Revisiting my views from the distant year of 2020
Before starting this blog, I wrote a couple articles in October 2020 on the DeFi lending landscape, commerce in crypto and my views on how the space would evolve.
I proposed a historical view on lending, starting from the Rothschild Family on the first article and a historical view on crypto commerce, starting with drugs on Silk Road and ending with NFTs and CryptoPunks. Just for context, a CryptoPunk back then was selling for $500. Currently the cheapest ones are selling for $100,000.
Moneychanging, Moneylending: Part I
How DeFi lending got here and what’s missing going forward
Lending is the natural next step for any new nascent financial market. The house of Rothschild got its start by collecting and exchanging coins (moneychanging). Once they had enough value under their custody, the natural step was to put it to work (moneylending). Then they expanded by doing the same for rulers locally and then, doing the same across Europe.
That’s analogous to what happened in crypto. Bitcoin was the first natively digital asset to accrue meaningful value at scale for multiple people. Others came with different narratives but following a similar path. Narratives are not as important here. The sole point is digital accumulation of wealth.
The next natural step is to have lending. Lending has existed in some form or another in the crypto markets from the very beginning. Early websites like BTCJam had p2p lending functionalities and, arguably, the exchanges themselves were the first credit takers and providers, being through margin trading like Bitfinex pioneered at scale, or through perpetual futures leverage and funding, driven by BitMEX.
Let’s decentralize that
But the true quantum leap in lending happened once we had on chain ability to lend, liquidate and pay. And that came as a consequence of Ethereum smart contract functionality.
What is curious about lending is that it takes not only a technological improvement for it to evolve, but also using the technology in a way to coordinate humans in a slightly different fashion.
The Rothschilds had a technological improvement over what was prevalent before. They combined the use of new networks of roads and communication that were existent into something new. The family was able to effectively create a financial network between the largest Big Five cities of Europe (Paris, London, Frankfurt, Naples, Vienna) and redirect financial capital as needed between the different branches of their business, each ran by one of the sons of the patriarch Mayer Amschel Rothschild.
The on-chain capabilities to borrow and lend is a similar technological improvement. In lending, most of the time the innovation doesn't come from an actual technology (roads, telegraphs, telephones, internet), but as a way to access and coordinate previously uncoordinated pools of lenders and borrowers.
If you understand borrow and lending as simply the act of trusting, giving credit to one, the ability to do that in a semi-trustless manner is a step forward.
DEX and On-Chain Lending: moneychanging, moneylending
The current scenario of decentralized lending is dominated by 3–5 protocols, while the DEX space has 2–3 dominant players. The current ranking is very much different from what it was 6 months ago, so I would say it’s still an open field, and you can refer to better posts on the current scenario than this (e.g. Arjun Balaji’sCrypto Market Structure 3.0).
I prefer giving the 10,000ft view of how we got here and where I think we are going next. Not interested in having this post get stale fast, since I’m too lazy to write that often.
If you were an outsider or an insider who stopped following crypto in 2017 you would naturally think that two types of candidates would come to do be dominant in lending: funds and exchanges. They were gobbling the most assets and they could provide these assets eventually to people willing to get it, right? Well, some of them are doing, but they don’t really have is scalability and flexibility to give access to the way people wanted.
The moment we started having functioning DEXs and an explosion of token listings powered by yield farming, everything went up: prices, yields, trading volume, TVL. A mix of true innovation, but mostly novelty at the end.
Given decentralized lending is still overcollateralized, the current borrower wants two things: trade or access better yielding opportunities (provided by, surprise, surprise, trading). He wants to use whatever assets he owns as collateral and access to assets that offer those good trades/yields. So flexibility is necessary.
Interestingly enough the way it came about was for these protocols to coordinate people through social engineering and incentives. It’s much easier to become a dominant player in the crypto lending space now by trying to have better incentives (like farm tokens were, but these seem shortlived), better offerings (meaning more customizable by the customer), and more flexibility in terms, than having a large pool of assets to begin with.
The incumbents are better positioned to offer this, but still, it’s very much an open game. A solution that seamlessly couples DEX and lending, solving high fee issues has the ability to outgrow its competitors in the short term.
Another way to outgrow is by offering safe under collateralization. I’ve been taking security as a given here because it seems that for the most basic functionalities that are overcollateralized we have this figured out, but undercollateralized lending requires a different solution.
