Podcast: A Deep Dive Into DeFi, Or Decentralized Finance – Fin Tech

The world of decentralized finance, blockchains, virtual and
cryptocurrency has grown exponentially in recent years. Many
financial institutions are looking to enter or expand their
operations in the digital economy, but the regulatory environment
gives many pause.

Over the coming months, McGlinchey attorneys from various
practice groups will dive into the world of DeFi and explore it
from every angle. In this episode of “More with
McGlinchey,” Aaron
Kouhoupt and Robert
Savoie (Cleveland) discuss this fascinating and
vibrant subject matter while giving a breakdown of content coming
– from articles, podcasts, and webinars on hot topics to a
client-only, live Q&A session, drilled down right to the good
stuff – what is DeFi and how does it impact
traditional finance?

NEW: This introduction is also available
to watch as a video.

Robert Savoie: Hey, I’m Robert Savoie.
I’m a partner in McGlinchey Stafford’s regulatory
compliance team and chair of our FinTech practice.

Aaron Kouhoupt: Hi, I’m Aaron Kouhoupt. I
am also a partner with McGlinchey Stafford in the Cleveland office.
I work with Robert in our consumer financial regulatory team.

Robert: Awesome. So we are here today to
talk about DeFi and decentralized finance and what it is. And so
what we’re going to do is talk a little bit at a high level
about what the concept is. And then Aaron is going to talk about
what we are trying to accomplish and what we are going to go
through over the course of this deep dive.

So, to start off, at a high level, DeFi is decentralized
finance. When you think about “what is DeFi?” it’s
important to think about, you know, what is traditional finance?
What is this concept of centralized finance that they’re
referring to? When you think about the way financial services,
particularly in the U.S., but also in other developed countries,
exist, they exist through this concept of a trusted custodian or a
trusted intermediary, enshrined with protections in law.

The simplest example is: you go to your bank account, right? And
you deposit funds into a bank. And what you’re doing is
you’re taking money that you’ve earned, and you’re
putting it into a bank account. Well, you don’t have access to
that unless the bank agrees to give it to you. And so, while it is
your money, and you have a legal right to it, you have chosen a
trusted custodian, one subject to many protections and governmental
restrictions and regulations, but nonetheless, a custodian that
holds assets for you.

When you go to take out a loan, you take out a loan
traditionally from a bank or credit union or a non-depository
license lender. And in each instance, you’re borrowing funds
from a mainstream centralized finance entity. What decentralized
finance seeks to do is essentially take that intermediary or that
trusted custodian out of its role and place humans in those roles
and allow that intermediary to be taken out.

So if you think about it from the context of the way in which
banks traditionally and classically operate, you put your deposits
into the bank, and the bank pays you a rate of interest. Then the
bank pools that money and they make loans to other people that need
to borrow that money. What decentralized finance tries to do is
say, hey, what happens if we take out the bank and you have the
individual giving their money directly to somebody else that may
pay them for use of that money, or, for example, borrowing money
from another individual instead of through an intermediary?

And so if you think about the most prominent use case for DeFi
being cryptocurrency, you think about cryptocurrency exchanges. Due
to, particularly in the U.S., the regulatory hostility from
traditional banking regulators to cryptocurrency, you see a lot of
that go through non-depository money transmitters who are licensed
across the states. And so while they may seem like they’re
DeFi, those are a form of centralized finance, because they, again,
are the custodian. You go to the exchange, you buy Bitcoin, you buy
other cryptocurrencies, and you have that, but to go get your
crypto out or to go get your cash out, you have to go actually log
onto your account and request access to those funds. So that’s
a different, but similar, form of centralized finance.

What cryptocurrency seeks to do, from a decentralized
perspective, when you’re not utilizing an exchange, is have you
go and buy your cryptocurrency through algorithms from other
people. And so somebody goes, and they’re gonna sell you the
cryptocurrency. And that’s the premise of the blockchain, is
this immutable record that, as opposed to the record of your
deposit at your bank being held with the bank with copies on file
with regulatory agencies and records all maintained by this
custodian, it’s all held in the blockchain. And so the
blockchain creates the record of when I bought my cryptocurrency
from Aaron. And so the cryptocurrency is now mine.

