China is a test case for decentralised finance (DeFi), exemplified by peer-to-peer (P2P) lending. The practice is when an online platform is supposed to serve as an information intermediary that connects borrowers and lenders. P2P lending started in China in 2007. According to McKinsey, by 2015, over 2,500 P2P players had entered the market.
McKinsey says P2P loan balances in China swelled to RMB1.3 trillion by June 2018. Many platforms extended credit without having proper risk assessment tools or processes in place, McKinsey said. Many more were operating as “shadow banks” where they offered high interest rates to individual investors and lent the money out to businesses at even higher interest rates.
Failures materialised in two waves. The first was in 2016, marked by the Ezubao Ponzi scandal. Xinhua reported that “the controlling shareholder looted US$7.3 billion from about 900,000 investors”. The second wave of failures was in 2018 following a crackdown by the Chinese regulators.
“If you look at the Chinese, they got some 6,000 to 7,000 P2P companies and then shuttered 4,000 of them because the individual who goes and puts money just does not have the wherewithal and knowledge to make sure that due diligence is appropriate,” says Piyush Gupta, group CEO of DBS Group Holdings, in a recent interview.
People participating in DeFi are likely to find hidden risks in the system which are not likely to disappear in the next 10 years. Another form of disintermediation was attempted some 40 years ago with companies accessing capital from investors. This led to the creation of investment banks and businesses, including DBS’s debt capital markets (DCM) and equity capital markets (ECM), businesses, which regularly top regional league tables.
If a company borrows directly from an investor, an intermediary is not required. “Guess what, the intermediaries still exist, they just call themselves investment banks and commercial banks,” Gupta says.
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In the past seven years, central bankers were experimenting with disintermediated central bank digital currencies (CBDC). In this model, central banks may not even be needed, but subsequently, the regulators have walked away from this model. Now, central banks are experimenting with a CBDC model operating through the banking system.
“Nobody wants to destroy the industry or job creation. Most central banks prefer the intermediated model because during credit creation, commercial banks continue to do the underwriting. If we don’t exist, that onus and burden either falls on the central bank, or you rely on individuals doing all the credit creation,” Gupta notes.
If central banks provide credit, that could inevitably get politicised and be held hostage to vested interest. In the end, people are unlikely to destroy nation states to become global citizens. “I think the idea of a completely decentralised finance by corollary becomes hard to make sense of,” Gupta says.
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Instead, Bitcoin is likely to exist as a speculative asset class along with other forms of digitised money such as CBDCs. “The underlying technology is very powerful, but I think it will be backed by central banks, so you will get digitised fiat money, such as wholesale and retail CBDCs,” Gupta adds.
“To my mind, where we are today, even if you get to a world where people are willing to participate directly, and an asset can be tokenised on a distributed ledger, I think you’ll get a new form of intermediation, you get an evolution of people who can still orchestrate the participation of people into this whole ecosystem. You still need people to create the UX, the UI, the front end, a platform to look at the alternatives, do comparisons, so you’ll still get a new form of intermediaries.”