As an aside, note that all of this is different from what happens in the traditional market. In TradFi generally you want to have access to the cheapest available supply of credit (or access the highest paying demand for debt), and build on that. Here we have a slightly different paradigm.
What’s next after the game of chicken?
Much of the activity that is happening is driven by speculation and a bear market in DeFi could mean that volumes come down on exchanges and yields come down on lending protocols. The really large ones will not die, but others will become analogous to ghost chains: no lending and no trading taking place there.
Given that there is no natural demand for crypto other than trading, when trading volumes go away because people got tired of losing their pants repeatedly, you have a decline in activity in these platforms.
So is decentralized moneychanging and moneylending unsustainable in its current form? Sure. Is it naive believing that yield farming alone was the way forward? Sure. Is it all a game of chicken? Pretty much. But the game of chicken laid out the infrastructure foundation and validated the ideas for what comes next. This was the “Hey boys, each of you go to a different town” moment. What comes next is where the real game begins.
The lacking component for crypto is commerce. But that’s a subject for Part II
Moneychanging, Moneylending. Part II: Commerce and Credit
How commerce in crypto was born in the darkness, died, and a speculation on how DeFi could resurrect it
Commerce is the foundation of modern society and globalization. If money is a store of value, a unit of account, and a medium of exchange, it is with the ultimate finality of buying something.
Cryptocurrencies have experienced three distinct phases of commerce so far. The Black Markets, the “We Accept Bitcoin” and the current “Death and Rebirth”.
2011–2013: The Black Markets
If you had no experience of using Tor to access Silk Road, I would urge you to read this 2011 article. It’s one of the first mainstream articles mentioning bitcoin, but it focuses more on Silk Road.
The Silk Road was a free marketplace. Like Amazon but, mainly, for drugs. It offered a completely new experience from what was available before, as you could simply buy online drugs that were previously not available to you or available in high-risk situations only.
Silk Road was enabled by bitcoin and presented the first commercial scalable use for cryptocurrencies, forging a generation of early bitcoiners. But lack of understanding of BTC’s privacy for this transaction and lack of a truly decentralized stack led to the seizure of the website and crashed the price of bitcoin. Some of the alleged founders of the website were arrested later.
Word on the street is that drug buying and selling today is done in a more decentralized way (at the individual level) directly through message apps and delivered locally. Crypto has very limited involvement in that, people just use centralized digital payment services like Venmo. The delivery/communication was decentralized, so the payment can be centralized and pose less risk.
2013–2017: “We Accept Bitcoin!”
The second phase was what I call the “we accept Bitcoin phase”: initial usage to buy real stuff, evidenced by “We Accept Bitcoin” stickers on coffee shops, taxis, and other providers of goods and services.
VCs happily poured money in something they saw as crypto beyond the despised “speculation” and the off-limit black markets. A future enabled by cheap, borderless payments was being built, and those building rails for the adoption of crypto by commerce would be the big winners.
Those turned out to be poor investments — the money was really in speculation.
Despite some reminiscence of that still existing, the financialization of bitcoin made it too expensive to transact in smaller quantities, and improvements of centralized digital payments systems made paying with crypto a clunkier solution by comparison.
2018–Present: Death and Rebirth
What can you buy with crypto today? And more importantly, what is strictly better to or only possible to buy with crypto today, as an eight of purple kush was back in the Silk Road days?
The last time I used crypto to buy anything other than money (crypto or fiat) was to pay for a VPN that I didn’t want to use my credit card. But it was hardly the only way to pay, it was clunkier and took more time than using my credit card. Before that, I honestly can’t remember anything recently.
It’s hard to find an obvious answer. The mainstream narrative now is that crypto as a solution for commercial arrangements is dead. But the mainstream has a very poor track record of narratives in this space, so let’s not give it too much credit.
I will also consider very briefly the hyperbitcoinization argument. I think it’s a teapot in the sky kind of argument. Cute but worthless, as it provides no evidence that it is happening until you can verify that it happened.
I’m not a gamer and I have no understanding of it but some people seem to be paying hefty amounts for skins and other stuff, but I see no reason why this can’t be done through the traditional rails, given most games are tied to a centralized company. Crypto may be one option, but unless it is a strictly better option, it doesn’t answer our question.
