Ethereum is often presented as the opposite of conventional finance, in a confrontation between decentralization and the traditional. However, there is actually no fight between them. Instead of undermining the traditional financial system, Ethereum is improving it. Soon, both systems will be closely related to each other.
Ethereum’s main value propositions – self-custody, transparency, and disintermediation – are hugely relevant to financial institutions, and can be realized within existing regulatory frameworks. Ethereum has already taken the first steps towards institutional adoption and, with its unparalleled decentralization of the network, it is practically destined to become the main settlement layer for financial transactions in the world.
Neutrality in a multipolar world
Ethereum is not here to offer a stateless altcoin or anonymized shadow economy. What it offers is simple: neutrality.
Ethereum is the first truly impartial arbiter of the global financial system, and its arrival couldn’t be more timely. The geopolitical stability afforded by the pre-eminence of the United States is eroding, and the domestic politics of the major economies have become increasingly volatile. In a multipolar world, the financial system urgently needs to maintain reliable rules of the game.
Ethereum’s system for settling transactions and storing data is virtually incorruptible. This is largely due to the unrivaled decentralization of its consensus layer, which encompasses more than 500,000 validators distributed among more than 10,000 physical nodes in dozens of countries. Despite concerns to the contrary, Ethereum is trending towards more decentralization over time, not less.
To be sure, Ethereum will never replace traditional contracts or legal authorities to mediate disputes. What it promises, with its impartial and inviolable code, is to prevent countless disputes from arising in the first place.
Solve the principal-agent problem
From Celsius to FTX to Silvergate, the events leading up to the “crypto winter” speak more to the shortcomings of traditional finance than to the failures of cryptocurrency. In each case, the classic principal-agent problem was compounded by lax supervision and over-centralization.
Historically, the default approach to this problem has been regulation. More oversight is certainly necessary, but Ethereum offers more fundamental solutions. Trustless smart contracts and distributed ledgers can eliminate certain dimensions of the principal-agent problem entirely.
Soon, Ethereum and its scalable chains will permeate traditional banking and asset management. From savings accounts to retirement portfolios, virtually all investors will self-secure their assets in untrustworthy smart contracts, and carefully regulated on-ramps will make fiat tokenization virtually frictionless.
Meanwhile, investors and, eventually, regulators will insist that asset managers report fund performance using trustless chain oracles. In these areas, Ethereum will not break the regulation, but will reinforce it. Over time, authorities will pay as much attention to the technical specifications of smart contracts as they do to the required liquidity reserves.
The future of Ethereum is not permissionless. Identity-based permissions will be the norm, but so seamless as to be virtually unnoticed. With the proliferation of central bank digital currencies, state censorship will be a serious problem. Laws preventing governments from arbitrarily freezing digital assets will gain major political momentum.
In short, Ethereum has the potential to drastically reduce private financial crime, but its impact on state censorship will be more limited.
Nascent institutional adoption
The future of Ethereum may still be some way off, but its building blocks are already here. Decentralized finance (DeFi) has overheated into a speculative conflagration in 2021, but that frenzy of activity spurred considerable innovation. The technology now exists to create a wide range of disintermediated marketplaces and tokenized financial instruments.
What is missing is connectivity to the broader financial system. That is the goal of an emerging class of on-ramps and regulated fiat-to-cryptocurrency custodians, such as Circle. This American company laid the foundations of the digital economy with USD Coin (USDC), its tokenized dollar. Circle is now building additional critical infrastructure, such as hybrid fiat and cryptocurrency accounts that connect directly to Ethereum and its scaling chains.
In the coming years, a proliferation of tokenized securities is expected, starting with risk-free fixed income assets. Much will also be invested in Ethereum staking pools, which will become a critical strategic asset in the institutional cryptocurrency market. Other areas of focus will include on-chain financial reporting, streamlined user flows for regulatory compliance, and institutional-grade tokenized derivatives.
The recent wave of enforcement has undoubtedly dampened development activity in the US, but it will continue to be an important market for the next wave of regulated protocols.
take care of the infinite garden
The increase in regulatory pressure on cryptocurrencies, especially DeFi, marks the end of an era. Large swaths of the Ethereum ecosystem, especially protocols unable or unwilling to adapt to the changing landscape, will be wiped out. Those that remain, however, will be well suited to integration with the existing financial system. Ethereum’s transformative impact on traditional finance has only just begun.
Alex O’Donnell He is the founder and CEO of Umami Labs and an early contributor to the DAO Umami. Prior to Umami Labs, he worked for seven years as a financial journalist at Reuters, where he covered mergers and acquisitions and IPOs.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
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