An interview with Prof. Dr. Fabian Schär about the future of DeFi
This is a transcript from my recent Qi Podcast interview with Prof. Dr. Fabian Schär, available here:
I had the honor of interviewing Professor Dr. Fabian Schär from the University of Basel in Switzerland for the Qi Podcast. We talked about the future of Decentralized Finance (DeFi), his academic work, and how institutions will adopt decentralized finance technology.
Go to the podcast: https://www.buzzsprout.com/1729379/8604631
Archon: Hello, Fabian, and thank you for being here today with me — at least virtually — to talk about the future of decentralized finance. Fabian, you are a professor for distributed ledger technology and fintech at the University of Basel in Switzerland and hold several advisory positions at blockchain-related institutions worldwide. In addition, you wrote your Ph.D. thesis about blockchain and cryptocurrencies, and you are the author of several publications, including the bestselling book Bitcoin, Blockchain & Crypto Assets. Could you give us a bit more background about yourself and your journey into Bitcoin and cryptocurrencies after starting your career in traditional banking at UBS?
Fabian Schär: First of all, thanks a lot for having me. I’m looking forward to this. So, I’ve only spent like two years with UBS, so I went right into crypto after my studies. And yes, I have some experience in the financial sector, but it’s pretty limited, and I’m young, so obviously, I don’t have that much experience in the industry.
The first starting point with Bitcoin was actually during my studies. Originally, I’m a monetary economist, so I came to terms with Bitcoin relatively early. And I have to admit, when you have the first talking points, I thought, yeah, it’s not going to work. But the more I looked into it, and the more I looked at the technology, and how it works, and what you can do with it, the more fascinating I became with it. So it’s the usual down-the rabbit hole story.
And then, I decided to write the master’s thesis on Bitcoin. I think that was back in 2014. Later on, I did my Ph.D. on the blockchain. That’s also when I became more and more of a computer scientist, even though it was an economics Ph.D. But obviously, when you really want to understand what’s going on, then you also have to look into the technology quite profoundly. I mean, then I got the chance to build a small blockchain lab with a consulting company, but then went back to the university and eventually got an opportunity as a professor for blockchain technology.
Archon: Which is quite unique in the world. Help us a bit to understand how an academic career in the blockchain field looks like. Are you more educating people from the traditional finance sector about the possibilities that blockchain technology opens up, or are you with like-minded people building at the edge of what’s possible?
Fabian Schär: It’s really a combination of all of these things, and that’s what I appreciate about the job. So, of course, it’s a lot of research, but it’s also teaching, working with young people who are interested in the topic. And we really care about the foundations of the technology, where we look into the details like the math behind the yield. And in total, I teach six different courses at the University of Basel. Right from the beginning, I always said I’m not necessarily that much interested in enterprise blockchain solutions because to me, honestly, in most cases, it’s just a glorified permissioned database, and that’s not new at all. So what I’m doing research-wise and also what we teach at classes is really on the public blockchain side. My research focuses mainly on the Bitcoin blockchain, and due to my economics background, DeFi is of great interest to me too.
Archon: Also, your latest research paper — which the Federal Reserve of St. Louis also published — focused heavily on DeFi. And we have seen the whole space getting more awareness during the so-called “DeFi summer” in 2020 and the recent crypto bullrun in 2021. Many DeFi applications such as Maker, Aave, Compound or Sushi have received much more traction, although many existed already for a while. But when exactly did you switch your focus from Bitcoin? Was there a particular moment when you realized that there is something exciting happening?
Fabian Schär: I couldn’t give you a specific date. And I also think there is not a strict line between just looking at the blockchain itself and looking at the applications. The first time I heard about DeFi — even if it wasn’t called DeFi back then — was probably from Mona El Isa (CEO of Avantgarde Finance and Founder of Enzyme Finance). She is also Switzerland-based and I saw her regularly at various conferences. I think it was her who introduced me to the concept of replicating traditional financial infrastructure on the public blockchain.
Archon: That’s an exciting story. Whenever we look at DeFi and cryptocurrencies in general, it’s always hard not to talk about price and market behavior. What we have seen now recently was the largest drawdown in the markets since March 2020. I would be interested in your opinion on what this meant. I mean, we’ve seen real capitulation for a few days when leverage dried up completely. And many people stated that this could actually be the end of DeFi. And on the other like on the contrary, I mean, DeFi applications have performed as they should and have survived. Many banks would not have survived such a drawdown. So would you say that DeFi is dead, or on the contrary, it’s more alive than ever?
