Fed’s Waller says DeFi can improve efficiency in centralized finance

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The policymaker discussed how DeFi and traditional finance might coexist.

DeFi can be a complement to centralized finance as these technologies can improve efficiency in traditional financial activities, said Fed Governor Christopher Waller at the Vienna Macroeconomics Workshop on Friday. He also views DeFi as a substitute for centralized finance since it allows individuals to trade assets without intermediaries.

“Rather than relying on each party to separately carry out the transaction, smart contracts can effectively combine multiple legs of a transaction into a single unified act executed by a smart contract. This can provide value as it can mitigate risks associated with settlement and counterparty risks by ensuring the buyer will not pay if the seller does not deliver. While these efforts are still in early stages, the functionality could expand to a broad set of financial activities,” Waller said.

“Things like DLT (distributed ledger technology), tokenization, and smart contracts are just technologies for trading that can be used in DeFi or also to improve efficiency in centralized finance. That is why I see them as complements,” he added.

Waller also touched on the benefits and drawbacks of financial intermediaries, which have often facilitated trading by reducing the time and cost associated with finding trading partners.

He pointed out that while intermediaries help in matching buyers and sellers, they also introduce transaction costs and control issues, often leading to a misalignment of incentives between the principal and the agent.

Technological advancements have historically driven changes in finance, with DeFi representing the latest wave of innovation aimed at improving trading processes.

Waller discussed the important role of stablecoins in DeFi. He described stablecoins as “effectively digital currency” which helps reduce the need for traditional payment intermediaries and lower global payment costs.

According to Waller, the technological underpinnings of DeFi, including blockchain and smart contracts, “will almost certainly lead to efficiency gains over time.”

While DeFi technologies offer promising benefits, there are concerns regarding their security, trustworthiness, and potential regulatory implications, Waller stated. He also cautioned about the risks associated with stablecoins, including their potential use in illicit finance and the historical precedent of synthetic dollars facing runs.

The policymaker urged tailored regulations to maximize DeFi advantages safely. In addition, he called for a balanced view that considers both the disruptive potential of DeFi and the enduring value of centralized financial systems.

“When it comes to our financial plumbing, which affects every person or business in one way or another, I think a balanced view of expeditious disruption and long-term sustainability is merited,” he said.