From Caveman Economy to DeFi — Why 2022 will be the year of DAOs

This is a follow-up to a three-part editorial I wrote for BeInCrypto Germany in 2020, titled Die Sprache des Geldes (The Language of Money). To summarize my Austrian School stance, capitalism (aka the only savior of mankind) is built on three pillars: trade, financial markets, and risk markets.

Trade pillar

Imagine you’re a caveman (“Alex”) and another caveman (“Bankman”) has something you want. You now have two options to get what you want: First, you can whack Bankman with your club and just take his stuff. Today, this method is known as taxation and taxation is theft, so this isn’t part of capitalism.

The other method is trade. Bankman wants something in exchange, which can be either goods or services (labor). Soon, Alex and Bankman discover that it is more comfortable to trade with a medium exchange, instead of bartering. This is how money is born.

Since humans rely on trade for division of labor, they will always agree that certain assets are “money” (= mediums of exchange).

Financial markets pillar

Afterwards, the cavemen discover that one of them wants something now, but cannot pay with the amount of money that he owns at that time. A third caveman (“Chu”), who wants to save her money for a later date, comes up and offers him a loan, in exchange for the guarantee to receive her loan back with interest.

Since humans prefer to satisfy their needs immediately instead of waiting for later, the one who wants to satisfy a need now must pay a price to the one who delays his gratification.

Risk markets pillar

The cavemen now have a bustling economy where cavemen trade their goods and services, and help each other out in times of need, using a shared medium of exchange. Now, what the cavemen desire is to reduce the risk of events they don’t like, for example getting eaten by a saber-tooth while looking for food.

Caveman “Danny” comes up and offers them to pay a small amount of money every time the moon is dim. In exchange, Danny agrees to provide money to their wife and kids, should the unspeakable happen.

Since humans are (generally) risk-averse, they must pay a premium for somebody else to take the risk.

Trading in DeFi

By now, taking numerous tiny baby steps and set-backs that are too numerous to mention here, the cavemen have finally arrived in the digital age. They have invented computers that are small enough to fit into any pocket and that are cheap enough so that, in theory, every caveman on the planet can have at least one of these devices, which were manufactured by caveman kids somewhere on the other side of the planet.

But the coolest thing about these computers is that all devices are connected to each other using something that is called the “Internet”. But some cavemen are not satisfied with the strange type of money that caveman Draghi invented. They don’t see a good reason why Draghi of all cavemen should be the one who controls the money.

Luckily, caveman Satoshi came up with the idea to use Internet-connected computers to create a digital decentralized ledger (“blockchain). He also came up with a method to ensure that all computers would keep the exact same record of the blockchain. This made it possible to create a type of digital money that was not controlled by a centralized party, a cryptocurrency.

Since the first cryptocurrency Bitcoin, numerous other money systems like this have been developed. Some of them have the general purpose of a medium of exchange, some of them mostly meant to be spent on that cryptocurrency’s own blockchain ecosystem. Some cavemen even took some of Draghi’s money (which had a more stable, albeit inflationary value than cryptocurrencies), and used that to mint receipts of Draghi’s money (“stablecoins”) on a blockchain.

After a few years, many cavemen have adopted cryptocurrencies for trading goods and services. Some even earn their money by acting as facilitators between cavemen who want to purchase goods and services using cryptocurrency, and other cavemen who want to receive Draghi’s money as compensation for their goods and services.

Soon, the cavemen also find out that blockchains can be used to trade digital items, such as artwork or items that can be used in some of the games the cavemen like to play on their computers in their spare time. This is where we are now.

Financial markets in DeFi

The cavemen also ask themselves why stablecoins should be controlled by a centralized party, so they invent decentralized stablecoins. Interestingly, the first stablecoin DAI also enabled cavemen to get a loan in that stablecoin if they deposit their cryptocurrencies as collateral.

