DeFi Is For Nerds
Pongo Points:
• At its core, money is just a tracking mechanism for resource allocation. Blockchain has attributes that can improve upon the "IOU" tracking in finance, but the crypto industry is focused on displacing traditional finance management tools instead.
• Decentralized finance (DeFi) is hailed by the crypto industry as the next evolution in creating, circulating, and managing money. While the promise of permissionless financial tools is appealing on its surface, it's not clear that DeFi is solving any legitimate problems and that many of its promises are no more than promotional clichés to attract dumb money.
• An estimated 20-25% of the world economy works in the broad financial services sector that crypto aims to replace with "trustless" protocols, despite DeFi being fundamentally incompatible with most regulated societies. A more likely outcome for "DeFi" is "Federated Finance," where trusted institutions must operate with greater transparency using blockchain.
Non-Participating Capitalists
If there are large groups of people donating money to the latest “NPC influencers” on TikTok, then it’s safe to suggest that there are individuals totally disinterested in finance. Money is a tool for them to pay for food, shelter, and occasional luxuries. For others, money is a scorecard for success and can be used as leverage for power or influence, but the methods they use to acquire money don’t necessarily need to be “fair” or “permissionless.” (In fact, it’s generally easier for them if financials tools aren’t fair.)
Decentralized finance (DeFi) advertises financial inclusion, lowering barriers to entry, and reducing fees charged by banks. Unfortunately for DeFi, the people that would benefit the most from these innovations couldn’t care less about them. Around 39% of the US population doesn't invest in stocks, which is largely the same population who suffers the most from the current banking system and its predatory fees. Those individuals turn to alternative financial services to avoid complicated systems; complex decentralized blockchain protocols probably aren’t a good fit.
Common tropes in the crypto industry range from “decentralization reduces our reliance on untrustworthy institutions” to “DeFi permits anyone to participate in the financial system, regardless of means or gatekeeping.” If the people who are currently excluded from the financial system aren’t excited to participate in DeFi, what problems are these DeFi protocols actually solving? Spoiler: DeFi offers high speculative yields, but needs more capital inflows in order to keep them high (i.e. stupid money).
It’s important to be able to separate the benefits of blockchain from the those who seek to capitalize upon the general public’s lack of understanding of it. DeFi has attracted a huge amount of investment over the years (over $56 billion dollars as of today), yet it hasn’t been comfortably incorporated into any industry or government. This ape shall point out why.
Not Particularly Complementary
Finance is a derivative of money, typically describing the system of money and its applications for individuals, companies, and governments (also known as "investments"). Considering 61% of the US population owns stocks (even if only some of those individuals trade or invest actively), is it reasonable to say that there are significant barriers to entry to finance? No. If 24% of the world is living in impoverished conditions or dire circumstances, are they barred from the financial system? Maybe, but...
Realistically, those individuals are more limited by income and acquiring basic needs, rather than a lack of investable assets. Those people are very unlikely to participate in asset lending, insurance, and derivatives trading, yet DeFi is “building a more inclusive market” for them to be participate in the world economy… Financial inclusion aside, the vast majority of DeFi markets are building out infrastructure for the crypto economy, with only a select few attempting to court traditional finance participation.
Of the top 100 DeFi protocols, only 4 are building products that connect to real world assets. In other words, 96% of DeFi protocols, accounting for 99% of all value in DeFi, are focused on blockchain-only assets. Anyone could analyze these numbers and come to the conclusion that DeFi is a fairly insulated system. Crypto companies are trying to build a new system, rather trying to fix or complement the existing one.
Sure, one could argue that DeFi is “testing” these products without convoluting real world operations, but it’s generally good practice to build a products with your users rather than building the products that you think they want. In any case, DeFi has attracted quantitative analysts, fintech enthusiasts, and gamblers; none of whom are presently excluded from the financial system. There’s nothing wrong with that, but it’s dishonest to suggest that DeFi is “for the people.”
Next Possible Channels
Modern banking is a grotesque economic mutation of the simple deposit and loan institutions that we learn in school. Fractional reserve banking isn’t the aberration it’s made out to be by the crypto industry, but the established intermingling of governments and banks has created a financial system that depends upon demagoguery and facade. The clearest evidence of this is the failure of three major banks in the US this year - all while our leaders chant that the economy is sound.
Ignoring the constant political appeasement we see in the news, it should be obvious that public tolerance of the ethics of financial institutions is reaching its limits. Bitcoin and blockchain are technological innovations borne from a desire for transparency from the ruling class. Unfortunately, history has shown that proletariat fantasies are typically met with either subjugation via complacency or, at best, compromise. Is DeFi an exception to this rule?
While DeFi’s ambitions to develop a more transparent and inclusive system are respectable, its essence is incompatible with how a regulated financial system works. Most would agree that financing terrorism is a negative, but that the know-your-customer (KYC) procedures banks require are onerous and invasive. Decentralized protocols aim to solve for the latter by ignoring the former, even if the benefits of anti-terrorist financing likely outweigh the inconvenience of KYC/AML.
Crypto developers might solve for these problems with zero-knowledge proofs, yet they are tantalized by the profits made available by obscure token protocols. The resulting furor of our regulatory bodies, like the SEC, CFTC, etc., are not without merit, as crypto developers ignore “the rules” in favor of finding novel solutions to already solved problems. The “true” spirit of DeFi might be bastardized by the innovation of “Federated Finance” and our most trusted institutions are driven onto the blockchain for transparency - but within the limits defined by the law.