DeFi can complement centralized financial systems, says Federal Reserve's Christopher Waller

Decentralized finance can complement centralized financial sectors, but won't serve as a replacement, said Federal Reserve Governor Christopher Waller.

Technological progress can "drive efficiency gains in finance," Waller said on Friday at the 19th Annual Vienna Macroeconomics Workshop in Vienna, Austria. DeFi won't replace centralized finance, in part because intermediation is still needed, Waller said.

"While there are certain services emerging through defi that cannot be provided by centralized finance, the technological innovations stemming from defi are largely complementary to centralized finance," Waller added. "They have the potential to improve centralized finance, thereby increasing the significant value that financial intermediaries and centralized financial markets deliver."

Waller is one of seven members of the Board of Governors at the Federal Reserve and was nominated to the position in 2020 by former President Donald Trump.

Previously, Waller has reportedly compared crypto to baseball cards and has leaned more towards innovation in stablecoins, rather than central bank digital currencies. Waller has also said he sees privately-issued stablecoins strengthening, rather than weakening, the dollar.

On Friday, Waller said distributed ledger technology, could be a more "efficient and faster way to do recordkeeping in a 24/7 trading world." For example, some financial institutions are trying out distributed ledger technology for repo trading, Waller said.

"But before these ledgers can be used to facilitate transactions in traditional assets—like debt, equity, and real estate—these assets must be tokenized. Undertaking the process to tokenize assets and use distributed ledgers like blockchain can speed up transfers of assets and take advantage of another innovation: smart contracts," he said.

DeFi might also have its own risks, such as giving funds to bad actors, Waller said and alluded to the need for regulation.

U.S. lawmakers have so far left out regulating DeFi in recent bills. In legislation passed out of the House of Representatives this past year, lawmakers opted to direct the U.S. Treasury Department, Securities and Exchange Commission and the Commodity Futures Trading Commission to study DeFi. That bill, led by Republicans, gives new jurisdiction to the CFTC over "digital commodities" and asserts the SEC would oversee digital assets offered as part of an investment contract.

On the regulatory side, the SEC proposed a rule in 2022, which has since been revisited, that would broaden the definition of an exchange to capture decentralized exchanges. The rule could ultimately require decentralized projects to register with the agency as alternative trading systems and has received pushback from the crypto industry.

"In centralized finance there are regulations that require banks to know who their clients are," Waller said Friday. "Are similar rules and regulations needed around some of these new technologies?"

Waller also touched on stablecoins during his speech, calling them an important part of DeFi, but warned there is risk involved. 

"History is replete with cases in which synthetic dollars became subject to runs. Stablecoins thus face all of the same issues any substitute for genuine U.S. dollars faces," Waller said. "If appropriate guardrails can be erected to minimize run risk and mitigate other risks, such as their potential use in illicit finance, then stablecoins may have benefits in payments and by serving as a safe asset on a variety of new trading platforms."