Again, of course, these are all generalizations. The world is big. Lots of people are part of both scenes. But if there are any anthropologists out there, I’d recommend someone really dig into this and write a book about it, because the difference is noteworthy.
What’s interesting for our purposes is that in addition to being a cryptocurrency, Ethereum is also a token. What’s a token? Well, the easiest metaphor, frankly, is to just think about a token at a Chuck E. Cheese. It’s a kind of money that’s redeemable for goods and services within a very specific environment. At Chuck E. Cheese, obviously, the tokens let you play videogames and pinball and Skee-Ball and whatever else.
In Ethereum world, the currency (ETH) lets you pay a network of computers to run various applications that are built on top of it. One of the biggest applications running on top of the Ethereum network is the aforementioned exchange Uniswap, where you can trade different coins for each other. Each time you place a trade, you have to pay a “gas fee” (denominated in ETH) to the network of computers that processes the transaction. So Uniswap, in this analogy, is like one of the games in the arcade.
There’s something important that happens when you move from being a currency to being a token, which is that the necessity of pure belief starts to fade. If someone hands you $100 worth of Chuck E. Cheese tokens, you might be annoyed, and you might find them to be completely useless. But you probably accept the premise that if you drive to a Chuck E. Cheese, then you’ll be able to use them to play the games. You might not want to. You might not have any use for it. But you know that you can. You don’t have to subscribe to any Chuck E. Cheese ideology.
For Bitcoin to have value, you kind of just have to accept that it has value. Either you believe or you don’t. With a token, there’s less faith involved. If you want to use an app that is built on top of Ethereum, then you have to use it. If someone sends you Ethereum, you know you’ll be able to use it within the overall environment. You might be skeptical of the whole thing and think it’s all speculative games. But as with the Chuck E. Cheese token, it works and it’s necessary if you want to participate in that world.
So what’s it all for?
So once you’re in the realm of tokens, you don’t need faith, but you still need a point. It’s fun to trade coins on a decentralized exchange, but presumably at some point the things you’re trading need to produce real-world value beyond just more trading of coins. Otherwise it all implodes eventually. So where does it all go? Here are three possibilities.
The first possibility is that it all implodes. This really can’t be ruled out. This is basically what happened in 2017 with ICOs. You needed to buy Ethereum to buy into ICOs, and those got tons of hype at the time, but that mania fizzled out. A bunch of the projects went on to be total flops. And beyond that, a lot of these were just IPOs but with a different currency, and so they were unregistered securities offerings that fell foul of the law. That all collapsed (along with a bunch of other stuff in crypto). And the public lost interest for awhile. Crypto winter.
The second possibility is that new modes of social coordination emerge. You might think NFTs seem kind of dumb. (Disclosure: I think NFTs are kind of dumb.) But obviously a lot of people think differently. People continue to pay real money for the right to claim ownership of some piece of digital content. It definitely seems kind of faddish, but there are more experiments in the space being done all the time. And even if it’s not NFTs per se, it’s possible that a new type of easily programmable money network might spawn modes of activity that we’re just not used to.
In this conception, perhaps Ethereum ends up as the substrate for a new type of decentralized social network: It has games (like digital horse racing), it has artwork (like Beeple), it has publishing and more. Since the beginning, people have been fascinated by the concept of a DAO (a decentralized autonomous organization) where people pool their money together in a way that’s kind of like a corporation, but also kind of different, with a new mode of governance that’s maybe more like a co-op. It’s hard to say where it all goes. The point is that there are examples of “real-world activity” that these tokens enable that don’t have a perfect analog to things that were done before. They’re just new.
A third possibility is that DeFi becomes something that matters for Fi. In the last few months, you’ve heard a lot about the rise of so-called DeFi or “decentralized finance.” This is a term that encompasses many different things. There are venues where you can stake your coins in a liquidity pool and collect trading fees from other participants. Other models involve posting coins as collateral in order to borrow more coins. There’s a ton of money in this space—the decentralized lending protocol AAVE has over $20 billion in locked-up funds—and a lot of people are excited about the prospect of disrupting traditional finance. So far, however, the main use case (as many participants will admit!) is just... speculation on more coins. People lend money to people who want to go long more coins.
If you squint hard you can kind of glimpse a future where DeFi becomes more than just a gambling game. From a tech perspective, it’s exciting to think that anyone can write some code and launch a de facto bank into the world that matches borrowers and lenders in some novel way. It’s also already possible on Ethereum to represent some kind of “real-world” asset on chain. For example, there are dollar-denominated stablecoins that exist as Ethereum tokens (in a format known as ERC-20). There’s an Ethereum coin backed by physical gold. And in theory, a stream of cash flows from a business or household borrower could be turned into a token.
Currently, all the lending and borrowing that happens on these platforms is overcollateralized. So you might post $110 worth of Ethereum and get $100 worth of a stablecoin back, which you can use to speculate on more coins. This type of lending is easy for a smart contract to handle because the collateral liquidation can be automated if the price of Ethereum goes down. This kind of model makes sense for speculative purposes, because lots of people have coins and want to borrow money against them to buy more coins.
Building a DeFi lending model for, say, getting a mortgage, is way more complex. The chain can’t judge your creditworthiness. The chain can’t just evict you if you stop paying. The chain can’t go out and do an appraisal. The chain doesn’t know if the market price of your home has gone down or anything like that. For all of that, you need actual humans.
People are working to solve all of the above, but it’s complicated and legally kludgy. Right now, they involve a hybrid of DeFi capital with human agents. There’s a startup, for example, called Centrifuge, which lends money into a Special Purpose Vehicle, which then goes on to finance small real estate investments. The income stream from that SPV then gets turned into an Ethereum ERC-20 token, which is then used as collateral in a protocol called Maker, which backs a stablecoin called Dai. Centrifuge is allowed to mint Dai (which it can then sell for actual dollars to an OTC crypto trading desk), and in theory this allows for real-world investment to be financed on-chain.
The degree to which this is actually going to work at any kind of scale is far from settled. And it’s also not clear what kind of edge these projects will have over traditional finance. (Centrifuge claims that its cost of capital is cheaper this way, and that the system can be used to finance projects that are too small for bigger banks to worry about.)
Another startup called Maple is doing something similar, building a platform that (theoretically) makes it very easy for anyone to create a lending portfolio, where an individual or team sources qualified borrowers, with funding drawn from decentralized pools of capital. The main pitch is basically that DeFi platforms are incredibly simple and elegant, with fewer middlemen and paperwork and so forth.