The DeFi Narrative
As the basics of blockchain and cryptocurrency are well documented, this series is a guide to navigating and capitalizing on the emerging opportunities presented by Decentralized Finance (DeFi).
Series Roadmap:
- The DeFi Narrative: Critical advantages over traditional finance
- The DeFi Ecosystem: Money legos and decentralized financial products
- Token Valuation Methods: Investment heuristics and price predictions
- Passive Income Strategies: Risk/reward profiles for lending, staking, etc.
- Yield Hacking: Trading strategies to maximize risk-adjusted return
What is DeFi?
DeFi, also called Open Finance, is a blockchain-based financial system built on trustless protocols (open-source code), rather than centralized institutions like governments and banks. The first goal of this financial revolution is to offer the same products that power today’s modern economies (currencies, payments, lending/borrowing, investing/trading, derivatives, insurance, governance, etc.) without rent-seeking intermediaries.
Critical Advantages over Traditional Finance:
- Enables global access to financial services for anyone with an internet connection
- Reduces costs for users by eliminating profit-seeking financial institutions
- Provides passive income for depositors by sharing loan interest pro rata
- Streamlines transactions with smart contracts to prevent arbitration
- Catalyzes innovation with open source code to decentralize development
- Empowers users to participate in the governance of their monetary policy
To emphasize the movement’s magnitude, I’ll contrast these value propositions with the centralized systems that dominate today’s financial landscape.
Let’s start by reviewing the centralized control of our money supply. As the COVID-19 pandemic sweeps the globe leaving human and economic wreckage in its trail, central banks attempt to mitigate the damage with new monetary policy. At the helm of the US’ money supply, the Federal Reserve has deployed measures including near-zero interest rates, direct lending, and infinite quantitative easing, i.e., unlimited treasury debt and mortgage backed securities purchasing. Combined, these measures have doused the US economy with $4T in cash created out of thin air.
To put this in perspective, the American, Chinese, and European Central Banks have each printed crypto’s entire market cap in single days. While President of Mineapolis’ Federal Reserve Bank, Neel Kashkari claims that the Fed has an “infinite amount of cash” — the US has already doubled its M2 money supply since 2008.
From the $700B bailout of the US financial institutions responsible for the 2008 Financial Crisis to the infamous Equifax hack of credit card and social security numbers affecting nearly half of all Americans — the track record of large centralized institutions safeguarding our wealth and data is far from spotless. While financial crises in the US result in Americans losing jobs, savings, and homes, the scale of disaster is far worse in developing nations.
Take Venezuela, where failed monetary policy compounded by corruption and falling oil prices has resulted in an economic and humanitarian crisis. As hyperinflation reaches 10,000,000% per IMF data, products that once cost $10 could now cost $1M. Monthly salaries for the ~50% of Venezuelans still employed often cannot afford them a gallon of milk. Today, more than 3 million people have fled the country and ten million more remain stranded in poverty.
While recessions are recognized as a recurring phase of the natural economic cycle, giving unelected bankers carte blanche over our monetary policy is no longer necessary. One of the most powerful advantages of DeFi is the ability for anyone in the world with access to the internet to audit and participate in the governance of their money.
DeFi users can transfer their wealth into store of value assets like Bitcoin with hard-coded finite supply, or other cryptocurrencies with inflationary, deflationary, or dynamic monetary policies voted on by their holders. P2P lending protocols enable depositors, rather than banks, to earn the interest paid by borrowers. Through the use of modular open source code (money legos), developers can share building blocks to create new financial products altogether, bypassing the steep regulatory and competitive barriers erected by incumbent institutions.
As ~1.7 billion people worldwide still lack access to a bank account, DeFi has the potential to provide a wider variety of financial services to a greater audience of global participants. For the first time in history, the only requirement to gain access is an internet connection.
In my next post, I explore the key products and players of the DeFi ecosystem.
Hope you and enjoyed and thanks for reading!
