Dialogue with Finance Professor of Columbia University: The Collision of Traditional Finance and Encrypted World

Original title: "Dialogue and Collision between Traditional Finance and Encrypted World - Interview with Columbia Finance Professor Prof Agostino"

Original Source: Arcane Labs

"Cryptocurrency investment has great potential in expanding traditional financial services, and the key to unleashing the potential is to empower the financial investment paradigm to deal with the unique risks and investment opportunities of the digital world."

——Professor Agostino

  Prof.Agostino Capponi &nb sp ;

Brief introduction of the professor:

Professor Agostino is currently an associate professor of finance at Columbia University. He is the founder and director of the Center for Digital Finance and Technologies and a member of the Data Science Institute.

Professor Agostino's research has been published in several well-known academic forums and newspapers, including Journal of Political Economy, Journal of Monetary Economics, Asset Pricing Research Review, Journal of Finance and Quantitative Analysis, Management Science, Operations Research, and Mathematical Finance.

At the same time, Professor Agostino is also a researcher of the Crypto and Blockchain Economic Research Forum (Crypto and Blockchain Economic Research Forum), Alibaba Group Luohu Research Institute (Luohoan Academy, Fellow of the Fintech@Cornell Center (Fintech@Cornell Center).

This article is an excerpt of the core content of the Arcane Labs team’s interview with Professor Agostino of Columbia University, mainly focusing on hot topics, such as regulation, academic research, DID, SBT, DeFi, industry Trends, tracks, etc. were exchanged and communicated.

Excellent point from the interview:

It is recommended to consider modifying the Howey Test criteria so that numbers can be included The asset class of assets, and then formulate a new regulatory framework in line with the development of the digital asset industry

The regulatory system of digital currency in the future may be distributed, and some of the regulatory regulations will be issued by Smart contracts are automatically implemented, while other regulations are enforced by KOLs through incentive mechanisms

The future regulatory system and its institutions need to be decentralized, with an international regulatory committee

The decentralized state of DAO is difficult to achieve autonomy without a complete incentive mechanism

There is little conflict between the interests of academia and government and private institutions, and even huge synergies can be generated

The core business of banks in the next ten years Unlikely to be challenged or disrupted by DeFi

DeFi introduces a whole new set of unknown risks and potential issues, including oracle risk, protocol risk, governance risk, arbitrage

The development speed of DeFi goes hand in hand with its regulatory system and policies

Homogeneous products and In the end of the service competition, only a few products can survive, and other brands will withdraw from the industry. The test of time will eventually allow the industry to screen out value-driven projects, and those worthless projects will withdraw due to the reduction of users

Let users protect transaction privacy And solutions to obtain value from verified transactions will likely become an important track for the next round of bull market

#1 Encryption industry, digital assets and supervision

Frank Fan: How will the Howey test affect digital currencies?

Agostino: The existing securities regulatory framework still needs to be improved, and the Howey test also needs to be updated and modified on the basis of digital assets.

Howey's test defines the core feature of traditional securities from a legal perspective - "agency theory", that is, shareholders extract from the manager's work results in the form of return on investment value. At present, project parties in the encryption industry have avoided the distribution of income by the project party through repurchase of governance tokens issued, and indirectly avoided the Howey test. Because project developers intend to avoid supervision, the designed digital assets, such as stable coins, governance tokens, etc., do not fully meet the applicable objects of the existing asset regulatory framework.

This situation proves that the existing regulatory framework is difficult to apply to the emerging digital assets in the encryption industry. Therefore, it is recommended that the regulatory system consider revising the standards of the Howey test so that it can include the asset class of digital assets, and then develop a new regulatory framework that is in line with the development of the digital asset industry.

Frank Fan: How will the framework to replace the existing digital asset supervision be presented in the future?

Agostino: First, you need to define each Token and its characteristics, and establish Token classification and subjects. Subjects and classifications serve as the basis for the regulatory framework, on top of which specific rules of regulatory regulations can be automatically implemented through smart contracts. The regulatory system of digital currency in the future may be distributed, some of which will be automatically implemented by smart contracts, while other regulations will be implemented by KOL through incentive mechanisms.

Frank Fan: Will there be a special agency responsible for supervising digital assets through smart contracts?

Agostino:Due to the change and innovation of the industry, digital assets will definitely need a dedicated regulatory agency in the future. Regulations for digital assets will not be formulated by traditional institutions such as economists, financial professionals, or lawyers. On the contrary, in the future, the regulators must understand the core operation of digital assets, be able to develop smart contracts, and understand the governance rules embedded in smart contracts, in order to be able to formulate a sound regulatory framework and implement it.

Considering the friction between different jurisdictions and the 24-hour operation mechanism of the digital asset financial market, the regulator must be operated and managed by an international regulatory committee . While avoiding frictions between national policies, the international regulatory committee can respond to emergencies in the encryption industry at any time and in a timely manner. If the agency is country-based, an automated regulatory infrastructure must be established to avoid the need for a single centralized solution. After all, the underlying technology and concept of digital assets is decentralization.

When it comes to decentralization, we also need to pay attention to the distinction between the parts that need to be supervised and those that don’t need to be supervised in the DeFi field. If DeFi is affected by regulation and is gradually centralized, there may be situations such as imposing a pledge requirement in the internal DeFi ecosystem. The advantage of this requirement is the improvement of network attack resistance and the acceptance and recognition of a wide range of users, while the disadvantage is the strengthening of centralization. Another situation that may arise in centralized DeFi is that users need to go through layers of KYC certification to conduct transactions, which makes DeFi inefficient.

In summary, a decentralized regulatory system and institutions are necessary, and excessive regulation will lead to infrastructure centralization, which is different from blockchain and The philosophy of digital assets runs counter to that.

Frank Fan: What regulatory governments or institutions are currently targeting digital assets?

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Agostino: At present, the United States has entrusted the regulatory tasks of the digital asset market to two institutions: SEC and CFTC.

The current debate concerns how regulators should treat digital assets, should they be considered securities or derivatives? None of these institutions has conducted investigations and research on emerging new digital assets. The parties have not yet reached a consensus on how digital assets should be traded.

In addition, the sanctions on Tornado Cash have also sparked debate on whether smart contracts should be supervised. While paying attention to the financial attributes of digital assets, regulators should also pay equal attention to their technical characteristics in order to fully understand the core of digital assets. The regulatory standards and systems applicable to securities and derivatives are not applicable to digital assets, and it is not feasible for regulators to try to manage digital assets in the same way as traditional financial markets.

Some Web3 users believe that the encryption industry does not need the supervision of a centralized government, and that the Web3 ecosystem can achieve self-government through incentive mechanisms. Self-regulation is actually very difficult to achieve. If the digital asset industry is to implement an autonomous regulatory system, the motivation of investors must be consistent with the best solution in society and the wishes of regulators. Most of the existing autonomous governance systems are very intuitive and easy to understand, but at the same time, there are many hidden dangers and risks in the structure.

Taking the autonomy of DAO as an example, most of the governance tokens in DAO are often held by individual accounts such as early investors and whales. Even, individual accounts may hold more than 50% of the total Token, which means that these individuals can control DAO's decision-making and core governance methods. Combined with the dislocation of incentive mechanisms, this gives huge potential for manipulation, mezzanine and attacks.

Therefore, in the current decentralized state of DAO, it is difficult to achieve autonomy without a complete incentive mechanism. If it is difficult for DAO to achieve fair and just autonomy, how to achieve autonomy in DeFi or even the entire Web3 ecosystem? This will be where the industry needs to continue to improve.

#2 Academia, Education and Blockchain Technology

Frank Fan: What is your view on the relationship between academic research and the digital asset industry?

Agostino:

Agostino: I believe that there is little conflict, and even great synergy, between the interests of academia and government and private institutions. Academia can help industry and government agencies understand the potential of digital assets, and can also help guide government agencies and support them in making sound decisions. I have seen many academics join the leadership team of Coinbase, or participate in the development of the consensus mechanism. From these phenomena, we can see that the academic community is already helping the encryption industry to progress faster.

The research and information provided by the academic community is based on the current market situation and its underlying operating laws. As in the 2008 financial crisis, academics joined the federal government to help the government explore how to improve the regulation of financial markets. Of course, there are also points of difference between academia and the crypto industry to consider.

Since academia conducts research on innovations observed in industry, the research objects and outputs of academia are in line with emerging digital assets and services emerging in industry There is a delay. For example, I am working on AMM protocols and designing more efficient AMMs to expand liquidity providers and investors in the ecosystem. From another perspective, academic research does not focus on the precise details of the mechanism, but on the logic and mechanism behind it. As far as automated market makers are concerned, I look at what type of convexity curve produces how much return, and thus come up with the optimal convexity curve. Over time, other DEXs may apply our research to benefit a wider range of users.