NFTs (Non-Fungible Tokens) were all the rage for approximately 48 hours during the DeFi hype, and I criticized them on at least occasions (here and here), but giving a second thought they may be some merit to them.
Demand seems to exist, and while I do not truly understand it and suspect it’s very tied to flipping (like we do with coins) there may be some fundamental demand.
Also, it seems to be a case where is much easier and safe to just pay with crypto than to provide a credit card and a crypto wallet for the NFT be sent to, so it’s really a case where it *is* a better way to do commerce.
CryptoPunks is an interesting case. It’s much less for the artistic value, much more for the historical and scarcity value (they pioneered NFTs and there’s only 10,000 of them).
I’ve always thought that Bitcoin could be understood as some form of art. There’s a fixed amount of it and there’s technical beauty in the solution found for it to exist. So this kind of resonates with me.
So NFTs are an answer. It seems to be too niched still — but that hasn’t stopped the internet from proving wrong people that made the same point before.
Remember that every last crazy internet idea from the ’90s became true by the 2010s? The commonplace is to say that every crazy idea of decentralized service from 2017 (Decentralized Uber, Decentralized Airbnb, etc) will eventually become true as well.
Decentralization for the sake of decentralization is silly and unpractical, so I tend to believe that the kind of services that will emerge in this networked sense will be autonomous in some fashion, or with human interaction in only a small part of the chain, in such a way that *not* being decentralized would be the impractical answer. Like a central government determining the price of truffle oil bottles kind of impractical answer.
Services available today to be paid in crypto are mostly 1-on-1 or ad hoc arrangements. You hire a dev who lives in Estonia and pay him in Dai, Bitcoin, or USDC.
The exception are DeFi protocol DAOs paying the DAO employees in crypto, so maybe there’s the early use case. Still niched, but having a semi-autonomous organization paying salary every 2 weeks to someone is something that is not possible without cryptocurrencies.
Enter DeFi (again): Credit
The NFT and DAO examples are already within DeFi, but there’s very little Fi in them. My current belief is that DeFi may be the catalyst for broader commercial adoption of crypto, way before the Decentralized Ubers emerge and way more consistently than everyone becoming a large consumer of digital goods.
What do you need to buy on credit? A car for you, a house for your family, supplies and machinery for your company? You can also buy food and cheaper items too, we do it on credit cards every day.
The utilization of finance to acquire goods and services through credit extension may be one direction where DeFi and commerce would find a natural fit.
If you have recurring on-chain payments for some reason, there’s a possibility for someone to give you credit (conversely, to buy your debt) and acquire a programmable claim on these future cash flows, with fewer intermediaries and with a smaller risk of default — hence, at a better price.
To move forward with crypto beyond our current bubble size we need a commercial use for it. For it to have commercial use it has necessarily to be a much better alternative than the incumbents, and this is getting hard by the minute.
Maybe there are some areas where this is true, like NFTs and DAO salaries. But to grow beyond this niche we need to tie it to credit: i.e people will want to be paid in crypto because it can buy them more things now at better conditions since they can trade their already contracted stream of cashflows with a creditor, who faces fewer intermediaries and a lower risk of default.
The moment people go “Wait, I can get my salary in the bank and get a loan for a Corolla, or I can get it in USDC and get a loan for a Tesla with the same downpayment and monthly?” we reach escape velocity.
Credit to companies may work similarly. In turn, commerce would indeed adapt to accept crypto, because commerce always adapts to what the consumer prefers, since the Silk Road (the original one).
The programmability of money can extend into more complex contracts, and better oracles can make more sophisticated versions of the simple contract I described more useful.
There’s a possible discussion here on which solutions are preferred by creditors, buyers, and sellers. It’s reasonable to believe that the equilibrium tends to use more centralized stablecoins like USDC or USDT vs. more decentralized or less stable options because the likes of USDC can give additional recourse in the case of disputes — hence, improving the credit price.
Who are the winners?
In this sense, smart contract platforms (currently: basically Ethereum) and stablecoins would be the medium for these exchanges to occur. Protocols to handle the moneychanging and moneylending involved with all of this will also rise.
And where does that leave Bitcoin?
That’s a subject for another post.