Decentralised Finance Needs a Web3 Economy

Abstract:

1. The social and demographic trends that have driven the creation of internet based money i.e. cryptocurrency are the same as the trends that created the burning man festival. Above all, the desire to return to a simpler economy and society is the critical common theme across the two phenomena.
2. As this pendulum of simplicity swings back to greater complexity with tokenisation and decentralised finance or #DeFI, the lack of real economy ( trade in goods and services) transactions on the public blockchains becomes a significant barrier to adoption. Crossing this barrier requires bridges to the off-chain fiat world, which add compliance, risk and operations costs that are similar to the banking system, reducing the promised economic benefit of decentralised cryptocurrency.
3. Addressing this contradiction in turn requires a set of foundational, infrastructure components that we call web3, i.e. infrastructure for cryptocurrency networks that can support real economy transactions at internet scale.

Burning Man Economics

I haven’t had the opportunity to attend the famous Burning Man Project festival yet but working in #Blockchain and #Cryptocurrency, I hear about it all the time. So I decided to research the event, and it’s association with cryptocurrency.

This is what Wikipedia has to say:

A Brief Introduction to the Burning Man Festival

“Burning Man is an event held annually in the western United States at Black Rock City, a temporary city erected in the Black Rock Desert of northwest Nevada, approximately 100 miles (160 km) north-northeast of Reno. The late summer event is an experiment in community and art, influenced by ten main principles: radical inclusion, radical self-reliance, radical self-expression, communal effort, civic responsibility, gifting, decommodification, participation, immediacy, and leave no trace. The event takes its name from its culmination, the symbolic ritual burning of a large wooden effigy (“The Man”) that traditionally occurs on the Saturday evening of the event.”

Burning Man and Crypto: Two Great Economic experiments

For the purposes of our discussion, a much more interesting perspective on the festival is offered by the Business Insider. I quote:

1. No money is exchanged at Burning Man, so participants are expected to bring food, supplies, shelter, and anything else they might need. If there we no crypto to fiat bridges eg exchanges, that’ kinda how we’d live.
2. Unlike the world outside the gates of Burning Man, the annual weeklong festival operates as a gifting society. Not sure if there’s a parallel in crypto yet. Maybe the reader can help.
3. According to one of the The 10 Principles of Burning Man, the festival “is devoted to acts of gift giving. The value of a gift is unconditional. Gifting does not contemplate a return or an exchange for something of equal value. Basically no debt, only tangible and intangible bearer assets as in #crypto.
4. When gifting is the currency, rather than money or bartering, a strong sense of community evolves, one veteran burner explained to Festpop. “Think about how you feel when you receive an unconditional gift. You feel an instant connection to that person, and a sense of gratitude.” This is how one feels when they receive ICO tokens in an Airdrop or tokens in a pre sale at a discount ahead of the masses.

Deep Ties to Crypto

CoinDesk wrote about these ties in detail and TwoBitIdiot came up with profoundest ever quote on the topic

… and the ties are serious because Burning Man attracts the staunchest crypto believers:

“Fundstrat co-founder Tom Lee claims the #bitcoin price nosedived this week because the crypto-sphere is distracted by the Burning Man festival. Moreover, Lee predicts the Federal Reserve will cut interest rates 75 basis points by the spring of 2020”.

The Essence of Burning Man: Simplify

Marc Andreessen’s Netscape generation that went to work in the 90s built the current web aka web2. We made lives too complicated with more transistors per chips, crazy bandwidth, smartphones, sustained economic growth, three car garages, financial engineering and big data. And we are still going at it while neo-millennials scream out for simplifying the endless complexity life and finance that I hinted at in my previous blog:

The Messy Real World: Complexity Strikes Burning Man

It turns out, it’s not just love that runs the Burning Man festival. Even the economic experiment of Burning Man can not be untied from the consumerist, monetary economy and all of its rather complex human characteristics. These include:

