Thanks for clicking into Issue 4 of Blockchain. Calmly. At this point it’s been a little while since I’ve last written you, and you might be thinking, “What’s taking so long? Didn’t he say an issue every week?” You’re right, I’m sorry, and also I’m really happy you’re patient with me. It’s been a wild few weeks in crypto, and getting to a place to explain things calmly has been a battle.
But here we are. And I think I’ve been able to distill this next topic with as little hype as possible: Decentralized Finance (DeFi).
Before we begin: this article is more about why it’s important. And like each issue attempts to put across: this stuff is new and confusing. And if you get that head-spinning feeling, please bear with me - I get the same feeling too. And let me know in a tweet or email if there’s anything you’d like for me to clarify. ;]
DeFi (Decentralized Finance) is the separation of institutional control from finance.
Big words from a little abbreviation. But what does that mean? What’s the point?
What is the point?
The point of DeFi is to create public goods. From this video by Lisa Tan from Economics Design:
We're really building public goods. That is: accessible by everyone and freely available to anyone who wants to use that. The difference is that instead of physical public goods like parks and libraries, we're building digital public goods.
That sounds a bit off, right? What is “digital public good”? Well, an example would be these different protocols that we use in our daily lives. An example would be the email protocol: your pop3, your imap. These are TCP/IP protocols to allow us to send messages to each other. This is free. It's available for everyone. It's a public good that anyone can have access to, and this is exactly what we're building.
We're using this concept of public good to enable [the execution of financial transactions], and we're just applying it in a different way. And that is what we are building with DeFi and tokenization.
Every Customer is an investor
That means that for every kind of financial instrument in traditional finance, run by traditional financial institutions, there is the ability to create a decentralized one, run in a way so that:
1. Each customer is an investor
2. Each custom gets investment returns like an investor should
3. Avoids the kind of fees and overhead that eats into the kind of returns customers like you and I can make with much much smaller accounts than normal.
Customer? That means you. That means me. That means everybody who has a computer (or cellphone) and an internet connection can participate and enjoy the benefits.
This is important. Because as inflation balloons, and the cost of goods rises with it, we get poorer. The amount our hard earned cash can buy shrinks. And so we need, as financially-conscious people, to find better places to put our money than our savings and checking accounts. Because traditional bank accounts are where our money goes to rot.
So then, what is DeFi?
Money Legos and Open Doors
On the technical side of the descriptive spectrum, I love how William Penster puts it when describing what DeFi is:
DeFi is an abbreviation of decentralized finance, a term for products and services built as open-source financial software on top of blockchain technology that can be pieced together like money legos via shared infrastructure.
Money Legos. Shared infrastructure. Open source. We can piece that together to get an idea that says, “There are financial products and services that exist on the open internet, based on the blockchain, that have been built to be freely used by you and I.”
But what does DeFi let you do? How about we let a major financial institution (ING) answer first:
… we use the following definition of DeFi:
DeFi are financial services that operate on a public permissionless blockchain. Currently, the majority of such financial services consists of:
- Translating monetary banking services (e.g. Issuance of stablecoins)
- Providing peer-to-peer (or pooled) lending and borrowing platforms
- Enabling advanced financial instruments such as Decentralized Exchanges (DEX),
- Tokenization Platforms, Derivatives and Predictions Markets
So that’s all word-salad if you’re not chest-high, so to speak, in the financial world. But what they’re saying is this: there’s nobody telling you can’t get in on the kind of projects large investors like banks and businesses use to make big money. There’s pretty huge implications to that, because to the curious and risk-taking person, there are too many barriers to working directly with one’s money in the first place.
But maybe that’s the first time you’ve heard that. “You mean, if I wanted to take my money and put it into some kinds of investments, I couldn’t?”
Walls and Barriers
Question: are you an accredited investor?
Just as a refresher, here’s the legal designation needed to participate in a slew of investment vehicles:
To be an accredited investor, a person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year…
A person is also considered an accredited investor if they have a net worth exceeding $1 million, either individually or jointly with their spouse.
The SEC also considers a person to be an accredited investor if they are a general partner, executive officer, or director for the company that is issuing the unregistered securities.
I’m going to guess that 99% of everybody reading this issue does not fit that criteria. That means 99% of everybody reading this, who has the character and acumen to attempt to grow their financial holdings in riskier investments, can’t participate in investments and business ventures like angel investing and are limited in equity crowdfunding, two major sources of investment returns.
Not your wallet, not your money
Or with the apps we use online to bank and transact with, who really controls our money?
Traditional centralized financial services are inherently permissioned to build upon, requiring “paper promises” based financial contracts between the two parties.
This raises the barrier to entry and makes it very difficult for developers to create fully automated or impartial financial applications because there is the ongoing possibility that access is revoked at any time.
The central entity now has control over key parts of the application, putting into question the deterministic guarantees the third-party developer seeks to provide.
Traditional finance has put all the control into large organizations. They have the resources to account for the movement of money, carry the risks for business ventures, and collect on debts.
But on the flip side, DeFi opens the doors to the determined financial player. The advent of the internet, and the creation of the blockchain create the conditions to move away from traditional, opaque institutions that have a huge say in how our money behaves. That‘s why DeFi is a huge change.
What then?
Who owns your accounts, the upside, and the responsibility? You do. You can see it as “permissionless composability.” Read that as: anything you want to do with it you can, so long as the two pieces can fit.
Doubling down on the idea of the blockchain in general being permissionless, transparent, and decentralized. That’s the beauty of the blockchain and decentralization: there’s nobody holding you back from making any choice you could desire to make with your own money.
Loved this piece! Simple. To the point. Defi is the future of allowing working Americans (and everywhere on the planet) to take control of their financial destiny. And it'll be possible with just the right amount of education so that anyone in that audience can do it. That's a fundamental component of the democratization of money and investing. Let's keep working people in mind as these systems and protocols develop so that it doesn't, again, end up in the hands of JUST the few.