And that creates certainly different outcomes from centralized
finance because you don’t have FDIC insurance necessarily. And
so you read stories about the person that bought a bunch of
cryptocurrency and had it, and the key to access it on the
blockchain, on a hard drive. And then they threw it away because
they thought cryptocurrency would never go anywhere and would never
do anything. And they threw away the hard drive where they stored
it, and it’s now worth 50 million dollars. And so there’s
the story of that person going nuts, digging in a local dump,
trying to find their hard drive.

So when you think about it, there are interesting opportunities
for decentralized finance, when individuals think about the
benefits of being sort of outside of control or crutch of
custodians, if they have a mistrust for those institutions.

But there are also risks, right? Because at the same time, you
don’t have that institution. When you think about how DeFi is
going to impact consumers or, you know, U.S. citizens, and citizens
all over the world, it is an interesting thing to break apart the
different use cases and the regulatory infrastructure that
surrounds that, then think about, how do you build DeFi programs?
How do you use DeFi programs? And what are the legal underpinnings
for those structures, you know, when you’re outside sort of
traditional, mainstream, consumer financial services institutions,
and you’re doing things like borrowing money, buying assets,
paying interest, and offering insurance, and other things through a
decentralized framework where it’s person-to-person as opposed
to person-to-institution?

And so those are some of the concepts that are so fascinating
about DeFi, but when you think about how you break that down, you
know, those are the issues that you run through.

Aaron, do you want to talk a little bit about sort of what
we’re going to dive into?

Aaron: Yeah, that’s a great
background. So what we’re going to do over the next few weeks,
a couple of months, really, is to talk a little bit about DeFi in
general: what DeFi is, how it impacts traditional finance. And
we’re going to talk a little bit about the interplay between
DeFi and traditional finance.

We’re going to look at a variety of different methods of
getting some content out to everybody with podcasts, webinars, and
some written articles. They’re going talk about things like
“when is virtual currency currency?” Robert earlier
talked about money transmission. What is it? Is cryptocurrency
money? Is it counted by the state as money? If I’m sitting in
between two parties and I’m transmitting that virtual currency,
do I need a license in order to do that or not? Does the state
consider that money? What is money, as the state defines it?

We’re also going to talk a little bit about enforcement
actions in this space. We’re going to spend some time in a
podcast talking about some of the more prominent enforcement
actions that have come down in this space and why you should care
about whether or not you are in a traditional finance space, but
might be offering something that touches this DeFi world.

So, for example, if you’re offering cryptocurrency as a
reward for a standard loan product, cryptocurrency is the way in
which you reward and incentivize a consumer for utilizing your
product. What’s the impact of that? And how are you sort of
brought into this world when you’re offering that kind of a
reward product, or accepting it as a merchant, and you’re
accepting cryptocurrency as payment? How does that affect the
payment rails and what your obligations are?

So we’re going to talk a lot over the next couple of months
about this DeFi world, how these different cryptocurrencies and
different things that seem like they aren’t going to touch you,
right? Like you’re sitting back going, no, I don’t do this,
this isn’t something I’m worried about. I don’t offer
cryptocurrency. I’m not mining cryptocurrency. It’s more
than that. And it can touch your business in so many different ways
that you’re just not even thinking about because you think,
yeah, I’ve partnered with somebody and they have a license to
mine crypto, and they offer cryptocurrency, and I’m not doing
anything as part of this. But you are, or you could be. And what
are the implications if you get caught up in that?

As with all of our Deep Dive presentations, most of this content
is going to be on our website and free for anybody that wants to
take a look at what we have going on. At the end, we do have a
client-only webinar where we will send a special link out to
clients that are interested, and we will do a live Q&A session,
and, on an anonymous basis, just talk about any questions you have,
or really just do a roundtable about this space and what we’ve
talked about over the last few weeks.

I appreciate Robert joining me on this introduction. You’re
going to see Robert and I in a couple of different pieces of
content, but you’re also going to see other partners, other
associates, and some other of counsel that we have both in our
division and in other divisions of the firm because again, it’s
not just consumer finance, there are other areas of your entity
that might be impacted by this. So you’re also going to hear
from some of our colleagues in litigation, and enforcement, and in
human resources.

So we look forward to bringing it to you and are excited to get
this rolling!

Robert:  Thanks so much, Aaron, looking
forward to it.

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