Crypto’s Person of the Year: DeFi


Illustrated design of Maker Protocol

The young bankers Hayek promised are here and they are building a new financial system that automatically operates just by code without any human involvement.

From the ashes of the bear market, so begins this new world which holds much promise as a new space of booming innovation.

The rise and rise of DeFi-ance, Dec 2019
The rise and rise of DeFi-ance, Dec 2019

The primary idea is simple. If you have a house worth $100,000 for example, and want to borrow say $20,000, there’s no reason why a bank wouldn’t lend you this $20,000.

The problem is of course you still have to apply, go through all sorts of paper work, deal with weeks not months, and after it all the bank might hike the interest rate once it has you chained.

So let’s replace the house with eth. Now there’s no reason why all this can’t run by itself through only an internet blockchain connection.

Compound stats, Dec 2019
Compound stats, Dec 2019

Stability has a premium as you can see, and it appears to make little difference if its stability is provided in a centralized way or decentralized as Circle/Coinbase USDC appears to attract the same lending savings rate as code based DAI.

The latter however is very unique. For USDC, you have a fairly boring process of going to Coinbase to turn USD into USDC. For DAI, there’s kind of a whole new world.

DAI stats, Dec 2019
DAI stats, Dec 2019

DAI turns eth into dollars, without selling the eth, through a collateralised debt position (CDP).

So you can put in eth, get dollars, buy more eth, and put that eth back into the dapp to get more dollars to loop until you lose it all.

Or, you can kind of hedge. Instead of outright selling, you draw DAI and hope price goes up so unlocking liquidity at the risk of price moving against you, but in that case you’d still have the DAI.

Or if you’re bored you can just keep closing and opening CDPs to get a vanity address because why not.

Defi interest, Dec 2019
Defi interest, Dec 2019

Compound and Maker dominate, in part perhaps because they’re the oldest – thus network effects – and in part because you’d presumably need some innovation to compete.

The innovations that can be seen are numerous. Starting with the DAI ambition, which can be quite fantastic albeit unlikely for many years to come.

The Code World

The long term potential of DAI is to first bootstrap this by pegging it to the dollar in the hope that an economy of sorts is created, with the data mining of this economy then potentially leading to a peg with prices rather than fiat money.

Whether this can ever be achieved is unclear, but the aim can be to have a money whereby one DAI buys you an apple today and an apple next century.

That is a money which is neither inflationary, nor deflationary, but algorithmically determined – say like the mining difficulty – based on economic parameters that aim to maintain a changing unit of account as value creation changes, but fixed – it growing or decreasing in line with the growth or decrease of value creation.

Now that maybe is for the Mars people, but here on earth we can have this DAI not pegged to dollars, but pegged to say the FTSE100 index.

So we now lock in eth that gets us the UK economy and play around with this tokenized UK economy which can potentially be itself locked to get us the US economy.

Compared to the changing fixed money, this one is far too easy, with the UK or US economy used only as an example. It can be some housing index, or indeed anything of measurable value.

The old bankers would say this is called stocks, or an index. The difference is the code runs all this, not old bankers.

Another easily seeable invention, though bit more difficult to implement, is to have the code itself play.

The aim there would be to lower capital requirements by having the code itself take hedging strategies so that you both have the cake and also eat it.

The how, or if it can be done at all, is of course for the young bankers, but there’s a lot of value added potential that can be seen in this natively digital finance area which somewhat uniquely does not quite require much onchain capacity.

Meaning there’s no constrain to the potential innovation that can occur here save for skill, will, and intellect, as well as a bit of luck trial and error.

That’s because you don’t require many onchain transactions, unless you’re CDP mining, hence can attract usage even with the current limited capacity.

In addition the on-chain transaction cost of unlocking liquidity might be comparatively minuscule even with significant fees. So this is a space where you have to run because the low hanging fruits will most likely be taken probably within two years.

The Future

As with the birth of any new invention, only “analogue” opportunities can easily be seen. What can’t easily be seen is what invention will the invention create.

For now, this is more kind of reflecting the old world. USD Dai, secured loans, potentially tokenized indexes or house price trackers.

In the future it might be a bit more native, more digital, more its own world.

The potential is… well, code based value measurement of entire economies.

You might even think our children might wonder how things could potentially be as we currently enjoy them where finance is concerned, just as presumably they wonder in a museum what that cassette player is.

For the inefficiencies of finance, and its many injustices, are mountainous.

If only a fraction of it can be improved, we might look back at the birth of this egg as the beginning of a leap at the dawn of the tech revolution which marches on to the sound of many dreams.



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