1. Consumption: “But there are two luxuries that attendees can buy — ice and coffee.”… there is no Dark Web involved though.
2. Hedonistic Consumption: “Every year now, an avalanche of articles lament the copious amounts of money and narcotics flowing into the commodification of a supposedly non-capitalist festival”. There may be some DARK Web involved here however.
3. Fiat Money: There’s always a bridge to the fiat world, like a crypto exchange and there’s indeed scarcity to justify a price. Besides, you are in America so there must be a car. “Most tickets sell for $425, according to the event’s official website, and you’ll also have to purchase a $100 vehicle pass for each car you drive in. Approximately 4,000 pre-sale tickets are available starting in mid-March, at $1,400 each. Kids 12 and under can go to Burning Man for free.”
4. The Corporations: Just like at the brilliant Consensus conference, the “old economy” sponsors keep piling up. “In 2014, North American companies reportedly spent $1.23 billion to sponsor music venues, festivals, and tours.”
5. Death and Taxes: Just like in Crypto, the IRS finds us. According to federal tax filings, the Burning Man non-profit garnered $3.7 million (after expenses) in 2017, after acquiring Fly Ranch for $6.5 million in 2016.
6. Externalities i.e. we do leave a trace: Well we did use a car or an RV to carry love to the desert in the same way we need mining hardware and electricity to mine bitcoin, so our trace was there from the beginning. “The CoolingMan organisation has estimated that the 2006 Burning Man was responsible for the generation of 27,000 tons of carbon dioxide, with 87% being from transportation to and from the remote location.[189] The Sierra Club has criticised Burning Man for the “hundreds of thousands” of plastic water bottles that end up in landfills, as well as ostentatious displays of flames and explosions.”
7. Inflation: What did we say about scarcity in Crypto? This is a wide open desert so we must create scarcity. “Meanwhile, the regular admission price has increased over the years. CNBC estimated in 2016 that the total cost of attending could range from $1,300 up to $20,000”.
8. Inequality: Burning Man has attracted a number of billionaires and celebrities, many of them from Silicon Valley and Hollywood. These billionaires have paid for more luxurious camps to be set up in recent years which general consist of lavish RV’s and luxury restroom trailers that are driven into the city and connected together to form de facto gated areas. These billionaires then fly in to the airport on private planes, are driven to their camps, served by hired help (nicknamed “sherpas”), and sleep in air-conditioned beds.”

Oh Well! Now we visit the other festival…

Bitcoin, the Burning Man of Finance

Crypto in the modern form started as a protest during Occupy Wall Street as a desire to simplify the world of finance with one word — “bitcoin”. In a way, Bitcoin is the burning man festival of blockchain and cryptocurrency technology. This desire to simplify to “one simple word” whether love or bitcoin, is indeed the subtle connection between the psychology of Burning Man and the psychology of Crypto.

Modern crypto funds have hedge fund like names eg “Morgan Creek Capital”. Here’s the aptly short-named founder of Morgan Creek Capital being quoted for “Short the Bankers, Long Bitcoin” cry, which apparently now is being extended to various other financial assets and market mechanisms…

And indeed, even in other #Crypto Platforms:

So which Morgan will prevail? Fiat JP Morgan or Crypto Morgan Creek? I think it doesn’t matter. Let’s see why…

When Debt Gets in the Way of Love, Money Arises

Basically, even at BurningMan, even when we gift, we end up owing each other, unless we choose to delude ourselves. That’s called being human and the act of “owing” is called Debt. These debts need to be settled but settling debts on a bilateral basis doesn’t work because you owe me less than I owe you and Peter owes me more than Peter owes you.

We solve this mess of debts with the magic idea called Money. By creating money, we can exchange goods and services on a bilateral basis in complex transactions and pay each other in units of debts owed to a clearing agent. All of this “money” system is supported by the artefacts of known identities, credit risk control and legal recourse using this thing called “money” that is expressed in units called “currency”.

This act of clearing turns an O(n square) problem of settling debts into an O(n) problem and allows us to engage in incredibly complex economic transactions, manage risk, plan businesses, create complex social hierarchies, trade goods and services across economies and raise living standards for humanity. The clearing agents are called Banks and when Banks end up with the same O(n square) problem, we create central banks to clear debts between these banks.

But there’s no Domino’s Pizza on a blockchain yet…

Wouldn’t it be nice if crypto could just deal with the money part and skip the messy parts about trade, data, goods, law and services i.e. delegate the real economy to the fiat people who deal with messy things and the technology?

The trouble with this #crypto dream is that almost no one ever buys a Pizza (or much else) with #Bitcoin or pretty much any other #cryptocurrency yet. Bitcoin is a terrific innovation but you can’t do much with it. It’s not a payment system because not many merchants accept it and not many buyers want to pay with it. All you can do is trade with it or HODL it.

Thus, somewhat conveniently, #Bitcoin becomes “digital gold” i.e. “censorship resistant store of value” rather than the “payment system” it was supposed to be when Satoshi designed it. If we want to do anything in the real economy, e.g. buy a Pizza, we have to go back to uncle Sam’s money i.e. the US Dollar aka Fedcoin.

