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What are CBDCs and what are their Future prospects vis-a-vis DeFi

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What are CBDCs?

Digital money is no longer a concept or a dream, it’s a fait accompli. Many leading businessmen around the world, including Elon Musk, and many governments like China, are betting big on the future of finance being digital. This is the reason why many Central Banks around the world are considering launching their own Digital Currencies (CBDCs).

The move towards Digital

The transition wasn’t easy, it required a serious shift in policy-making mindsets. Central banks are now going all-in on digital finance: China has already started pilot testing its Digital Yuan. What is the reason behind central banks, governments, and big businesses betting big on digital currencies? The answer is simple: digital money represents yet another revolution in digital finance, making monetary circulation truly programmable.

China is working on its own blockchain network: BSN. It is designed to support one hundred public blockchains and their virtual machines including Ethereum, Neo and IrisNet etc. This project will create an internet of blockchains allowing dApps to interact across platforms. 

What are the factors behind this shift towards Digital?

The two key factors here are technology and the possible investment returns. As Bitcoin and other non-regulated currencies reached a market size of one trillion dollars in early 2021, the question of regulation, compliance, and control has become more important than ever. Global players aim to remain in control of all those moves while enjoying the benefits of blockchain technology. As the distributed ledger technology gets a wider adoption, traditional financial institutions will be challenged.

How do CBDCs link to DeFi?

Beyond digital currency, CBDC that serves as a substrate for smart contracts, can realize a range of monetary policy tools and novel financial instruments.

Blockchain technology is just the base, the lowest level of an entire ecosystem. Decentralized financial solutions are built on top of this ecosystem. The beauty of DeFi is autonomy: the technology resembles many traditional services with one crucial difference, there is no human factor involved and hence there are no human-associated risks. For example, the Uniswap DEX is similar to a traditional money exchange.

Are there Any notable risks?

Some of the major risks associated with systems of this kind include risks related to development and coding processes, system sustainability, data protection, and general cyber security. Cyber security firms such as RNS Solutions can certainly help mitigate these risks. Understanding of these technologies by businesses and individual clients would need to improve for them to be productive.

Although many DeFi solutions exist in the market, most are not user-friendly with many either having very complicated UIs or requiring complicated blockchain knowledge by average customers. Despite these drawbacks, DeFi has gained substantial popularity in the crypto community. 

What will the Future of Finance look like?

This technology is a major step towards reinventing the financial sector. Consider a small example of smart contracts which can provide flash loans that require no collateral. 

Throughout 2020, DeFi related solutions grew in value from less than one to more than 60 billion dollars. The big question now is: how stable coins will act in this new decentralized financial ecosystem. Chances are that the digital yuan, the digital dollar, and other currencies like a digital euro will do the job in the future. 

In the long run, a state-supported presence of DeFi is inevitable. State institutions are to remain as a regulatory framework for such systems, and maintain their DAO (Decentralized Autonomous Organization) status. 

Conclusion

DeFi still needs to overcome many obstacles, and multiple questions need to be answered before it can take over as the next financial framework: legal and compliance, technology and security, and product feeding and market positioning.

We anticipate that the DeFi sector will see a massive inflow of capital in the coming years with new projects launched both in emerging and well-established regulated markets. Investments are being done into the sector due to higher returns. Compared to traditional banking, DeFi offers higher APYs, less friction, lower transaction costs, and it requires no operational desks/offices. 

With 90% of people around the globe owning a smartphone, digital gadgets are the battleground of the future. We see huge potential for technologies like DeFi and CBDCs in this digitized future. But there are some points that need to be addressed immediately:

  • The DeFi market is in dire need of structuring: the landscape of existing projects needs to be monitored including reliable sector statistics and project data etc.,
  • Other points that require immediate attention are legal issues, research, and other compliance and disclosure requirements,
  • The most important point is knowledge: it is of utmost importance to understand the workings of DeFi and blockchain ecosystems and their pitfalls related to technology, regulation, and business prospects,
  • And screening and studying best market practices, and launching new projects.
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