What is “DeFi” and how will it impact investment management

Welcome to Invesco's new series of articles where we will be exploring evolving themes in digital assets and investment management. My name is Dave Dowsett and I am the Global Head of Technology Transformation and Emerging Technology at Invesco, leading a concentrated team of specialists and data scientists focused on digital assets and other leading edge technologies relevant to the asset management industry.

You may have heard of decentralized finance or “DeFi” in the context of cryptocurrencies. You would be forgiven if your mind immediately went to crypto speculation and arcane workings of code. Yet what truly underlies DeFi is a trend that is reshaping how we think about and structure the financial economy more broadly. The idea is to take traditionally centralized aspects of traditional money management such as decision-making authority, settlement, and recordkeeping and to introduce a decentralized approach with the goal of reducing potential for fraud, abuse and corruption, and increasing efficiency and access. DeFi accomplishes this by using a decentralized database technology, commonly referred to as blockchain. This technology makes it possible for users to access different types of financial products and services without the need to go through an intermediary, such as a centralized institution.

In traditional finance (or “TradFi”), participants rely on institutions and intermediaries in our global financial markets for the issuance, trading, banking, and settlement of investments. DeFi introduces a shift in the trust mechanism to blockchain technology which introduces public verification of transactions, leading to greater transparency, efficiency and speed. In general terms, the advances in technology do not change what we are doing but how we are doing it. For example, research from major central banks has highlighted the potential for blockchain-based transactions to accelerate payments and security settlement. Another anticipated upside of decentralization is increased matching of buyers and sellers and greater depth and access to capital markets as new liquidity sources are opened in equally secure and trusted manners.

With all the buzz and recent headlines in this space, you may wonder what it means to participate in a so-called “trustless” system. Such systems achieve consensus through code and cryptography rather than relying on institutions to process and settle transactions. In other words, “trustless” systems disintermediate trust and distribute it across network participants. Without sacrificing data privacy, a single version of irrefutable truth is recorded that can be inspected by selected parties but cannot be controlled by any single authority. The ledger actually ensures traceability and the encryption layer has the promise of leading to better cybersecurity protections for capital markets participants.

Since the inception of stocks in the 1600s, advances in technology have progressively enabled the movement from paper shares to electronic trading to T+2 settlement. The 2000s saw an acceleration that reshaped the industry from trading floors to electronic trading portals, increased data frequency and availability, and high-frequency execution speeds.

Now in the 2020s, blockchain offers the ability to record the ownership of assets in a publicly accessible, decentralized record. This “tokenization” allows for the recording of ownership of any asset, whether it’s tangible/physical or intangible/non-physical. If an asset can be owned and has value to someone, it can be offered as a token and then be incorporated into the larger asset market.

In this article series, we will explore exactly how this is possible, and what the potential implications are for the asset management industry. The timeline below shows several notable recent developments highlighting the growing adoption of DeFi across the global asset management universe. In our next blog, we will take a deeper dive into tokenization.