Money, like love, gets complicated over time…

So what else do we do with crypto? Maybe we can lend it? Oh yes! Crypto folks, like fiat folks also want to borrow and lend and crypto is just a bearer asset, so we create various types of lending and borrowing mechanisms with #DeFI aka decentralised finance.

With the explosion of lending apps, in 2019, crypto has started to evolve its own parallel wall street with 100s of ex wall street folks and financial engineers going at complex derivatives and synthetic on-chain products.

Why? It’s Debt. Again, Debt. The one word we can’t get away from. Here’s what that does:

1. As soon as we start with lending crypto onchain, we realise that love is good but credit losses are not good but →
2. On permissionless networks, the borrower doesn’t know the lender and conversely so →
3. The only way to manage the risk is Collateral but →
4. Crypto collateral is highly volatile so most defi lending apps require more collateral than the loan itself. Of course →
5. The only time one would post 150% collateral if they were speculating massively on a price increase.

A quick recap. So far our one word answers to finance have been:

1. 2008–Infinity: #bitcoin
2. 2012–2014: #Blockchain
3. 2015: #smartContracts
4. 2016: #Decentralisation
5. 2017 and 2018: Tokens, ICO and STO.
6. 2019: #defi and #OpenFinance

As the savvy reader might notice, every year, the complexity reducing burning men and burning women have been adding their own layers of complexity on top of love and bitcoin.

We haven’t quite come full circle yet but maybe, just maybe … we can see the arc… except… we are tied to fiat.

Tough Love: We can’t have two tier financial regulation…

We work around this minor of issue of almost no real economy transactions (the medium of exchange and unit of account problems) by creating fiat bridges i.e. asset backed stablecoins, synthetic stablecoins and crypto exchanges (both centralised and decentralised) as workarounds and bridges to fiat.

Complexity has started FWIW.

Unfortunately, when we create fiat bridges to the real economy, we run into a fiat based monetary system and a fiat based regulatory system aka the much (un)loved AML, interstate commerce, securities law and systemic risk regimes, which aren’t designed to deal with internet based money or a p2p, decentralised financial system. We don’t like it because its not love or self expression, it’s hard complicated work to make finance and economies work.

So We Must Create a Real Economy to feed Crypto Finance…

As Marc Andreessen noted in his A3Z podcast, I paraphrase, “Amazon had a book store… who’s using THIS thing?”

a16z Podcast: From the Internet’s Past to the Future of Crypto

Where do we go now…

So what do we do to make this thing work? I think the narrative needs to change back to the internet of value, with the internet being the operative word this time and not value. Here are a few suggestions:

Build useful

In 2015 Balaji S. Srinivasan invoked the #BUIDL cry and in 2017, I fortunately echoed it. Unfortunately, fuelled by the ICO boom, 90% of what we as a community built has been pretty useless (10% is exceptional and foundational, which IMO is a great harvest even for tech). For the 90% in nonstarters and failed experimentation, it’s my personal view that the amount of what I call “non-product” (something that sounds cool but no one needs or wants) in #blockchain exceeds any other technology I have ever had the opportunity to touch since the dot com boom. That of course is par for the internet course.

So I’d say it’s about time we update this rallying cry to #BUIDL-USFL ie build useful stuff, stop disrupting and start building. As John Wolpert said:

Invest 10x in Web3 than we do in De(centralised)FI and Ce(ntralised)FI

As I argued earlier, the path to #defi goes though #web3 ie for a public chain based financial system to be sustainable, there must be corresponding levels of public chain based real economic activity aka internet commerce to support it. The internet had to become a vehicle for finance because it became a tremendous vehicle for people to engage in real economic activity. With Crypto, we have to swing it in reverse. We started with money, now we need to build something for someone to need this new money.

Essentially, If #cryptocurrency needs to become money in the real world, then the blockchain has to play this role of enabling the real economy i.e. more than speculation and trading among coins. To make that possible, we need to make web3 work. Web3 is where the next generation internet products and services work because of the enhancements to the current architecture of the internet provided by secure shared ledgers, cryptography and decentralised applications.

Unless the web3 infrastructure works, many of even the most robust and well thought out ideas in #DeFi and #OpenFinance will be restrained in their potential. Spending a ton of money on DeFi over Web3 is like putting a cart before the horse and the fintech fallacy is at the heart of it. This emphasis on Web3 is what Ethereum community at large is getting exactly right as we speak.

