The DeFi Boom is Making Me Nostalgic, but there is a Dark Side…

Decentralised Finance, also known as DeFi, is sweeping the world again; but those that have been paying attention may experience a deep feeling of Deja Vu. Didn’t we already go through this before?

Although Bitcoin itself was the first DeFi protocol, the first working prototype of decentralised finance started with Counterparty and Ethereum back in 2014/15 — they were the first fully-fledged decentralised exchange and smart contract platforms. Almost like a cycle, we have now come back full circle into the same mentality with similar promises that were made during their inception back in the day. However, it is important to note that the Counterparty project was entirely self-funded, a huge difference to the DeFi protocols of today.

Can DeFi technology really break into the mainstream? I’d like to make the case that the new technologies appear no different than they did four years ago: clumsy, expensive, and slow. It’s going to take quite some time until they are ready for the use-cases they are intended for.

At Plutus.it, we have had some of the world’s most skilled blockchain developers and PhDs draft blueprints for one of the most basic DeFi use-cases, customer loyalty reward system, token distribution, cross-chain payments, etc. Our conclusion four years later? It is not possible to fully implement these concepts into existing business logic at this point in time — not only due to recurring costs, but also the infancy of the technology and its security risks when scaling to a mass market.

“DeFi” has to be developed step by step.

In its current form, it can only be used for transaction verification; not for a honey pot of digital assets.

The result of our research and development is that we have successfully managed to implement potentially the world’s first decentralised one-way exchange, which allows you to purchase cryptocurrencies using fiat without any intermediary or 3rd party touching the assets — directly from wallet to wallet. Our trustless fiat and crypto exchange is online and in use by users all across Europe: plutus.it

Since the beginning, we have not changed our trajectory from KISS (keep it simple stupid) — but it will be quite some time, if not years, before more aspirational and complex DeFi tech is ready for mainstream consumption.

The aspirations of the newer DeFi projects aim far higher off the ground, without any safeguards in place if they fall. I fear that this is a recipe for disaster for a variety of reasons:

• The business logic might not be able to scale — it will become prohibitively expensive and slow once enough users are active.
• They will have issues with regulators once they reach a substantial scale.
• Loss of funds due to malicious actors and manipulation is still the most severe risk — starting from the $150m DAO hack in 2016 up until the most recent hack of the so-called Harvest Farm and BZX DeFi protocol.
• If the amount of funds managed by a DeFi project exceeds a certain amount, or even eclipses the entire platform it is based on, hacks and other asymmetric attacks are nearly guaranteed. This in turn attracts regulators, and it all continues in a vicious spiral.

As George Santayana once wrote when referring to common sense,
“Those who cannot learn from history are doomed to repeat it”

I am here to warn other projects that they may be blinded by the effects of ‘hopium’ and wishful thinking. Don’t get me wrong, DeFi is almost certainly bound to be the wave of the future — but we need to remain realistic and face the facts. This will take time.

In its current state, DeFi is often nothing more than ‘yield farming’ — creating millionaires and multi-millionaires through an elaborate gambling process. Many development teams will gladly throw themselves at the task until they encounter roadblocks time and time again. Decentralisation means trading efficacy and reversibility for a slower more robust system.

We must never forget that PoW does not simply mean proof-of-work, but also skin in the game; tech/services that have lost favour and hype over time may return back into the limelight once their flaws have been ironed out.

There are a few things we must ask ourselves to distinguish hopium from innovation:

• Does this project solve a need which provides incentives to be decentralised?
• Can the project resist attacks and scale — indefinitely if need be?
• Who are the users and why do they really need it?

Let’s take a closer look at why Bitcoin has a good answer for all four.

What is the Byzantine Generals’ Problem?

The Byzantine Generals Problem is an allegory for a long-standing issue that must be, at least partially, solved for any decentralised system to function. We need to ask ourselves, “how do you ensure the system continues to work smoothly even if some or many of the nodes involved are unreliable?”

Bitcoin was the first “real” solution for this issue. Bitcoin does not recognise borders. It does not recognise gender, nationality, or ethnicity. It does not, and indeed cannot, deny access to anyone. It simply is. This brings us directly to the next pertinent question.