Next, the cavemen want to decentralize the markets cryptocurrencies are traded on, so they invent automated market makers, which make it possible to trade cryptocurrencies on decentralized exchanges. Since these decentralized exchanges need liquidity, they reward cavemen for depositing their cryptocurrency, which is another possibility to earn yield on cryptocurrency holdings.

Finally, some cavemen try to use blockchains and cryptocurrencies to create community-owned funds that seek to accomplish various goals (“Decentralized Autonomous Organizations”). One of the caveman tribes has even adopted Bitcoin as the tribe’s official money. This is where we are now.

Risk markets in DeFi

One of the problems with the decentralized finance markets the cavemen have built is that they often get hacked, which leads to some of them having lost their money. As they want to decrease their risk of losing money, they invent decentralized insurance policies, through which they can protect themselves.

Some are even trying to enable decentralized insurance for risks outside of the digital realm. This is where we are now.

How far has crypto rebuilt the three pillars?

Let’s look at the three three of capitalism and how far crypto has come in building their own blockchain-based copies of them.

On the trade pillar, we have already gone most of the way to the top. There is a plethora of digital wallets, centralized exchanges, eCommerce solutions, payment gateways, and NFT marketplaces. On the financial markets pillar, we are about halfway there.

There is a solid foundation of decentralized stablecoins, exchanges, and yield farming platforms. What we need now are creative solutions to construct the next layer of the pillar.

On the matter of risk markets, we have only just begun constructing the pillar. A foundation of working smart contract insurance protocols has already been built. Occasionally, you see insurance protocols tried out that seek to encompass more risk types, such as crop insurance. Additionally, some real world risks can be measured and mitigated using prediction markets.

Which layers are coming up next?

From the progress we have made on the three pillars, we can deduct what the next layers will be that are constructed on top of each pillar. With NFT artwork covered, the next step in the trade pillar will be integrating NFTs with virtual worlds, games, and the metaverse at large. All in all, there is not much work left on this pillar until we hit the top.

On risk markets, there is not really a solid foundation to build on yet. The projects we are seeing right now are still largely experimental and there is a lot of basic research that still needs to be done. Look out for projects that are innovative, but not too ambitious.

If only two layers out of one hundred in the pillar have already been built, it does not make sense to try and build the tenth layer next. You should be looking to build the third and fourth layer. Like in the traditional business world, it is often the second generation of projects covering a specific area of DeFi that gets the upper hand, as the first-movers are often way ahead of their time.

A famous, or rather infamous example of a crypto project that was ahead of its time was The DAO in 2016. It was the first decentralized investment fund, but failed spectacularly due to a hack and regulatory issues. Another example is Bancor, which was the first DEX to use AMMs. Among DEXes however, Bancor still only plays a minor role, despite having made several innovative improvements on AMMs since.

Building the next layer of the finance pillar

It also doesn’t make much sense to try and squeeze a new project into a pillar that has already mostly been built. The financial markets pillar will likely hit the sweet spot between being overcrowded with projects and not having a solid foundation to build upon without having to do basic research first.

On that pillar, we already have a solid foundation of stablecoins and DEXes, so there is no use of creating yet another of these projects. What might become interesting next are synthetic assets.

In essence, every algorithmic stablecoin is a synthetic asset, but any method used to peg an algorithmic stablecoin to a fiat currency can also be applied to create synthetic assets that track the value of gold, silver, oil, Tesla stocks, crypto indices, or whatever financial asset or instrument you can think of.

The most important trend within the financial markets pillar that is becoming apparent right now is the growing importance of DAOs as vehicles for joint investment and development efforts. ConstitutionDAO, Blockbuster DAO, or BitDAO are recent examples of this emerging trend. It can be assumed that we will see a plethora of new DAOs coming up in 2022.

At InstaLiq, we are looking to enable DAOs and other crypto projects to issue their project tokens through a novel distribution method, the Initial Liquidity Swap. Stay tuned by following us on Twitter and joining our Discord server, to help us build the next layer of DeFi’s financial market pillar.