The Emerging Financial Stack
An overview of the technologies that are shaping the future of finance on the blockchain
The financial stack outlined in this post is the set of technologies that enable decentralized financial applications and services.
A user recently took out a $10k USD loan denominated in DAI (a stable coin) via Bloqboard (a relayer for loans) on Dharma (a debt protocol) and then converted the principal from DAI to BAT via Bancor (a decentralized exchange) — all on Toshi (a browser that provides access to financial services).
No middlemen, within minutes and all that was needed was a phone.
Why rebuild finance?
We already have a functioning financial system, why try to rebuild it on the blockchain?
While blockchain as a platform is slow and costly when compared to what we have available today, it does have one property that no other platform enables: trust. The blockchain relies on cryptography and economic incentives instead of promises as its source of trust. Just like we can all agree that 1 + 1 = 2, we can mathematically verify that certain things are true on the blockchain.
Prior to the existence of blockchain technology, we relied on governments, institutions, and markets to determine what is true. Blockchain provides a new alternative to build trusted systems — a new way to coordinate economic activity.
Inherent to blockchain are properties that financial infrastructure of an increasingly digital world should have. Among them are transparency, decentralization, programmability and of open source nature. Just like anyone can tap in to the technologies of the web to start building and using different services — an open financial system will grant more access and economic opportunity to the world.
So what is the financial stack?
At the very bottom of the stack we have a settlement layer (a blockchain) that defines what is true. Just like we have brokerages and banks to tell us who owns what and whether or not a trade took place, we have Ethereum, a distributed ledger to record what is true.
- Did a trade actually take place?
- Who was the loan made to?
- Who owns what?
- What were the agreed upon rates?
- Should I trust this?
This is a big paradigm shift — prior to blockchain, the questions above have always been answered by institutions or governments (beyond face-to-face interactions). We have a new institutional technology.
On top of the settlement layer, we have the basis for all economic activity — exchange. 0xProject is one example of the protocols that enable you to exchange one asset for another in a decentralized manner. That is, to trade with another party without middlemen.
Protocols are message formats that computers use to communicate. On the blockchain, two parties can sign a message to exchange in a trustless manner. An example of this would be: Alice wanting to exchange token A for Bob’s token B. Both parties sign a message with their private keys to verify that they indeed own said tokens. They then send the message to the 0x smart contracts which atomically swap said tokens. Extrapolating this, when millions of trades are taking place within the 0x network, liquidity builds up. Protocols one level-up the stack then have deep liquidity freely accessible.
“Anything that can be assigned a value in the world is going to eventually be tokenized and moved into an open financial network like the Ethereum blockchain”
Beyond digital currencies, tokens could represent anything — equity, ownership of real world assets, debt, credit, derivatives and more. The exchange layer then becomes an important piece of infrastructure that starts stripping away middlemen and enables others to build upon.
Next up the stack we have financial primitives. These are protocols that, like 0x, are suites of smart contracts that you send signed messages to in order to execute a certain function. Dharma, for example, is a protocol that enables one to borrow and lend. Going back to our Alice and Bob example: Alice wants to borrow 10 tokens from Bob and Bob wants to lend her said tokens. They would then sign a message that states that Bob will lend Alice 10 tokens at an interest rate of x% with collateral y. The signed message is sent to the Dharma smart contracts which atomically swaps the principal, mints a non-fungible debt token, keeps track of payments and seizes the collateral in the event that Alice were to default on the debt.
We now have protocols, just like we do for email (SMTP), that enable financial activity to take place in a trust-less, open and transparent manner. Like 0x and Dharma, the ecosystem is rapidly growing to enable everything from lending, derivatives, tokenization of real world assets, insurance, baskets of assets, credit scoring and more.
Decentralized Applications and Services
On top of it all — the user facing applications and services.
These services use the stack below it to enable end-users to access financial services on the blockchain. Applications range from decentralized exchange that allow trust-less trading, relayers that allow users to borrow and wallets that help users custody their own funds.
Decentralized services and applications function much like a regular business functions today. They are for-profit businesses that provide services to customers. The difference being that they are enabling access to a shared data layer. Instead of changing 0s and 1s on a bank’s ledger, they change the Ethereum ledger. Instead of allowing lending from banks, they are enabling p2p lending across the globe. Instead of relying on centralized 3rd parties for credit worthiness, they enable credit because of peer-to-peer and organizational creditworthiness.
Where we are today
- 50+ independent teams working on protocols, apps and services
- Tokenized USD
- Over $180M+ of value exchanged hands through the 0x protocol
- $100k in loan volume has been made using Dharma
Although the main use-case is speculation, we must keep in mind how technology evolves. It tends to improve at an ever faster rate — quickly surpassing any linear predictions we attempt to make.
Today we have clunky interfaces, thin liquidity and a subpar user experience. And why wouldn’t we? Not only are the projects less than one year old, but naturally, technical folks gave birth to it all — not designers. As the space matures, we can expect to see a more diverse set of talent to make the user experience better. Each improvement compounding on the next to move the entire system forward. A process that will take many years to come to fruition.
Global Open Finance
While using one protocol alone may enable a specific set of use cases, using them together compounds their collective utility.
“…Software is analogous to writing… You can take words and build sentences. You can take sentences and build paragraphs. You can take paragraphs and …”
— Chris Dixon
The beauty of a bottoms-up, modular and open-source approach is that we get to try out thousands of ideas in the wild. As Denis from a16z recently outlined, “Worse is better”. This philosophy can be applied to the modular approach we are seeing emerge. While no one entity in the financial stack offers an all-in-one solution, it allows for the ideas to spread like viruses. We end up with a big melting pot of projects that borrow and build on each other to improve the system as a whole. And while the system is indeed modular — we also see a shared vision across all the teams working independently from each other.
Blockchains enable us to build scalable trusted systems. To build a financial stack on the blockchain means to give the world open and more accessible financial infrastructure. The internet commoditized information, blockchains will do the same for finance.
Feedback? Interested in joining the space? Reach out! @espitia7