Fabian Schär: Oh, on the contrary. Honestly, I was really impressed by the performance of the DeFi sector in these very turbulent markets. I mean, you look at what happened, I wouldn’t have expected that the liquidation events would go through that smoothly. So I’ve been really excited. But then again, I also don’t care that much about price. I am much more excited about the technology and the protocols. And I think, in this case, it’s been an excellent example of protocols working as intended, and that’s quite impressive.
Archon: You have many connections and interactions with people from traditional finance because you are an advisor to many active firms in both sectors. How would you summarise the perception of DeFi from this target — not just related to this drawdown, but let’s say over the last 12 months?
Fabian Schär: I think we have to go back to the beginning of the blockchain boom again. When the blockchain hype started, traditional companies made the big mistake that they all wanted to control it or many of them at least. And it seemed to me that every single bank wanted to have their own blockchain, which, of course, doesn’t make any sense at all. Right. I mean, what’s really new is the immutability that you have this layer that is owned by the community where you can build something up in the public domain. And obviously, you lose all of this once you have your own personal, permissioned blockchain. And that I think even today, some people don’t understand that and they think something is immutable just because they put the name tag blockchain on it.
But now, I think it’s a lot different. I think this time, many of these companies already had their learnings from the initial blockchain boom. They have some background and have the foundations in place. And to my surprise, to be honest, I saw that many banks, many financial institutions are eagerly looking into DeFi and really looking for ways to participate. One could say it doesn’t make too much sense because DeFi is supposed to be decentralized and what are banks doing in there? But honestly, I think it’s not that we should have a really strict line there. I think it’s great when people have the option that they can hold their own assets, that they can use these protocols and don’t have to go through an intermediary or custodian. But as a matter of fact, many people actually want to do that. And that’s why I think it’s positive if you have the option and if you also have these professional players in the space.
Fabian Schär: I mean, I’m not sure if you’ve seen the article I recently wrote for CoinDesk, where I said that even though in theory, DeFi is highly transparent, in practice, it’s a bit different. When you actually look at the data in DeFi, it’s not that simple to make sense of it. I mean, in theory, yes, everything is there, but especially when you’re looking at macro data (outside what’s happening on personal accounts), it’s not that easy to make sense of it.
Archon: We see that with many exploits that are extremely complex, and just a few people can actually make sense of how that happened. Is this something relating to your statement?
Fabian Schär: Yeah, absolutely. Especially many token wrappings are quite extensive. In some cases, you have a token on top of a token on top of a token, which is also part of composability. It is really exciting, but what you lose is transparency. At least without the tools and researchers to make it understandable.
Archon: You said before that you mostly focus on Ethereum, but especially in the last month, we see countless other blockchains acting as a settlement layer for DeFi protocols and applications like Binance Smart Chain, Fantom, Terra and others. does this influence your work?
Fabian Schär: I mean, the foundational research we do is really looking at the protocol layer. And in many cases, when you’re looking at something like constant functioning market makers, that happens to be another factionally theorem currently. But in theory, you could also deploy that on pretty much any other base layer. So I don’t think my research is exclusive to one protocol. But when you look at the numbers and the community and the number of developers and everything, it’s a fact that most of the action is on Ethereum or on blockchains that are to some extent really close to Ethereum and pretty much use the same technology with, in many cases, just a different consensus protocol.
And then on that, on a personal note, I really hope that we will see true decentralization on the base layer. In many cases, you will have a hard time claiming that a blockchain as a base layer is decentralized. And the reason why I think this is important is that when the base layer is not decentralized, then everything you put on top of it certainly isn’t decentralized either. I mean, when you have a blockchain that they can roll back, where you can make some arbitrary decisions, where you have a centralized operator essential. So even if the protocol that is deployed on top of it would be perfectly decentralized, it wouldn’t make too much sense. But I’m really saying that I hope that we will see a truly decentralized protocol that will win at the end.
Archon: We mentioned before the high complexity of DeFi nowadays. This is a critical reason for the many hacks and exploits we have witnessed recently. And in my opinion, this is holding back a lot of adoption. Actually, there’s no single week without a hack or exploit, especially in recent months. And if we look at the rekt leaderboard top 10, each of them cost more than 20 million U.S. dollars. I mean, that’s in line with the most extraordinary art thefts of all time, probably even worse, because in art, you don’t have that sell-side liquidity. What’s your view on that? Is this just a logical consequence of working in this sector that is so nascent, or is it just sloppiness, or is it just bad actors? And how can we overcome that?
