What it means for society
By: Esat Mert
Tags: Esg, Decentralized Finance

Photo by Jamie Street on Unsplash

The aim of DeFi is to provide frictionless access to sophisticated financial services and asset-backed lending to virtually anyone on the planet with an internet connection. Every financial institution in the world is either stunned by the parabolic uptake of DeFi, or they are digging their own proverbial grave or obsolescence.

What is DeFi you might ask? DeFi is short for Decentralized Finance. A financial software built on trustless platforms that can be pieced together (like Lego blocks).

It focuses on open access financial services that run in parallel (and for now separated from) the conventional financial institutions and political system. Growing since 2020, the ratio of the spot volume of DeFi to the volume of the centralized exchange approaches 15%.

What is the impact of DeFi on society? Let’s explore the ESG considerations of DeFi.

Environmental: Much has been discussed about the energy expended in mining cryptocurrencies, especially those mining operations that rely on Proof-of-Work consensus.

The trade-off is that the current setup consumes lots of energy. Most of the marketplaces conduct their sales through Ethereum to maintain secure transactions through the mining process. This process is similar for Bitcoin, too. Doing so uses energy on the scale of countries now. On the other hand, many DeFi protocols started to support crypto assets that do not rely on energy-intensive consensus models. Ethereum is planning to launch its Proof-of-Stake consensus model soon. Lastly, nearly 40% of mining activities rely on renewable energy sources now. With these developments, the environmental issues will become less of a challenge for DeFi in the coming period. In any case, we might see more companies disclosing their emission data publicly. Data integrity and transition plans to more purposeful models will be more important in the future.

Social: DeFi aims to increase financial inclusion and brings censorship-resistant transactions.

However, because of the high volatility of crypto assets, these instruments are not suitable for many investors. The regulatory activities for exchange platforms continue. There is a concern whether the platforms could be a tool to sidestep the compliance safeguards. DeFi platforms have different approaches to compliance safeguards. We expect to see extensive regulations in this area, and different regulatory standards of the countries might lead firms to be subject to additional burdens.

Governance: The ideal of the DeFi platforms is to have a decentralized autonomous organization (DAO). It might be tricky to evaluate “governance”, but as DeFi becomes more mainstream, governance will improve because the platforms will be forced to disclose more information.

Into the future…

DeFi restructures the current financial system by reducing the cost of financial intermediation, improving transparency, and reducing information asymmetry. Although the industry’s current form is beyond being ESG-compliant, we will see a more “purposeful” sector in the future as DeFi’s volume converges to centralized finance volume.