What is the real unique value behind decentralisation?

The primary benefit of full decentralisation appears when parties cannot trust each other or cannot hold balances. The perfect examples here would include grey and black markets, unbanked societies, hostile governments, collapsed states, and more. Whether intended or not, the principles of all correctly implemented DeFi are ultimately libertarian.

However, censorship-resistant technologies can open legal loopholes where KYC and AML become entirely unenforceable. This is why every truly legally compliant system must include an aspect of centralisation — an entry and exit point which can be enforced. The only alternative is to exist outside of the government and legal system entirely — like Bitcoin has done.

This has both advantages and disadvantages. The fact is that any sufficiently powerful tool can be used or misused. Cars can help a bank robber escape, but they can also help apprehend them, or drive your kid to school.

It’s undeniable that if your software needs to interface with fiat or incorporate as a company, there is always a centralised vector of attack — and always exposure to regulators. However, in the end, the development of other technologies predicated on full freedom such as Bitcoin are most likely inevitable.

Most Expensive Experiment in History?

Any sufficiently decentralised system must be resistant to reversals. This spurred an immense controversy during the DAO hack — which raised the question of whether ETH can be held liable for their hard fork or not. After all, it was a centralised manipulation of an alleged decentralised system.

Does this not mean that the team could theoretically have to answer what happens on their chain — if they rolled it back for their own financial benefit?

The DAO Hack and what it means for DeFI

On June 17, 2016, the DAO was attacked and over 3.6 million Ether was stolen — valued at the time at over $50M.

The DAO hack split Ethereum into ETH and ETC (Ethereum Classic).

While it had nothing to do with Ethereum itself, presumably because the founders including Vitalik Buterin had significant funds invested in the project (many millions) they were motivated to roll back the chain.

Ultimately, it seems the system still relies on faith and consensus of belief. This is also a good argument for why Satoshi decided to, firstly, remain anonymous and, secondly, disappear from the space altogether. However, pointing this out appears to make many people in the industry extremely angry and defensive.

And yet, that is not a reasonable argument.

We absolutely have to ask ourselves a simple question, which one is the “true chain”? Which one is the “real” Ethereum?

The one that is longest would be the logical answer, but now we have empirical evidence that it is simply the one secured by the most community belief and zeal, more or less inspired by the ‘dogma’ of a central authority; much like fiat currencies which are supported by market confidence and the long arm of the government.

What happened? Incentives became misaligned.

Intrinsic value and PoS/PoW algorithms aside — the value of money still lives in the hearts and minds of living breathing people, even if this seems a bit uncomfortable for us to accept. The more you strive for financial freedom, the more you may seek to deny this fact.

And yet, we cannot create an artificial dichotomy between object and subject. Everything manmade is ultimately an extension of humanity, existing some way in symbiosis with ourselves and others. Even the seemingly most alien and decentralised technology carries a part of ourselves.

Ultimately, the price of something boils down to what people are willing to pay for it.

By all means, continue to invest and innovate, but do not sacrifice your sight of reality. Optimism, price, and hype are never reliable indicators whether a technology will survive or not. Even if the technology works as expected, the real question is always, “what real-world need does it solve and for whom?”

As the age-old saying goes, “never invest more than you can afford to lose”. Markets run on optimism as they always have, making them fragile and prone to change. The post-2016 era was a harsh enough lesson for those that were around during that time. Don’t let it happen again.

As the economist John Maynard Keynes once famously said:

“The market can stay irrational longer than you can stay solvent.”

Innovation and DeFi still has vast potential

Despite the number of failing projects masking themselves behind “DeFi”, there is still a tonne of innovation and activity going on that truly is pushing the newly coined term forward. We have seen this with the recent introduction of Uniswap and MetaMask swaps, a company that already supports a massive 1-million monthly active users — something that was merely a pipe dream during the early days of crypto. Whilst many are fixated on price swings, it is easy to forget that the rush to use decentralised platforms is probably the most cypherpunk movement since Bitcoin itself, and real product use-cases are only just emerging little by little.

Although it may not be an overnight transition, progress is being made. The technology is still in its infancy but decentralised finance…real DeFi, has unimaginable potential still to come in the months and years ahead.