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Why DeFi Will Win the War Against Traditional Finance

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I’ve struggled a lot with the idea of decentralization and why it is so intrinsically valuable. After all, I live in America- where finance runs pretty well, for certain people. I’ve been able to easily finance my undergrad and graduate education with loans, I have no minimums or fees on my checking or savings accounts, and I have a Visa that’s accepted everywhere- even with Girl Scouts selling their cookies with iPads and Square card readers. Centralized finance has worked well for me. But look below the surface, and there are issues. Grocery stores, coffee shops and clothing stores all have to pay Visa a 3% fee just so they can accept and transact with a piece of plastic. Millions in the US still have to resort to check cashers and payday lenders, and can’t get access to financing for a mortgage. Why does the government get the right to decide who owns what and at what cost? Centralized finance has proven unable to bring financing to over 2.5 billion adults worldwide. Decentralization is by far the biggest selling point of blockchain technology- right up there with ease of scalability and transaction speed. There’s no better example of a decentralized technology than blockchain.The arrow of history in the 21st century has pointed one way- democratization and dispersion/decentralization. It’s no longer a question of if. 

Since the industrial age, we have by and large lived in an age of super-centralization. Concentration of power and control essentially allowed the Financial Crisis of 2008 happen- with centralized finance (big banks) being the culprit. As news of the crashing markets broke, politicians in Washington attending dinner parties in their tuxedos left early to scramble to The Hill and meet with Ben Bernake, who stated that if action wasn’t taken in the next 48 hours, first the American financial system would fail, then the world financial system would fail. The solution was to double down on the old system of concentrated power- and spend trillions to rehabilitate centralized finance. Central banks became even more important by pumping these trillions into the fiat economy via the same banks that caused the crisis. History doesn’t repeat itself but it rhymes- we’ve seen this play out again with wrinkly politicians spending trillions to bring us back from COVID-19 collapse, and then some. With near-zero interest rates companies levered up (corporate debt doubled in the period from 2000 to 2020), and wealthy Americans bought homes and more assets with these low rates. Not much was left for the rest of America.

There is a decentralization trend emerging- mostly thanks to new technologies giving people the tools to cut themselves off from being dependent on big centralized institutions. With technologies like solar, homeowners can remove themselves from the electrical grid entirely and platforms like RedFin align home sellers with home buyers- bypassing realtors who often charge a fixed fee of 3-5% regardless of the transaction size! With AirBnB, we can book accommodation without hotels; with Sparetoolz we can rent tools from our neighbors without going to the hardware store; with Wag! we can get pet care from people nearby and bypass pet care facilities. The premise is this- people have figured out if they have idle assets, they can sell usage of them. The same will be true of crypto- staking assets and nodes with idle computing power will confirm money transactions and smart contracts worldwide. Ethereum, Polkadot, and Cardano are leaders in this space. This new system of sharing has been dubbed many things by economists- the collaborative economy, the sharing economy, the platform revolution. Firms with decentralized businesses have ironically become the most powerful. Google, Facebook, and Apple are all worth trillions and got to where they are by encouraging peer-to-peer middleman-free activities. Advertising on Google meant businesses could bypass big ad agencies- Apple’s iPhone and App Store platform provided a developer-friendly layer and audience to deploy software applications written by anyone quickly and cheaply. Twitter allowed people to design their own newsfeeds, and Facebook allowed people to build communities organically, held together by the convention that the consensus of the crowd trumps everything else. 

The communities of ETH and Cardano are just that. Both are open-source software development projects that lack a formal head or authority. The platforms welcome thousands of other projects, and their protocols can be used for anything developers would like. 

There is a clash coming. The biggest institutions that will be disrupted by platforms like Cardano and ETH are those with the most centralized power- governments, big finance, law. David Johnston of MasterCoin states that anything that can become decentralized will. 

My graduating MBA class at Dartmouth, along with me, went into many of these fields where power is centralized. For those of who aren’t familiar, people go to do their MBAs because we’re tired of driving Honda Civics and we want to drive Teslas. We “pivot” from whatever careers we’re in into consulting, investment banking, private equity, fortune 500 leadership development programs, and big tech. These fields are competitive (read: high-paying) and require strong signals (read: employer’s fetishization of top higher ed degrees) to employers in order to break into them. You have to be smart, well-spoken, and since most of these roles you transition to are client-facing (read: mostly clients are older white men), you also have to be socially palatable (read: mostly young white men ). These employers are the ones who have benefitted the most from centralization with cheap money provided by banks and equity, and have used acquisitions to buy out competition, so they can pay employees large sums. Does that sound fair and democratic to you?

