead. In this process, market-making companies like Citadel Securities pay a broker a fee to access orders from retailers. Taken together, these orders provide market makers with access to information about possible near-term future price movements. Is there an advantage for the retailer? As the brokerage firms say: Yes, as this practice enables commission-free business.
While these practices are narrowly common in traditional internet and finance, things can become uncertain when we look at similar effects of censorship in other areas of our society from a broader perspective.
In response to this broken system, viable decentralized alternatives create the conditions for a mass exodus that represents a historical restriction of centralized structures. Decentralized Finance (DeFi) and Decentralized Exchanges (DEXs) play an important role in this broader transformation by addressing the opacity of the existing financial systems and the resulting disadvantages for common participants.
Connected: The GameStop saga shows legacy funding is rigged, and DeFi is the answer
Can DeFi and DEX be a fair alternative to conventional financing?
The decentralized nature of blockchain technology gives it censorship resistance. It thus enables applications in which the ability of central actors – such as Robinhood – to restrict traders can be easily designed. The open source and verifiable nature of a decentralized ecosystem would make such steps obvious and lead to such an exchange being discredited by its users. Thus, DEXs offer the promise of a censorship-resistant exchange feature that conceptually allows users to participate in a much more even playing field regardless of their retail or institutional status.
Innovations around DEXs are still in an early and experimental stage. However, it has the potential to allow different participants unrestricted access to a limitless world of asset exchange, not only for traditional blockchain tokens, but also for public stocks, commodities, derivatives and – yes – even possibly for GameStop, if the users require this.
Connected: The Rise of the DEXs: Fired by DeFi and ready to disrupt the status quo
Many founders in space say the inequalities in traditional finances have motivated them to build their part of the DeFi ecosystem. Alex Pack, Managing Partner of Dragonfly Capital said:
“The goal of DeFi is to reconstruct the banking system for the whole world in this open, permissionless way. You only get this shot every 50 years. “
In 2014, the Bitcoin Foundation’s Harsh Patel published a paper titled “A Blockchain-Based Decentralized Exchange,” which outlines how code, not institutions, can manage the trading market. The idea wasn’t new, but it came at a time when the crypto markets were facing difficulties. Mt. Gox and many other centralized crypto exchanges saw their decline between 2011 and 2014 due to hacks and the loss of their users’ assets.
Connected: Report on Crypto Exchange Hacks 2011-2020
In order to avoid the shortcomings associated with centralized exchanges, a number of entrepreneurs attempted to introduce DEXs to support DeFi’s core values: transparency, unrestricted access to trading opportunities and markets, and the ability to participate in decision-making on the platforms they use by owning governance tokens.
Connected: DeFi is the future of banking that humanity deserves
The future is decentralized
Early DEX protocols worked using smart contracts to make it easier to trade cryptocurrencies 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 significant strides to address these challenges and are evolving into trading interfaces familiar to traditional markets. For example, merchants these days can buy crypto with card and bank balances directly using fiat on / off ramps that convert fiat to cryptocurrency and vice versa.
In addition, DEXs will soon introduce features that are important to traditional markets such as market analysis and trading tools such as liquidity charts, trading volumes and order book depth. These features provide users with real-time, objective data and insights into the trading landscape.
In this new financial system, DEXs who use automated market makers such as Uniswap or 1 Zoll create a level playing field for all participants. There are no brokers, clearing houses, or centralized market makers. Trades are peer-to-peer or peer-to-protocol transactions with no arbitrator other than those codified by smart contracts. And critically, there are no different rules for different groups of players.
Access is also being improved. While the complex accreditation requirements can make access difficult in traditional markets, a typical DEX requires little to no private information from the user. These standards offer an advantage of pseudonymity and a level of data protection that is otherwise not guaranteed when you hand over your personal, identifiable information to a central broker. That may change, however, as DeFi adopts more anti-money laundering laws and the regulatory environment remains uncertain. However, the teams are working on solutions to meet both compliance requirements and an individual’s desire for data protection. This allows users to retain full ownership of their assets and identity rights, and gives companies specific permissions to verify their identity.
If the GameStop saga turns out to be more than just a passing anomaly, there could be a profound change in the financial system right now, or the creation of an entirely new one. As financial technology companies have made it easier for consumers to participate in financial markets, DEXs address the shortcomings of centralized markets. In a way, this generation of DEXs could become the new Robinhood. Perhaps this is one of those moments when people, not institutional inheritance, will determine the future.
This article does not contain any investment recommendations or recommendations. Every step of investing and trading involves risk and readers should conduct their own research in making their decision.
The views, thoughts, and opinions expressed here are the sole rights of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Elvina Kamalova is Director of Investments at Aludra Capital, a San Francisco-based digital asset investment management firm. Elvina has a background in digital asset investing, portfolio management and fintech product development. She is the recipient of the President’s Volunteer Service Award given by former President Barack Obama. She supports underrepresented entrepreneurs and girls’ STEM education, and believes in the importance of developing solutions to reduce the wealth gap and promote human progress.