Fabian Schär: It’s a combination of all of them. On the one hand, you have investors that really don’t care and really don’t look into these protocols and in some cases are getting really greedy. And before they take the time to look into it and understand what’s going on, they throw the money at it, which is usually a recipe for disaster.
On the other hand, when there is a lot of money in a space, you also have scammers. I mean, in many, many cases, it’s just some incorrect code or even more so economic attack vectors. But in some cases, and certainly, it’s the intention of these people to go for a rug pull. So this is actually a big issue. And then, of course, the inherent complexity of the space is also a big catalyst you have mentioned.
We have to admit that the user experience in many cases is bad.
I mean, you get used to it after a while. But imagine you never heard anything about Ethereum before. And then you have to make decisions like setting a gas limit and gas price, and you are confronted with things like frontrunning, and then you don’t really know what’s really happening in the contract you are using because of. So, I mean, there are so many issues and things you really cannot easily explain on an intuitive level. But I think it will get better. Usability will get better; education will get better. Also, when you look at the hacks in the early days, it was just some sloppy code, some coding issues. And now these attacks yesterday are still there, but they’re also getting more and more complex. Especially recently, we see more and more game-theoretical economic attack vectors.
Archon: I completely agree with you here. We are still far away from mass adoption just because it’s just too complex. But do you think we can get better adoption through improved usability and stripping out complexity on the wallet side or through intermediaries?
Fabian Schär: That’s an excellent question. Usability will get much better. But as you point out, rightfully, the question is at what price? Because let’s say you’re not confronting the user with his or her private key anymore. Right. So people get a regular login and the passwords. This will probably be a good thing from a usability perspective because people are used to it. But I mean, they will be ultimately the opposite of what we want to achieve. And you couldn’t talk about non-custodial solutions anymore.
So I think there is a particular tradeoff then that the biggest challenge will be to come up with better usability without undermining the self-sovereignty and decentralization of the space.
Archon: Let’s hope so. Let’s talk now a bit more about the long-term future. How would you describe your personal vision of decentralized finance? Not actually what you want it to be, but what do you think realistically it will be, let’s say, in 5 to 10 years, especially looking at the intersection of DeFi and traditional finance.
Fabian Schär: I think that anyone will be able to connect to various DeFi protocols. But to me, it wouldn’t be surprising if many people decide not to do that just because, in some cases, it is too complex or too expensive, at least on the base layer. And in many cases, people really don’t care, and they want to and want to talk to a client advisor, and they don’t want to have anything to do with managing their own money. And that’s fine.
But the great thing that DeFi brings to the table — and I think we should not underestimate that -, is that there is an option. So if you’re not happy with the services provided by your financial intermediaries, you can do it on your own. That’s a big difference. I think the worst thing that could happen — and that’s that is a topic in politics currently for a relatively long time — when you get rid of cash and therefore people really cannot hold their own wealth without any alternatives and people are basically forced into a commercial banking system, that would be a bad development.
Archon: What do regulators think about having this option and what hurdles do you see in the near to medium term for adopting DeFi protocols?
Fabian Schär: I have no legal background whatsoever, but I still speak at least once a week to regulators worldwide about DeFi. And they are somewhat worried. I mean, there’s this new technology they don’t really understand, which might undermine all of their efforts. So you cannot even blame them that they are worried. On the other hand, I usually tell them that they should not regulate something because it’s called DeFi, and neither should they not regulate something called DeFi because they tend to just put something in a box because of its name. And that would be a really, really bad idea as far as I’m concerned.
There are various categories of decentralized finance. I mean, some really exciting projects that are completely decentralized don’t allow for any interference. Then there is a lot in the middle where you have some centralized admin key or centralized oracles. And then some projects are — when you look at them closer — are completely centralized. So, therefore, I think the big challenge regulators are currently facing is looking into the technology to understand what is going on and differentiate between these various DeFi implementations. Otherwise, it’s not going to end well.
Also, trying to regulate developers would be completely wrong because in many cases, when it is an actual DeFi application, they don’t have any control over it anymore. It could be deployed by someone else or it could be deployed anonymously. So I think, long story short. Eventually, regulators have to understand that when something is completely decentralized (so when you don’t have any of these centralized oracles in place when you don’t have any admin keys when you don’t have any special privileges), like Uniswap V1 for example, then the only thing they can and should do is regulating FIAT on and off-ramps. So basically, go to the financial institutions and say whenever you put money into that space, whenever you’re buying or selling any of these coins through a financial intermediary, then, of course, the usual regulation applies. But they have to be aware that within the space, at least when we’re talking about these really decentralized platforms protocols, they neither can nor should do something about it. And I think that still takes some work. As I said, I talk a lot to them and I think eventually we will get there.
