The future of finance technology is hybrid as TradFi and DeFi converge
FinTech has evolved significantly over the last five decades, and the latest wave of developments suggests that more change than ever before is coming for 2022 and beyond as Traditional Finance (TradFi) and Decentralized Finance (DeFi) are each on a path of convergence as they tackle similar challenges to modernize the financial services experience and underlying platforms and infrastructure (read more here on the history of what has brought us to today's current trends).
TradFi continues to embrace DeFi, with announcements such as Coinbase and BlackRock partnering to provide institutional access to digital assets, and DeFi continues to drive innovation and prove it can evolve at scale with releases like the upcoming Ethereum Merge.
Read more here to understand how the future of finance technology is hybrid:
This vision for a hybrid future is based on four hypotheses, based on current trends in TradFi and DeFi:
Figure 1: Four hypotheses that suggest the future of finance technology is hybrid between TradFi and DeFi.
Hypothesis #1: The future of finance is hybrid & distributed.
As we have learned previously that FinTech is going internet, digital and cloud-native more broadly, we hypothesize that today’s generally siloed and heavily trust-based institutions, financial products, technology, and modernization paths across both TradFi & DeFi will evolve tomorrow into a future of integrated and symbiotic organizations, products, and technology roadmaps.
Figure 2: Hybrid and shared components in the form of integrations, bridges, and diverse platforms are forming the connective tissue between TradFi and DeFi.
In the figure above, Traditional Finance (TradFi) is described as technology components and services from incumbent banks, capital markets institutions, and cards & payments companies across applications & institutions, platforms & protocols, and IT infrastructure.
Decentralized Finance (DeFi) is described as modern financial technology components from completely new projects in the blockchain, cryptocurrency, and web3 domains across the same stack of applications & institutions, platforms & protocols, and IT infrastructure.
You can read more here to go deeper into each of the layers of TradFi and DeFi across infrastructure, platforms and applications, how they are mutually exclusive, and where there are hybrid and shared constructs that are starting to bridge and integrate the two worlds. Also, read the deep dive on Hybrid & Shared platforms in TradFi and DeFi to better understand the platforms of the hybrid future. Some of the major players in Hybrid & Shared platforms include Chainlink, Plaid, Stripe, and the Consensys Product Suite.
While most would agree with the categories above, the differentiating aspect of this continuum is the hypothesis around the hybrid and shared components that will make up the connective tissue of the hybrid financial landscape of the future, including: Interoperability & open standards; API-led connectivity & blockchain service fabric; Modern & traditional product overlap; and Financial infrastructure integration.
We are seeing all of this happening before our eyes. Coinbase and BlackRock are partnering to provide Aladdin clients access to crypto trading and custody via Coinbase Prime.
... the future is hybrid!
Hypothesis #2: The future of DeFi is multi-chain & distributed.
Multi-chain for smart contracts platforms and DeFi applications (dApps) at a minimum appear to be the future, as a number of Layer 1 solutions have come about and seen a reasonable degree of maturity and use case development while the community continues to try and push Ethereum to its Eth2 vision. While Ethereum is furthest ahead in user community & developer interactions, platform maturity & use case adoption, other smart contracts platforms with different philosophies & design principles will continue to make smart contracts & DeFi constructs evolve & compete at light speed.
... but will the multi-chain future also be cross-chain?
Bridging technologies are evolving to support blockchain to blockchain value transfer, blockchain to conventional TradFi systems, and data feeds to blockchain agnostic constructs such as Chainlink pricing oracles.
Integration cross-blockchains is technically feasible and can even increase cross-chain liquidity and value transfer; however, new risk and security issues are introduced that are causing crypto-natives to reflect on this
Increasing interdependencies cross-blockchain (going beyond just two chains) of the inter-network and fabric between blockchain environments will create systemic weak points and potential security issues that are not native to the blockchain or smart contracts platform itself, exposing itself unnecessarily to external vulnerabilities
Read more here for Vitalik Buterin’s views on why the future is multi-chain, but not necessarily cross-chain (original Reddit post here and Twitter post here).
