Jan 31, 2023
DeFi Fans Are Courting Traders in $7.2 Trillion Currency Market
(Bloomberg) -- The cryptocurrency world has been suffering a crisis of confidence, but that’s not stopping proponents of decentralized finance from going after the $7.2 trillion global currency market.
Researchers behind one of the largest decentralized finance market places are courting traders of fiat currencies, arguing that moving them onto blockchain would cut the cost of global remittances by 80% and eliminate settlement risks.
In a paper published online, scientists and executives for Uniswap Labs and Circle Internet Financial say that users of the $550 billion global remittances industry could benefit from cost savings of up to $30 billion a year using stablecoins and DeFi protocols to send money instead of traditional financial intermediaries.
“Foreign exchange is one of the first areas where decentralized finance has a powerful use case,” said Gordon Liao, chief economist at stablecoin issuer Circle and a co-author of the paper, “On-chain Foreign Exchange and Cross-border Payment.”
DeFi, financial technology based on distributed ledgers similar to those used for cryptocurrencies, cuts out the fees that banks charge. Anyone with an internet connection can use it, with individuals able to transfer money between digital wallets. Yet its image has been tarnished by chaos following the collapse of stablecoin TerraUST and sister token Luna, and by the blowup of Sam Bankman-Fried’s FTX empire last year.
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Undeterred, the paper’s researchers argue that the traditional flow of currencies, the world’s largest market, is ripe for a shift in structure. They say moving all foreign exchange onto DeFi platforms would close a growing settlement gap, or the risk that one party to a trade fails to deliver the currency owed.
The dollar value of transactions subject to one of the counterparties failing rose to $2.2 trillion a day by April 2022, up from $1.9 trillion three years earlier, the latest figures from the Bank for International Settlement show. As a result, the BIS said currency market settlement risk could undermine financial stability.
“On-chain FX trading and settlement using DeFi technologies has the potential to address many of the challenges faced by the traditional FX market, such as slow settlement speeds, high costs and settlement risks,” the DeFi paper stated. “The use of payment stablecoins, particularly those pegged to the U.S. dollar and other major fiat currencies, has allowed DeFi to find immediate real world applications in the foreign exchange market and international payments.”
Lending weight to the paper’s findings is the involvement of David Puth, formerly the chief executive of the global settlement utility CLS, which is overseen by the US Federal Reserve. The other co-authors were Austin Adams, Mary-Catherine Lader and Xin Wan.
The authors have invested interest in arguing that stablecoins — cryptocurrencies designed to have a relatively stable price — would make currencies more efficient. Adams and Wan are research scientists at Uniswap Labs, a DeFi market place, while Lader is the Chief Operating Officer of the firm. Puth, meanwhile, is a senior advisor to stablecoin issuer Circle.
Still, Stephane Malrait, chairman of the ACI Financial Markets Association, an organization representing major dealers in currency and money markets, said the paper put forward some “very interesting” ideas and noted the “strong interest from the FX community” in digital assets. But wholesale change won’t happen overnight.
While central banks are experimenting with stablecoins in cross-border payment systems, the hurdles to adoption remain high. A lack of regulatory clarity, hacks and theft in the broader DeFi space and the absence of user-friendly ways of interacting with these money pools makes adoption of the technology slow for now.
“The TradFi market structure is still very distant to the technology used in DeFi,” Malrait said, adding it would be complex to shift the global currency ecosystem to a new infrastructure and that the adoption of new technology could take years.
--With assistance from Muyao Shen.
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