AN INTRODUCTION TO BLOCKCHAIN,
CRYPTOCURRENCY, AND
DECENTRALIZED FINANCE




 

Andreas Park

Presentation for Lakehead University's
Third Age Learning Initiative

 

 

Agenda for the presentation

  • Answers and quick explainers to some questions - what is \(\ldots\)
    • a cryptocurrency
    • a blockchain
    • Decentralized Finance
  • An Outlook:
    • Some risks and what's coming over the next years.

What is a blockchain?

What is a cryptocurrency?

What is Decentralized Finance?

decentralized finance =
provision of financial services without the necessary involvement of a traditional financial intermediary

in practice: new financial infrastructure that will be a common resource

payments

stocks, bonds, and options

swaps, CDS, MBS, CDOs

insurance contracts

Application: decentralized trading

Application: Decentralized Lending

\(\vdots\)

dapp-linking, Defi-Legos and flash loans

Source: Harvey, Ramachandran, and Santoro (2020)

Risks and open problems

  • many apps are still experimental, many kinks need ironing, and tech progress is needed
     
  • smart contract risk: 
    • detecting problems with code
    • detecting problems with economic incentives
    • foreseeing unforeseen contract contingencies
    • contract contagion risks
       
  • governance of decentralized organizations
     
  • role of regulators

What lies ahead?

Fall 2021 description

previous description: "New financial infrastructure"

NB: underlying language "Move" is explicitly designed for financial contracts

Source: Croxson, Frost, Gambacorta and Valletti (2021)

cellphone data from 2018 (NewZoo), inflation from 2020 (World Population Review)

DIEM = "new financial infrastructure"

Source: BIS Working Papers No 880 "Rise of the central bank digital currencies: drivers, approaches and technologies" by Raphael Auer, Giulio Cornelli and Jon Frost 

central bank ISSUED Digital Currencies

CBDCs are on their way

Can and will the Bank of Canada issue a CBDC?

The Bank of Canada's Contingency Plan (Feb 2020):
Consider Issuing CBDC if:

  • Cash becomes unusable, and/or
  • An alternative digital money starts taking over

Will they?

Veneris, Park, Long, Puri (2021): BoC is in a legal position to issue a CDBC and there are several legal paths to do so

Can they?

Possible CBDC architectures

Source: BIS Quarterly Review, March 2020

Disintermediation through CBDCs: the common view

  • Greg Baer, Bank Policy Institute
    "A necessary consequence of any CBDC would be to shift money out of bank deposits and into cash – in this case, digital cash. As a result, those deposits would no longer fund bank loans, which are the primary asset of banks, as well as Treasuries and other assets. Banks’ lending would decrease in supply and increase in cost as banks paid higher rates to persuade businesses and consumers to hold deposits rather than CBDC"
     
  • Jens Weidman, Bundesbank President
    "
    Depositors could also shift their funds into CBDC only gradually and over a long period. In this scenario, banks would still lose a convenient source of stable funding. To make up for it, they may increasingly turn to other sources like the bond market or to the central bank to finance their activities. This may affect the amount of credit which commercial banks supply to the economy. The impact on the equilibrium depends on various factors and is not clear-cut to predict."

BoC analysis (August 2020):

  • [banks] are well-positioned to absorb potential temporary negative effects on profitability and liquidity
  • Banks[can] absorb the shock under plausible adoption scenarios.
  • [No] threat to the stability of the financial system or to banks’ competitiveness in terms of ROE.
  • banks will maintain healthy liquidity levels, and liquidity could become a concern only in the most extreme scenario.

Disintermediation through CBDCs: the evidence

Disintermediation through CBDCs: the evidence (part II)

BoC paper May 2020 (Chiu, Davoodalhosseini, Jiang and Zhu): "[...] a CBDC that competes with bank deposits as a means of payment can compel banks to raise the deposit rate and expand bank intermediation and output. The model [... for US]  suggests that a CBDC [...]  can raise bank lending by 3.55% and output by 0.50%. "

Federal Reserve Board research by Anderson, Du, and Schlusche (2021): when large U.S. banks lost access to roughly $1 trillion of below-market-rate funding because of the 2016 reform of money-market mutual funds, these banks did not cut back on lending.

Duffie and Krishnamurthy (2016): "By lowering frictions in the payment system, a CBDC should improve the efficiency of money markets and lead to increased lending."

My reading of the evidence:

  • access to deposits will be more difficult
  • you have to compete more
  • your margins will decline
  • but that won't harm stability or the economy 

Final Thoughts

Evolution

CBDCs

  • "DeFi refers to a fast-growing and highly opaque corner of the cryptocurrency market which allows users to engage in a variety of financial activities – including lending, borrowing, and trading derivatives to take on leverage – without an intermediary like a bank.
     
  • Given that participants and project developers may remain anonymous, DeFi could present particularly severe financial stability risks.
     
  • According to a 2019 Financial Stability Board report, decentralized financial technologies may raise new forms of concentration risks, unclear allocation of liability, and recovery and resolution challenges."

Source: Letter to Janet Yellen, Chair of the Financial Stability Oversight Council (FSOC) https://www.warren.senate.gov/imo/media/doc/FSOC%20Crypto%20Letter%2007.26.2021.pdf 

What is decentralized Finance and why should you care

“[…] the need for a coordinated and cohesive regulatory strategy to mitigate the growing risks that cryptocurrencies pose to the financial system”

Blockchain = Web 3.0

metaverse =
marriage of the digital and physical world

Web 4.0: The Metaverse and Non-Fungible Tokens

  1. to business lines
     
  2. of operating with the new tech
     
  3. of spillovers from customers who engage with new tech
     
  4. of business complacency 

Qualitative description of risks

Proof of Work uses unsustainable amounts of energy

Source: Cambridge Bitcoin Energy Consumption Index https://cbeci.org/

@financeUTM

andreas.park@rotman.utoronto.ca

slides.com/ap248

sites.google.com/site/parkandreas/

youtube.com/user/andreaspark2812/

Blockchain and Decentralized Finance Primer

By Andreas Park

Blockchain and Decentralized Finance Primer

This is the slide deck that I used in a presentation for UofT Alumni on June 10, 2021.

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