Hypothesis #3: The future of underlying infrastructure is multi-cloud and distributed.
If you look at the infrastructure layer across both TradFi and DeFi, the world is going toward cloud-native hosting and technology stacks regardless of organization or project. The future is hybrid and multi-cloud, with distribution of infrastructure as a demand of both TradFi institutions that want to exit owned data centers, as well as web3 and crypto projects that are distributed by design and do not have the desire or often ability to build in-house, wholly owned infrastructure.
The hyperscalers are responding to this trend as all of the “Big 3” Cloud Service Providers (CSPs) are officially strategically multi-cloud. The boundaries of these CSPs are also becoming increasingly blurry as edge and regional computing is becoming a significantly larger demand for distribution to get data and computation closer to customers and end users.
Hypothesis #4: The future of finance governance is hybrid & distributed. xxx
Your next boss might not be human. If you look at practical examples of DeFi projects using DAOs for governance like Uniswap and Compound, it provides a good indicator of what the future might look like. In the TradFi space, governance continues to be completely centralized and human oriented. However, given that TradFi is rapidly getting involved in a variety of other DeFi concepts like crypto custody, digital wallets, etc., a hypothesis that the concept of the DAO is embraced is highly reasonable, especially if a TradFi institution attempts to create a “challenger” model within the walls of its organizations in an attempt to create a greenfield, segmented crypto and web3 based business model.
This may very well leave us in an eventual hybrid state of governance, where all could be true at the same time. TradFi’s could participate in public permissionless smart contracts ecosystems like Ethereum, but also create their own governance models. DAOs could exist in pure play format but also are adopted by TradFi and centralized crypto projects. VC’s such as Andreesen Horowitz continue to back “decentralized” DeFi and Web3 projects.
… do you agree with these hypotheses, or see the future trajectory of finance technology differently? There are some other great viewpoints out there, to include the latest Coinbase blog post on the Web3 developer stack.
So what does this landscape look like today and in the future?
If you take a traditional tech stack view of Infrastructure, Platforms, and Applications, underpinned by industry standards and regulatory guidance, I believe that currently we are roughly looking at the following architectural components across TradFi, DeFi, and Hybrid & Shared components connecting each domain:
Figure 3. A hybrid hypothesis on the tech stack for TradFi, DeFi and Hybrid & Shared Components
... and within this reference architecture, we can illuminate it with some practical examples of institutions, crypto-native projects and FinTechs that are operating in each domain:
Figure 4. Highlights of the vendor landscape for TradFi, DeFi and Hybrid & Shared Components
How is this forcing TradFi to change and innovate?
Currently, TradFi is generally seen as a highly trusted intermediary while DeFi concepts such as trustless agreements, democratized and decentralized governance, tokenization, and decentralized identity are starting to make financial incumbents question where they should evolve. TradFi has a great opportunity to leverage its status as a trusted, centralized entity while offering diverse products and services in both conventional and digital assets, while also operating as an "Amazon Marketplace" and bridge to the DeFi economy... much like Coinbase is already doing from a CeFi standpoint. Coinbase is operating as a crypto-native exchange that offers both custodial services and non-custodial wallets and a gateway to the Web3 world. TradFi could consider a similar future that leverages its strengths with its current customer base.
Additionally, DeFi is already disrupting TradFi in three key mega trends of Digital Cash, DLT as a Platform, and Emerging Asset Classes.
These institutions must leverage that trust and act as a diverse "Amazon Marketplace" of a broad range of both TradFi and DeFi assets to increase wallet share. Otherwise, consumers and institutional investors may continue to seek these DeFi financial products and exposure to digital assets elsewhere, with non-custodial wallets, crypto-native exchanges, and even the FinTechs that are expanding to the full range of TradFi and DeFi assets such as Robinhood, PayPal and Bakkt.
