Crypto and DeFi are the solution to systemic risk not the genesis of it
Amongst all the public discussion about the collapse of SVB and Signature Bank, a major point is being missed. While regulators are somehow blaming “crypto businesses” for the recent collapses, those involved in Decentralized Finance, (DeFi) know that this technology can actually help regulate banks, reduce systematic risk and prevent bank failures.
The current banking system is opaque or ‘snap shot’ truth. This means there is no dynamic platform, dashboard or public account where bankers, depositors and regulators can see the same data and know the same current state of any one bank or general risk.
A snapshot of a bank’s leverage comes out in quarterly reports. As we all know, however, circumstances don’t wait for quarterly reports, and a bank’s snapshot can change very quickly and without much warning.
DeFi can help us get away from relying on outdated quarterly snapshots.
Banks offer services to depositors. They profit by managing the demands of depositors versus loans or investments. If those loans and investments were simply on a blockchain ledger, they could be visible to everyone.
An enhancement would be to have smart contracts ‘delta hedging’ a bank’s equity (DeFi). Or, if you don’t like automatic rule based actions - at least warn bank operators of potential negative equity.
If a bank had contracts governing its ownership of treasuries, these contracts could be sensitive to treasury prices and contain stop losses. The contacts could force liquidations to keep the equity in a bank within an acceptable band. The result could be a continuously adjusting balance sheet - and not the sudden rebalancing we have now.
There is more. Insurance contracts and liquidity pools could be engaged to raise capital using the above contracts or ledger entries of any bank as inputs. We could get to a real-time, consensus of exposures at banks and to even take real time diverse action.
The change that ledgers and DeFi bring is that we share a consensus source of truth and not our current siloed, slow, fractured reported truth. Anyone, including regulators, could have an overview and incrementally act such that systemic risks are much reduced.
There is confusion about what cryptocurrency actually does. You don’t necessarily need crypto to pay for your milk but you do need crypto currency to update the public ledger. The benefit of a public ledger is that we all have a better idea of leverage and systemic risks.
People speculate on NFTs and crypto but what gets lost in the confusion and the big headlines is that crypto facilitates beneficial public ledgers and will ultimately lead to an improved infrastructure for banking.