I don’t regret doing my MBA at all, despite the $150k in tuition. On a risk adjusted basis, it’s a good deal. Most students matriculate into the MBA having left jobs that pay in the range of $60k-$90k, and then leave for jobs that have $120k-$180k base salaries with nearly equal amounts in other compensation. If one were to compare this with staying at a current job or starting a business, after adjusted for risk, the MBA is a well-worn path. Plus it’s not pretentious or nepotistic at all that MBA alums hire fresh grads from their alma maters.*

*This is a lie. 

I need to make a big digression back to DeFi. 

We could be wrong about crypto and DeFi, and what it will do for the world. Humanity has more than enough potential to overhype certain things. During the Dotcom bubble, one company bought furbies for $200 and then turned around and sold them for $100, and was valued at over $10 million. Crypto could be left to its own devices without institutional adoption- it could remain a fringe asset, its technology never catching on, and people could lose interest. Paul Krugman, a big name economist in the US, stated in a WSJ article that usually after a decade of existence a given technology finds its use case and bitcoin and blockchain haven’t yet- therefore it’s a no-go. He is wrong about this. When the Dotcom boom peaked in 1999, the internet was already a 30 year old technology, having been created at my graduate alma mater UCLA in the summer of 1969 as a defense-sponsored communications project. We’re likely experiencing the golden age of the internet now, with internet companies breaking $2T valuations. Firms that ignore blockchain may fall prey to it- I’m talking about Western Union, check-cashing services, payday lenders, and even car dealerships (who make the majority of their revenue through financing, not auto sales). Some of these firms are employing the stand-and-fight strategy: MasterCard has spent millions and hired top lobbyists in Washington to advise congress on anti-crypto strategies. What does that tell you?

The smartest firms will co-opt blockchain technology. Because of the rockstar compensation, the top banks often employ intelligent and creative people, and have jumped onto the new technology. Robinhood (despite being a menace) introduced no-fee trading- now essentially all brokerages are doing it. Apple, Square, PayPal, and Venmo have made payments digital, faster and easier. But there’s still a hitch- this system is still stuck in the 500 year old institution of big, centralized finance and banks. All of those digital payments are still traced back to bank accounts. Those banks have rates and policies determined by the federal government. Merchants that accept Square, PayPal or Apple Pay are still hit with fees from those companies. It does not solve the main issue of the concentration of power. Blockchain will force the institution of finance into a gilded age of innovation because of these simple facts- the fees suck.

But China is different! Not totally. The state controls the banks, and makes sure nearly zero fees are levied on merchants for digital payments or otherwise. This is fantastic for both merchants and consumers. This means blockchain’s cheaper technology would have less advantage, and be less appealling. But it’s the government that enforces the zero fees. Since the government controls this, there is a central entity that could remove these privileges from businesses who do not comply with the CCP’s wishes. Sometimes, maintaining privileges from the government and innovation are in direct opposition to each other- a fact that could make Chinese businesses less competitive with Western ones, and thus less wealthy.

There’s no free lunch. Who will charge fees now? Miners on the blockchain, but for a much lower cost. Miners and stakers on the chain use their computing power to confirm transactions, with each node contributing a unit of work (with proof of stake) for little cost. The most adamant proponents for blockchain will end up not being the consumers- it will be the merchants, who will pressure the banks to adopt a blockchain system that is far cheaper or else they’ll switch. This is even possible without having to switch to crypto payments- the blockchain tech can work in unison with fiat. That’s another blog post, though. 

It’s clear that all of this points to a crypto boom to likes we have never seen. Currently only 1.5% of the world’s population owns or transacts in cryptocurrency- that means the hockey-stick graph-style explosive growth hasn’t yet come. It may not even be with the coins we like to own now, and blockchain’s best use case may not have yet been established. Will the power of NFTs solve Africa’s land ownership rights problem? Will the ability to tip online creators with crypto surpass the utility of lending via smart contracts? Anything is fair game.

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