Fed official touts DeFi as ally, not rival, to traditional finance

Federal Reserve Governor Christopher Waller believes that DeFi is more likely to work alongside traditional finance rather than replace it entirely.

Speaking at the Vienna Macroeconomics Workshop on Oct. 18, Waller delved into the ongoing debate surrounding DeFi’s role in the financial system, acknowledging its innovations while highlighting the enduring value of centralized finance.

A complementary system

According to Waller, intermediaries, or “middlemen,” remain essential to managing the complexities of financial trades. He noted that the benefits of centuries-old centralized systems, such as reducing transaction costs and ensuring trust, still hold value in today’s evolving financial landscape.

He stated:

“DeFi has brought new technologies that can improve efficiency, but it cannot substitute for the complex and trusted systems that centralized finance has developed over centuries.”

Waller acknowledged that DeFi introduces technological advancements that could streamline and lower the cost of financial activities without the need for intermediaries. However, he warned against the notion of a completely decentralized financial system, pointing out that intermediaries still serve a valuable function for most individuals. The Fed governor stated:

“The idea that finance can be fully decentralized is unrealistic.”

Waller added that DeFi platforms may reduce the need for certain intermediaries, but the need for trust in financial systems remains paramount. He highlighted how crypto exchanges often reintroduce the very same intermediary role that DeFi aims to eliminate.

Benefits and challenges

One of the key benefits Waller discussed was the potential for distributed ledger technology (DLT), tokenization, and smart contracts to enhance the speed and accuracy of financial transactions.

He noted that these technologies could be especially useful for tasks such as recordkeeping in a 24/7 trading environment. For instance, smart contracts can automatically execute complex transactions by ensuring all terms are met, potentially reducing the settlement risks typically associated with manual processes.

Waller highlighted that several financial institutions are already experimenting with DLT to improve traditional trading methods, like the use of blockchain in repo markets. He added:

“The bottom line is that things like DLT, 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.”

However, Waller was clear that DeFi’s efficiencies come with challenges, particularly regarding regulatory oversight and security. He raised concerns about the risks posed by decentralized systems, including the potential for illicit financing and the absence of established trust mechanisms that are foundational to centralized finance.

According to Waller:

“Centralized finance relies on regulatory frameworks to ensure financial stability and prevent illegal activities, and similar guardrails may be necessary in the DeFi space.”