My Definition of Web3

This is part of the problem. Web3 is whatever folks want it to be, so while I wait for this definition to be standardised (by web3c or some other body of geniuses), I will provide my own list of foundational components in what I think the web3 stack here needs to be at a minimum:

1. Web-scale shared ledgers (may or may not be a blockchain when we’re done).
2. Smart Contracts/Deterministic stored scripts
3. Settlement finality for transactions
4. Portable Identity
5. Data Privacy
6. Wallets with superior UX and key recovery
7. Governance protocols for asset recovery
8. LegalTech

De-Emphasise #NumberGoUp

NumberGoUp is a meme that stands for “if my coin is going up, I must be doing something right and my theories about my coin and the world at large must be true”. Each crypto tribe spends an enormous amount of energy in keeping their number i.e. “the price” up — so yeah, we could all try to make the #NumberGoUp instead and if it works, it’s a faster path to short term riches. Most bitcoin maximalist arguments can be translated as “my number go up and your number go down”.

The trouble with spending any energy on NumberGoUp is that not just hot capital like “crypto funds”, even the sage-like long term investors of #SiliconValley get restless when the Number Don’t go Up as the leading minds at USV did last week. This “gap in expectations” can make the number go down.

Is Ethereum the AOL of Crypto?

and Fred Wilson had a few feelings about that too

Some Thoughts On Crypto

Argue for Regulatory Reform, Not Special Treatment

If people were buying pizzas for #crypto no financial regulator would have a problem as long as the pizza is safe, reasonably priced and good. If on the other hand, the point of #crypto is to buy fiat then sadly the fiat world #regulation has to apply because a two tier regulation is just an unsustainable minefield of regulatory arbitrage.

Essentially we the #crypto community won’t be getting much love for our cries for favorable treatment because if we do get any, the banks are going to justifiably cry. We have to make sound arguments for broader regulatory reform across the fiat and crypto financial systems.

For example, special rules for ICOs are untenable whereas a technology independent conversation about private securities markets reform tends to be a very sensible conversation with the regulators, and it quickly leads to … “oh so here’s how the public blockchain can help!”.

It’s not the Regulators, It’s the Consumers

This point needs to be stated twice. As noted earlier:

1. OECD regulators are under no pressure to reform any rules to support cryptocurrency because →
2. Consumers (aka voters) aren’t creating any such pressure because →
3. Most Consumers aren’t using any #cryptocurrency based services because →
4. er… there aren’t many useful services out there because and even when there are →
5. The UX is awful More on that later.

In the absence of consumer utility, much of the focus of crypto advocacy has been on the innovation argument — which essentially says, “policymakers and regulators should make special rules for crypto because we are innovative and if you don’t support us, you will lose the competitive advantage of nations”. Some of the wiser folks even invoke the great Michael Porter and his book.

Here’s the catch though. Every time we argue that regulators must support #innovation, regulators tend to ask the Marc Andressen question “ok, we get the innovation, but who’s using this innovation”?

Essentially #crypto needs a bit more than “innovation” to justify its existence and its time to look for better arguments for broader policy measures and reg reform that support #crypto

Code is not Law. Invest in Legal Tech and turn Law into Code

Law governs and enables all economic activity. As Raghuram Rajan argued, it’s the “Rule of Law” rather than natural resources or population that determine economic progress. If there is going to be a decentralised economy to provide a sound basis for a decentralised financial system, legal tech will provide the foundation for it. Without legal tech to provide a foundation of legal basis and legal recourse, #DeFi applications will largely be limited to speculation and experimentation and not complex real economy products and services and business models required for the #FutureOfWork.

Fortunately, some teams like OpenLaw and Clause are doing critically important experiments and product engineering in this area:

Emphasise UX

As much as Anthony Pompliano says “ short the bankers”, the consumer experience of #crypto wallets remains much worse than the consumer experience of even big bank mobile apps, let alone Paypal and Venmo. Unless we go crazy about UX, decentralisation and revolution aren’t gonna land customers and consumers.

And we close this story with a Ch(r)ant

I have seen things across the ecosystem become much more focussed and grown up this year and I think the relative scarcity of capital, compared to the glut in 2017 and 2018 has a lot to do with it. In 2017 and 2018 everyone was doing cool things for cool’s sake and the P word (Product) became disconnected with the C word (Customer). This year, the capital got a lot tighter across the crypto ecosystem and even people building speculative and gambling products started thinking about the C word — the Customer. To me, this is the revolution we have desperately needed.

So we return to the “immutable” laws of Physics and chant (rant) together: