In October, Meta (then Facebook) CEO Mark Zuckerberg launched a five-year talent recruitment plan to create a "Metaverse" that blurs the boundaries between the virtual realm and physical (real) world. The term swept the world in a flash, and it is widely believed that cryptocurrency will play an indispensable role in the metaverse.

The payments industry is also gradually seeking opportunities in the metaverse. For example, in October, Mastercard announced that it would use Thai, Australian, and Singaporean cryptocurrency exchanges to issue the first cryptocurrency card in the Asia-Pacific region. Users can directly convert cryptocurrencies into legal tender for daily payments, showing the new possibilities of digital payments.

The future application of blockchain technology to the banking industry will also enhance existing financial services, move centralized finance to decentralized finance (DeFi), disrupt existing business models, bring efficiency and innovation, and create new opportunities.

Bringing the physical financial system to the metaverse

“DeFi can provide almost all the same functions as physical financial institutions” said Shyh-Chin Huang, director of Bank of Taiwan’s InnoLab. DeFi applications cover payments, identity verification, insurance, investment, exchanges, lending and more, forming a complete financial ecosystem.

Financial services in the physical world operate through central bank issuance of banknotes and coins, bank teller services, banknote vaults, auditors, laws, and regulation. In the metaverse, financial services operate automatically through uses programming, cryptocurrency, and the rules of smart contracts.

Huang pointed out that traditional banks in the physical world have payment, insurance, investment, exchange, and lending services in fiat currencies. With technological advancement, the traditional banking industry has undergone its first transformation: virtual and digital banks have emerged one after another. Banks use technology to digitize the physical world.

In contrast, DeFi “integrates the physical and virtual.” The metaverse must be connected to the physical world to have value, while physical services want to move closer to the virtual world to improve their efficiency.

Traditional finance can provide moderate centralization

As COVID-19 has swept the world, economic activities have moved online, accelerating demand for virtual cash flow, and also driving development of DeFi. Some futurists anticipate that the metaverse will eventually surpass the physical world in economic scale. As the concept is gradually realized, virtual assets such as cryptocurrencies and NFTs, the key tools of the metaverse, will increase in importance.

11 years ago, Laszlo Hanyecz gave Jeremy Sturdivant 10,000 bitcoins in exchange for 2 pizzas, a story which is well-known in crypto circles, inspiring the creation of Bitcoin Pizza Day. The meaning of this day is linkage of value in the physical world to the virtual world.

Huang said that cryptocurrency and smart contracts are the key factors for the establishment of DeFi. When cryptocurrencies have meaning and value, using smart contracts, banking, insurance, lending and other virtual analogues to financial services can be developed, solving shortcomings in the traditional financial system such as cumbersome procedures and transaction costs from high centralization.

However, humans will never completely live in the metauniverse. NFTs, cryptocurrencies and DeFi only have meaning by coexisting and connecting with the real world. This joint system creates opportunities for traditional banks.

Virtual currencies such as Bitcoin and Ethereum are volatile, making them speculative investments, not payment tools. However, in the future, the traditional financial industry will likely use stablecoins to develop DeFi media.

Coins pegged to the US dollar, Japanese yen, and other currencies already exist. Looking at Taiwan, MaiCoin Director Leo Seewald said that this coming year has great potential. He plans to join hands with payments and technology companies to launch a stablecoin as a future payment tool for Taiwan, helping prevent the sharp volatility and difficulty in measuring value with most cryptocurrencies. He expects this to become an important bridge between traditional finance and DeFi.

Decentralization is a double-edged sword. In the absence of regulators, users have a great degree of freedom, and also lack protection. If money deposited in a traditional bank is stolen, the bank, insurer, or government will give compensation. The DeFi world, however, lacks a regulator. If a platform fails, has flawed code, or is hacked, investors will have no way of seeking compensation.

In April, Coinbase was listed on NASDAQ. Circle also intends to list on the New York Stock Exchange (NYSE) through a special purpose acquisition company (SPAC). Although these examples are engaged in decentralized transactions, they are regulated by their listings on centralized exchanges, which strengthens public trust and acceptance.

Huang said that moderate centralization will help the long-term development of DeFi, as well as opportunities for the traditional banking industry.

Banks can prosper with crypto

Corresponding to the current international development of cryptocurrencies, in mid-October, Bitcoin Strategy ETF was officially listed on the NYSE. Although the US has not yet allowed a Bitcoin spot ETF, this move still attracted global attention. For the crypto industry, it is a significant milestone in terms of regulation.

Huang said that the finance industry will be able to directly participate in trading and issuance of cryptocurrencies and their derivatives, including futures and ETF issuance and trading, or issuance of cryptocurrencies used in the financial ecosystem to provide payment and identity verification, insurance, investment and lending.

Guo-rong Lee, founder of Bidai Technology, said that banks are currently developing digital finance, which can be called banking 2.0. Future applications of blockchain technology should become the basis for banking 3.0. For example, LINE is already preparing for blockchain, which is intended to assist countries to create central bank digital currencies (CBDCs).

Virtual currency is characterized by decentralization and anonymity, which makes government tracking difficult, and also generates unresolved tax issues. Huang said that the current commodity trust model, in which investors’ assets are entrusted in cryptocurrency exchanges, can be compared to banks. The exchanges play a role similar to centralized custody exchanges in the stock market, which helps resolve the problem of transparency.

Lee pointed out that with only smart contracts and no third-party endorsement, there is a significant risk of malfeasance, which will affect user assets and cause them to distrust DeFi and the blockchain. Banks could act as trusted third parties to protect consumer assets and smart contracts, greatly reducing customers’ security concerns.

In 2019, the FSC promoted a adopted a hierarchical management mechanism for security token offerings (STOs). If companies not listed on the GreTai Securities Market or Emerging Stock Market issue virtual currencies as securities, the funds raised up to 30 million NT dollars are exempted from declaration requirements. Huang believes that another opportunity for the banking industry will be to assist companies that cannot be listed to issue STOs, increasing circulation of their shares and promoting fundraising.

Huang also said that virtual currency exchanges operated by banks would allow consumers to store assets with peace of mind. It would also bring consumer virtual currency or asset transactions into the scope of regulation.

DeFi is a new challenge for regulation

However, the establishment of DeFi opportunities for the banking industry must still be premised on regulatory openness and approval. Some cryptocurrency companies have admitted that their current legal positioning remains unclear. When they inquire about the possibility of cooperation, banks frequently have concerns.

Banking is a charter industry. Regulation is the main reason why people trust traditional centralized financial institutions. When the era of decentralization comes, the industry will wait and see what happens to cryptocurrency firms and traditional financial institutions. Everything comes back to the central issue: clarity of regulation.

A few days ago, the central bank pointed out that virtual currencies such as Bitcoin have tried to challenge the dominance of fiat currencies, but due to issues such as price volatility and speculation, they have been defined as risky virtual assets or commodities, not currencies. Considering that virtual currency trading platforms may be used as money laundering channels, the Executive Yuan gave responsibility to the FSC for anti-money laundering prevention for virtual currency trading, but their work has still not involved the industry governance, operation management and consumer protection levels.

It remains unresolved whether cryptocurrency is to be considered a currency or a virtual commodity. With the rise of the metaverse, virtual currency has been discussed at high levels. Neither Taiwan’s central bank nor the FSC has yet to change their views. It is not difficult to see their concerns.

Internationally, 2050 has been set for the net zero carbon goal, but due to the decentralized blockchain algorithm, a Bitcoin transaction is equivalent to the carbon footprint of 730,000 Visa credit card transactions. The unfavorable environmental impact and execution efficiency compared with traditional centralized finance all require careful consideration. The gradual resolution of these problems through future technological improvements will be a challenge for DeFi.