At present, there are two types of scholars in the field of digital assets. One class of academics is very supportive of blockchain technology, while the other is skeptical. I think the suspicion of some scholars stems from distrust of cryptocurrencies. After all, cryptocurrencies are the first type of products that scholars come into contact with when they enter the field of digital assets. These skeptical academics, accustomed to fiat currencies, do not understand the value of digital assets. The inefficiency of cryptocurrency mining and the high energy consumption make scholars believe that cryptocurrency is not a perfect and successful design. The design of the blockchain consensus algorithm is also another reason for scholars to doubt and deny digital assets. Scholars who support this field believe that blockchain has the potential to become a technical infrastructure, rather than the narrow usage scenarios of financial technology and cryptocurrency.

Frank Fan: Do you think DID and soul-bound coins can have an effective effect on the existing education system?

Agostino:DID and SBT have many potential application scenarios in the education system, for example, it is beneficial to include teaching grade certificates in the education system of. For example, completing certifications for online courses, or rewarding students with digital assets. However, the centralized education system and certification system provide many empowerments that cannot be achieved by a decentralized system, such as the relationship network established between teachers and students in the centralized education system, and the interactions and discussions generated research topics, etc. From this perspective, the blockchain is unlikely to completely replace the centralized education system and certification institutions in the short term, but the application of new technologies such as DID and SBT may generate innovative practices in some subdivided fields.

#3 Looking forward to the prospects and industry trends of the encryption industry

Frank Fan: Is DeFi a model innovation or a repeat of CeFi's mistakes?

Agostino: DeFi has both advantages and disadvantages. On the bright side, DeFi can overcome some of the constraints set by CeFi and provide better financial services to a larger user base. For example, reducing intermediary costs, real-time settlement, increasing liquidity for users subject to counterparty risk constraints, and reducing negative externalities through incentive mechanisms.

On the other hand, one of the disadvantages of DeFi is the limitations of its projects. Most projects just repeat the mechanism of CeFi, which is inefficient. Algorithmic stablecoins are an example of a failure in the digital asset industry.

In addition, we should proceed with caution, because DeFi introduces a whole new set of unknown risks and potential problems, including oracle risk, protocol risk, governance risk, arbitrage risk wait.

In general, the current DeFi design in the encryption industry is inefficient, and there is still a long way to go for the development and improvement of digital assets.

Frank Fan: Do you think there will be only a limited number of successful products or a winner-take-all situation in the digital asset industry?

Agostino:I believe that the digital asset industry will develop into a winner-takes-all market structure in the future. Taking DeFi as an example, there are many projects in the existing DEX that provide similar services. In the final competition of homogeneous products and services, only a few products can survive, and other brands will withdraw from the industry. From an industry perspective, I believe that the core services of digital assets will remain, such as lending and Swap. The rest, like algorithmic stablecoins, will exit the digital asset industry.

Frank Fan: The investment portfolios of many asset management companies are now beginning to cover two categories: digital assets and traditional assets. Lines are blurring. Do you think the two will merge into one or separate in the future?

Agostino:From Considering long-term development, the industry will definitely see the gradual integration of CeFi and DeFi. At present, companies and individual customers have begun to use both centralized and decentralized trading platforms; other combined cases such as stablecoins, although it is CeFi linked to the US dollar, are also in a decentralized system; the industry is about to See the addition of the central digital currency CBDC; another example is oracles, most oracles that are easily manipulated extract information from centralized trading platforms. My guess is that CeFi and DeFi will have a certain degree of integration in certain financial fields, which will create a new business model.

Frank Fan: In terms of widespread adoption of digital assets, how do you see its progress relative to the risk of losing access to addresses and their custody ?

Agostino:It depends on the progress of DeFi in developing products and services based on non-technical background users. I don't think DeFi will eventually replace banks unless DeFi's services are friendly and accessible to non-technical users. In addition, DeFi must be safer and more convenient before it can be used by the general public.

Central banks have evolved over thousands of years, improving with each iteration. Therefore, I think that according to the current development speed of the industry, the core business of banks is unlikely to be challenged or subverted by DeFi in the next ten years.

Frank Fan: Do you think the development speed of DeFi will change?

Agostino: DeFi’s development speed goes hand in hand with its regulatory system and policies. If the pace of designing and improving the regulatory system can be accelerated, so as to establish the trust of a wide range of users and non-technical users in digital assets, and increase the general public's understanding of digital currency, it can effectively speed up the adoption of DeFi by the public.

Frank Fan: You mentioned that the industry should eliminate digital assets that are not value-driven. What is your definition of value-driven?

Agostino: The core driving force of value refers to the user's demand for services or products. Taking the automobile industry as an example, Honda has solved the needs of users for private transportation within the affordability of the public. From the perspective of transactions, Honda, as a car brand, provides benefits and value to paying customers in disguise.

Web3 projects have such potential, such as DEX and zero-knowledge proof, but most projects in the industry have not really provided users with value or benefits product or service. I believe that the test of time will eventually allow the industry to filter out value-driven projects, and those without value will exit due to the reduction of users. This is a process of self-adjustment within the market.

Frank Fan: From a macro perspective, who are the ultimate winners and losers in the process of transition from web2 to web3?

Agostino: The winners will be those projects that can design innovative assets, projects that provide valuable services, users who use these projects, And (unfortunately) bad actors who succeed in running the scam. Now there is a project in Kenya that is providing financial products and lending services to farmers who cannot borrow in banks due to credit problems. This is a high-quality win-win case.

Losers include most gamblers and cheaters. Through the innovation and development of the web3 space, speculative and hyped users will lose arbitrage opportunities and thus continue to exit. As web3 becomes more transparent and efficient, other losers may include large web2-based intermediaries.

Frank Fan: Which applications or infrastructure do you think will be the tipping point of the next round of bull market? What types of products or services can stimulate large-scale transactions and usage? What facilities are lacking at the basic level now?

Agostino: The core of this problem is the obstacle faced by DeFi trading platforms - "excessive transparency" . Transparency is one of the basic concepts of the blockchain, but at the same time, excessive transparency also makes users lack arbitrage trading opportunities in the process of trading digital assets, thus hindering the transaction volume to a certain extent. I think a solution that allows users to protect transaction privacy through a method similar to zero-knowledge proofs while guaranteeing miners’ interest in verifying transactions will stimulate wider use of DeFi, thereby stimulating the next round of bull market.

Current innovations such as Flash Bots and Privacy Channels partially address the problems caused by excessive transparency. Dark Transactions can solve the problem of user privacy very well. In the process, the user directly submits the order to the verifier, bypassing the mempool of the blockchain. Flash Bots will also start to be widely used by Ethereum users in mid-2021 to solve transaction privacy issues. However, while the above methods successfully protect user privacy, miners lose arbitrage opportunities and affect the sustainability of the entire ecosystem. To sum up, the existing schemes have not been completely successful in protecting the privacy of users' transactions while protecting the interests of miners. If there are applications or mechanisms that can protect the interests and privacy of all participants in the entire DeFi ecosystem, DeFi will be more widely used, which will trigger the next bull market.

Frank Fan: Do you think it is possible for government or national funds to participate or inject into the digital asset ecosystem to accelerate the development of digital asset technology ?

Agostino: At this stage, due to the absence of industry regulation, the participation of government agencies and countries is limited. In the future, if the digital asset industry adopts a sound incentive mechanism and the government participates in automated governance, the general public may start to hold digital assets and generate large-scale transaction volume.

The premise of this phenomenon is the understanding and trust of government agencies in the digital asset industry. Enough trust in the crypto industry is needed before government agencies can consider injecting money into the crypto industry, or incorporating it into existing economic systems such as taxation.

The status quo of the encryption industry, including the avoidance of risks, the autonomy and incentive mechanism in the DeFi field, etc., are not enough for the government to have enough trust in the encryption industry. Therefore, there are still many areas in the industry that need to continue to evolve and embrace regulation, so that the government can participate with confidence, which will be an important driving force for industry compliance.

#Postscript

Professor Agostino has a high position and recognizes the innovative fields such as digital assets Crypto and DeFi Technical value and financial value, but at the same time, it also puts forward some effective suggestions from supervision to industry development for industry problems and bubbles. Professor Agostino is full of confidence in the development of the industry, and also provided valuable advice on the investment theme and direction of our Arcane Fund.