Archon: But in any case, it is a very positive sign that they approach you and try to understand what is behind?
Fabian Schär: Yeah. I was surprised because I don’t have any legal background whatsoever, but I think what they are looking for at this point is something that they really want to understand how space works and get some basics from computer science on the protocol level.
Archon: Let us talk about a concrete example like Aave Pro for instance. They are now onboarding institutions to experiment with DeFi in a «safe sandbox» from an institutional perspective. It seems to be a permissioned version of Aave that allows for AML and KYC compliance. Will this be the future for institutional adoption? But then how does this interact with, let’s say retail DeFi?
Fabian Schär: Well, I think there will always be some form of a connection between the two. I don’t believe that it’s completely isolated. But once you leave the permissionless the actual DeFi part, you go more into a permissioned world that is not decentralized anymore. It’s really just centralized finance implemented on-chain. I mean, I would be surprised if you could just move on back and forth without KYC. That wouldn’t make any sense then. And they can tell you right now that’s not going to happen. But once somebody is identified, why not allowing them to move back and forth between the two worlds? So we will see some connections, but it will be handled just like the on and off-ramp thing, so in a regulated manner.
Archon: You mentioned the need for more research in the space, also to strip down complexity and build tools around it to better understand what is happening. And for this, you need to have a better formal education. Do you see more universities like in Basel adding courses, professorships for blockchain technology, or will it just find its natural way into its traditional economic education?
Fabian Schär: Yeah, I think so. I think some DeFi protocol education should be part of any good finance curriculum at this stage or at least in the next few years because it’s fascinating what’s going even if you don’t care about blockchain. And I also hope that more universities will jump on the train education-wise, but also research-wise. But I mean, when you look at it today, much of the innovation does not come from the universities, which I don’t think is a bad thing. Regardless of the background and basic education these people have, they are just pushing innovation forward. And that’s the best thing that can happen from a financial innovation point of view.
Archon: Just a few days ago on Twitter, you announced a free and open lecture program about blockchain technology and cryptocurrencies from the University of Basel; tell us a bit more about what to expect from this free educational service.
Fabian Schär: We’ve been teaching blockchain courses since 2016. And what was funny is that you have this lecture room with 300 students, but many of them are sitting there in suits and are somewhat older. And then you start talking to them, and then you realize that these are people from the financial industry. We then started to record these sessions and quickly realized that this is a great opportunity. Just make it available to the public. When you think about it at the end of the day, the university is funded by public money. The idea of the university is to generate knowledge, be it in research or by educating people. So I don’t think there isn’t any good reason we couldn’t make it available to the public. And luckily, we got it approved by the university. And now the plan is really to have all of our classes open to the public. And we’ve created this open platform to consume it, but it’s also on YouTube. The hope is that there will be an ecosystem where various universities can use this material.
Archon: It’s incredible. So definitely, everyone, please check out the free course as it is an excellent service and for everybody globally. You also told me in our preparation that you are working on a new paper. Can you tease a bit about what it will be?
Fabian Schär: Yeah, I’ve been working on that for a really long time. It’s about and its concept of the metaverse. It is basically a bit similar to Second Life, but in a decentralized way, where you can have your own parcel and build stuff on there or just explore this virtual open world. And what we did there is, we took the entire data from the land auction and applied these models from urban economic theory where you’re looking at the price building mechanisms and the willingness to pay. So we analyzed, for example, how the proximity to streets or proximity to a plaza or certain districts affects the willingness to pay. And it’s a cool paper. We will release it in the next couple of months.
Archon: That sounds interesting, I am looking forward to it. Thank you very much for your time. I think it was a fascinating interview with great insights.
Fabian Schär: Thanks a lot for having me.
About Qi Capital
Qi Capital is a group of like-minded and experienced individuals from around the globe, sharing two common objectives: providing insights about crypto and DeFi, and proactively working with ambitious teams on the future of decentralized finance. Our core principle is to promote and foster individual creativity, growing not only as a group but also as creative thinkers and builders. To learn more about us, check out our website www.qicapital.org and our “Qi Podcast” via www.buzzsprout.com/1729379/ or engage with us on Twitter: @QiCapital.
Disclaimer
This content is for informational purposes only and you should not make decisions based solely on it. This is not investment advice. All market prices, data, and other information are not warranted as to completeness or accuracy, are based upon selected public market data, and reflect prevailing conditions and the author’s own views as of this date, all of which are accordingly subject to change without notice.
