The following is a full text of a keynote address delivered at the opening of BlockBali 2020 on December 1, 2020 and explores the impact of decentralized finance on the fortunes of the emerging region.
Good morning, good afternoon and good evening. Wherever you’re tuning in to us from, thank you for joining us for BlockBali.
My name is Patrick Tan, and I’m the CEO and General Counsel for Novum Alpha, a quantitative digital asset trading firm, as well as General Counsel for the Novum Group, a diversified cryptocurrency and blockchain services companies with interests in media, software development, trading and services.
It is my privilege to welcome you to BlockBali 2020 and Novum Alpha is proud to be the gold partner for this year’s event.
But what a difference a year has made!
As you can see from where I am seated, I am unfortunately not in Bali, one of the most beautiful places on earth.
Like many of you, I’m tuning in from my home office because of the coronavirus pandemic, far from the sandy beaches and crystal-clear waters of Nusa Dua.
For billions of people around the world, what we are experiencing now, tuning in to virtual conferences and attending online events, has become a new normal.
But while the coronavirus pandemic has no doubt caused untold economic hardship, it has also created unprecedented opportunities and hastened dramatic shifts in technology, finance and consumption, that may yet prove durable.
The race by countries to deliver much needed economic aid at the height of the pandemic has highlighted the gross deficiencies in legacy financial systems, and brought into sharp focus the billions of people who continue to remain unbanked and lack access to even the most basic financial services.
Nowhere is this more apparent than in Southeast Asia.
Home to over 655 million people, Southeast Asia is one of the most economically vibrant and culturally diverse regions on the planet, with over a hundred different spoken languages and ten discrete currencies.
The region is also a cornucopia of contradictions.
While Southeast Asia has a mobile penetration rate of 133%, where some users own more than one SIM card, less than a third have a bank account.
Consider that Cambodia, which has the region’s highest mobile connectivity at a staggering 173% also has a population which is 95% unbanked, according to a report by financial services firm KPMG.
And according to the World Bank, 80% in Indonesia, the Philippines and Vietnam are unbanked, with 77% for Myanmar, and around 30% for Thailand and Malaysia, while Singapore has about 2% without access to a bank account.
Yet access to financial services is key ingredient for economic development, with the ability to prove creditworthiness and borrow money, integral to lifting fortunes and ending endemic poverty.
Which is where the development of decentralized finance or DeFi comes in.
Consisting of smart contracts, protocols and decentralized applications called dApps, DeFi represents a push for a more open, transparent and inclusive financial system built on the immutable decentralized ledger technology that is blockchain.
With increasing regulatory burdens and higher costs, traditional sources of financing are overlooking small and micro businesses, a vacuum which could potentially be filled by DeFi’s ability to provide more inclusive access to financial services, and credit at lower costs.
Put simply, a DeFi loan consists of a smart contract, typically built atop the Ethereum blockchain, where borrowers and lenders put up their collateral, and an immutable smart contract governs payments of interest and secures that collateral in the event of default.
The ability to earn interest, especially where the sums being lent are small, represents a significant step forward for financial inclusivity, providing greater security, as well as opportunity for the unbanked to participate in the financial system.
For now, the nascent nature of the space has meant that such smart contract loans have tended to be over-collateralized, in other words borrowers have had to put up more collateral than they actually borrow.
Over time, this could change, as some investors may be willing to take on borrowing risks in return for a higher rate of return.
Or as cryptocurrency wallets develop a vintage, for instance demonstrating a regular history of repayment, the need to overcollateralize could potentially come down for such borrowers.
Considering that DeFi services only picked up over the past summer, it is still early days for the space and the potential for microlending and borrowing, is exponential.
But it’s not just borrowing and lending that makes DeFi special.
Companies are also actively working on fund structures that would only be possible in the DeFi space.
Where once, access to fund managers and other institutional investor-grade vehicles was limited to the well-heeled, a handful of firms are working on making investments available to investors of more modest means, through smart contracts and DeFi.
After the hard lessons learnt from Ethereum’s Decentralized Autonomous Organization or DAO, which was an early conception of a decentralized venture capital fund, much improved DeFi investment vehicles have the potential to provide investment opportunities to even the most humble investors.
The DAO hack, as unfortunate as it was, and which led to the hard fork in the Ethereum blockchain, at least helped to expose the vulnerabilities in early smart contract iterations and provided developers a list of things to avoid for future versions.
Today, smart contracts are hopefully more robust, subject to community audit, and transparent, which should help to avoid some of the risks associated with the DAO.
DeFi then provides an opportunity for investors and fledgling managers alike, with the transparency of the blockchain providing an unprecedented opportunity to audit an investment manager’s track record, without the need for fund administrators or auditors.
This means that a fund manager without the traditional credentials such as a degree from a prestigious university, has just as much chance of raising significant amounts of investment capital as one who does, based purely on the success of their track record.
Remittances are another area where DeFi can also revolutionize fund flows in Southeast Asia.
According to estimates from the United Nations Department of Economic and Social Affairs, there are over 20 million migrant workers from Southeast Asia, but the true number, especially for migrant workers within Southeast Asia is likely to be even greater.
Data from the Asian Development Bank, suggests that as recently as 2019, sending a $200 cash remittance to the Southeast Asia region could attract fees as high as 6.3%.
And with remittances accounting for as much as 10% of GDP in countries like the Philippines, huge savings can be garnered through leveraging DeFi.
DeFi liquidity pools, which could pit fiat currency-backed stablecoins against each other in smart contracts provide an increasingly frictionless means to both remit money, as well as facilitate a currency swaps by eradicating the legions of money changers and middle men that typically exact their pound of flesh from such transactions.
Bringing down the cost of remittances could substantially increase disposable income and generate significant welfare for households in recipient economies — a major reason why the United Nations has made lowering the cost of remittance transfers to 3% by 2030, one of its Sustainable Development Goals.
But legacy systems can only do so much, and it’s estimated that depending on the origination of a remittance, a simple money transfer can pass through as many as seventeen intermediaries before arriving at its final destination.
Given the significance of fund flows to Southeast Asia, the region is not sitting back and doing nothing.
Countries such as Cambodia are launching a nationwide payment system based on the blockchain, a precursor to its own digital currency that will be more easily transferrable between borders.
And with as many as 80% of central banks worldwide actively studying the issuance of their own digital currencies, it is only a matter of time before DeFi can be leveraged to both improve the efficiency of foreign exchange as well as reduce friction in remittances.
Because decentralized exchanges that exist in the DeFi space have almost no barriers to entry, any digital token that is built atop the Ethereum blockchain can be swapped for another.
And with the vast majority of fiat-currency backed stablecoins built on Ethereum, the network effect should eventually attract more fiat currency stablecoins to the Ethereum blockchain, where more opportunities to swap fiat currency stablecoins are present.
Even if the fiat currency stablecoins are not built atop the Ethereum blockchain, as has been seen from wrapped Bitcoin, almost any digital currency can be put in an Ethereum wrapper for use on the Ethereum blockchain, demonstrating how such limitations can be overcome.
Remittances, just like water, will ultimately find the paths of least resistance.
And when they do, DeFi will play a major function in supporting that evolution towards a more frictionless means to both swap and transfer value.
But it would be naïve to think that DeFi in and of itself is a silver bullet.
Just as there are almost no barriers to entry in the DeFi space, that very feature allows for abuse.
And authorities are not likely to take kindly to the absence of anti-money laundering and know-your-customer procedures on DeFi platforms.
Given the pseudonymous nature of blockchain transactions, it’s difficult to see how governments will be in a rush to embrace DeFi, particularly when it would be almost impossible to police.
Because DeFi platforms are generally not created by a company and ultimately administered by the community, it would be hard though not impossible for governments to effectively regulate them.
The continued existence of some of the most heinous websites on the internet is testimony to the challenges faced by government when not just access to information becomes decentralized, but access to financial services as well.
Governments may also take umbrage at DeFi’s ability to avoid the existing tax regime altogether.
Capital gains made from trading or investing on dApps would escape traditional taxation routes because of anonymity, depriving already hamstrung government from much needed revenues to fund public infrastructure such as schools, roads, hospitals, ports and airports.
And the small fees that decentralized exchanges charge for facilitating the smart contracts that are used to swap digital currencies, would also for the most part avoid taxation as well, making it challenging for governments, particularly those which are less technologically-enabled, to levy taxes on such activities.
Unfortunately, people will avoid paying taxes where possible and Southeast Asia is no different.
Decentralizing finance, particularly when it comes to lending, investing and remitting, makes it all the more difficult to collect such taxes.
Yet regulatory solutions to manage DeFi may not be effective.
Unlike centralized exchanges with offices and known personnel, many DeFi projects are community run and by design decentralized.
That means trying to govern or regulate such DeFi projects would be challenging at best and impossible at worst.
Given the relative anonymity with which participants in the DeFi ecosystem enjoy, it’s entirely possible for illicit fund flows to use the many tools available in the DeFi space to obscure those fund flows and to obfuscate the source of funds.
This leaves DeFi susceptible to criminal capture and provides a cover for corrupt officials to siphon away illicitly obtained funds without ever having to open a secret bank account in an overseas country, or navigate the complex web of shell companies in tax havens.
But just as the internet is agnostic as to its users, being both a tool for good and evil, the argument that just because DeFi can enable bad actors is insufficient reason for its development to be dismissed.
Just as Africa leaped ahead and skipped over copper landlines, jumping straight to mobile, Southeast Asia has the potential to skip ahead from the clunkiness of legacy banking and financial institutions, to forge ahead with DeFi.
And concerns from existing stakeholders in both banking and finance, that DeFi will usurp their role may be exaggerated.
Already, the rise of digital payments has meant that many legacy banks in Southeast Asia have been able to cut costs by closing a number of physical branches, and such banks can also take on new roles, such as providing value added advisory services to digital currency wallet holders, including investment advice.
DeFi is not a zero-sum game.
If nothing else, the experience of Bitcoin has demonstrated that far from undermining the legacy monetary system, Bitcoin has actually complemented it, acting as a ballast in times of volatility and economic turmoil, while keeping central bankers on their toes and forcing them to maintain a watchful eye on inflation.
DeFi has the potential to do the same.
Remittance companies which have long enjoyed their quasi-monopolies over a captive audience, will be pressured to reduce costs and to make their systems more efficient.
Digital currency wallet addresses, provided that proof of ownership can be established in a practicable way, can be a new gateway for remittance companies to act as intermediaries, in some cases providing forward payment credits where required.
And banks may want to consider creating their own DeFi solutions that satisfy all existing KYC and AML requirements, while at the same time being able to serve customers which they otherwise wouldn’t be able to serve because of cost.
One way would be for banks to assign ownership of particular digital currency wallet address to specific individuals, having performed the requisite KYC and AML, and then to allow the blockchain to do the rest, allowing the public blockchains themselves to act as the bank’s ledger, while preserving the client’s privacy by retaining the knowledge of which individual is tied to that specific digital currency wallet address.
Given the otherwise high costs of maintaining savings accounts and branches, digitalization for banks is more an inevitability than it is an option, and DeFi can help to speed that development along.
Southeast Asia as a region has already recognized the potential of DeFi.
Despite some initial speed bumps for digital currencies in Vietnam, the country has since seen a blossoming of several DeFi protocols.
Singapore is in the process of awarding digital banking licenses next year and countries from the Philippines to Indonesia are all looking into how blockchain technology as well as DeFi can generate even more value for their economies.
As Southeast Asia pushes for greater economic cooperation and integration, DeFi helps to create a more level playing field, one which national interests can neither control nor dictate.
If the goal of financial services is ultimately to serve, then the unfortunate economics of legacy business models have literally left millions unserved.
And where service is available, it is both expensive or inefficient.
For Southeast Asia’s millions to benefit from the revolution in financial services that is taking place, a better and more inclusive path will need to be forged.
And while the challenges facing decentralized finance are not insignificant, they at least represent a grassroots and community-led response to an otherwise challenging problem — the lack of access to financial services.
To be fair, it was never going to make economic sense for profit-driven financial institutions to offer services to the financially feckless.
There will always be some parts of society that will fall off the grid, but when the vast majority of a region are unbanked, that is not a failure of the people, but a failure of the system.
This was always going to be a problem that required out of the box thinking and an out of the box solution.
And while DeFi is by no means a panacea, it is at the very least, a step in the right direction because it requires no government intervention or political will, which can often be found wanting.
Instead, DeFi represents what it means for people to take personal responsibility and ownership of their own financial futures, and that in and of itself is nothing short of a miracle.
Once again, it is my privilege and pleasure to welcome you to BlockBali and an honor to have some of the leading figures in the blockchain and DeFi space to grace this event.
Whilst we are unable to meet in person this year, let’s hope that it will be soon that we can.
Thank you for joining me and I hope you will enjoy the other speeches, panel discussions as well as networking sessions of BlockBali.
I pray that your experience with BlockBali will be a fruitful and decentralized one, thank you.