So people are, in fact, trying to solve the “what for?” question. There are active efforts to make this all something beyond just people borrowing money to buy more coins. Whether they actually scale up and become useful is a separate question.
The other huge question is whether governments end up being cool with people launching apps that are basically banks or lending institutions or stock markets or synthetic derivatives exchanges, all without adherence to existing financial regulations.
Like right now you can go to Uniswap to connect your Ethereum wallet, and trade it for a token that will track the price of Apple. Check it out yourself.
There’s no registering for an account at Uniswap. They don’t have your name. There’s no KYC/AML or anything like that. All they have are the numbers and letters that constitute the Ethereum address you’re using to connect.
The general bet for DeFi at this point seems to be: Regulators will be cool with all this. Or: If they did want to stop it, they couldn’t because it’s just open-source software and that even if the companies were to go away, the software will live on. We’ll see about all that.
And again there’s the question about how well it all scales if it goes after under-collateralized lending, which is necessary if DeFi will actually be responsible for credit creation. If you need actual humans to underwrite loans and sue delinquent borrowers in court, that raises some significant costs. You might just end up doing fintech, but with ambiguous rules and a clunky database. (Blockchains are necessarily going to be clunkier and costlier than a standard database, since that’s the price you pay for achieving decentralization, lack of transaction censorship, and a permission-less system where anyone is allowed to build for any purpose.)
Meanwhile, TradFi capital is pretty cheap right now, so cutting into traditional financial activities may not be so easy in a space where part of the attraction for lenders is the fat yields. The point is though there’s a lot of techie optimism in DeFi that may at some point run into some serious headwinds (legal, scaling, etc.) that don’t have an easy software fix. But anyway, let’s set all these questions aside.
The Problem With Being Used For Something
So, the problem with being a coin that’s actually used for something is that it has to be good at its job. Bitcoin is slow, inefficient and transactions are costly, but nobody really expects anything more from it.
(Also: Yes, to be clear there are projects that already exist that create ultra-fast payments and smart contracts on top of the Bitcoin network. I’m acknowledging them here because otherwise someone is going to freak out and say that Bitcoin has solved these problems. They remain pretty niche. And more importantly, even if they don’t take off, Bitcoin’s digital gold application narrative would remain intact).
Ethereum, as it currently stands, has more or less the same problems as Bitcoin when it comes to scaling. It’s fairly slow and transactions are expensive. Slow and expensive is fine if you’re gold. It’s not great if you’re trying to power financial services. Let’s go back to the arcade analogy for a second. One difference between Ethereum and Chuck E. Cheese is that the price of a game isn’t fixed. It’s a little bit like surge pricing. When lots of people are suddenly trading (during a spike in volatility), your fees go up, as the system can only process so many transactions at a time and traders compete with each other for scarce block space. So if you’re playing digital racehorses, and suddenly there’s a market crash and transaction fees surge, that’s not ideal.
Here’s something that actually happened: A few weeks back, the cost of using the Ethereum network surged because someone made a parody coin of Dogecoin, and it was briefly so popular that everything else got slowed down or more expensive. Because there’s a finite amount of Ethereum transaction capacity, anyone else using the network either had to wait their turn in the back of the line, or pay more to jump ahead of the dog token traders.
There are theoretical fixes to all this. Ethereum also has so-called Layer-2 solutions designed to make transactions faster and cheaper and more reliable and all that. But building these things take time, and people have been working on them for awhile. In the meantime, you have to accept that if market volatility spikes or there’s a meme token mania again, everyone has to pay higher fees or accept sluggish service.
The other thing is that once you’re measured on performance, another platform can come along and theoretically offer superior performance.
Around the end of May, Kyle Samani of the crypto fund Multicoin Capital wrote a blog post arguing that DeFi is the killer app of blockchain technology. Bitcoin had its day, he says, but now we’ve found a much better use. What’s interesting is that his argument isn’t a ringing endorsement of Ethereum per se. Instead it talks about Multicoin’s bullish case on Solana, which is totally separate platform which competes with Ethereum to power decentralized finance applications. The basic gist of his piece is, simply, that Solana has better specs than Ethereum, that it’s already scaling better with sufficient levels of censorship resistance and decentralization. Solana launched in March 2020 with the specific purpose of creating a high-speed blockchain platform aimed at financial services.
Others can debate whether it’s actually better or not, but the point is, when you read Kyle’s post, it reads like an evaluation of two different software projects, like someone comparing AWS to Azure or Oracle. There’s not much talk about culture or any of the things that have characterized Bitcoiners and Ethereans. The argument is basically that this can get the job done now in a powerful way, and that it doesn’t have the roadmap ambiguity that Ethereum currently has. In a tweet reply (to me), Samani says that he’s intellectually short Bitcoin (not literally short it) and that the most valuable cryptocurrency will end up being the native token of whichever network ends up winning.
Anyway, the big picture is that this thesis is radically different than the original Bitcoin vision. Nothing about Solana requires any faith or mystical belief or culture like Bitcoin. If decentralized finance takes root, and one chain or another becomes the dominant platform for it (whether it’s Solana, or Ethereum or some other chain we’re not even talking about) then its native token will have value.
Going back to the Chuck E. Cheese analogy, in addition to there being tokens and games, there are also the tickets you win from Skee-Ball, and the knick-knacks (real world assets) for sale in the gift shop in exchange from tickets. Presumably, the implied markup of those sales of stuffed animals, alarm clocks and stickers in the gift shop was egregious. But in a sense, their existence anchored the value of the other assets inside the arcade, the tokens and the tickets.
You can theoretically imagine an open-source arcade, where everyone is free to build a game and place one inside the Ethereum (or some other network) universe and when you play it, you get some kind of ticket that has rights to real world assets or cash flows. Again, you don’t need faith or culture to make the assets have value. There’s enough real world activity to anchor them.
Wall Street And Silicon Valley Get ETH-pilled
Let’s zoom out for a second. All blockchain-based systems share two basic ideas. The first is that for the first time you can have a thing online that can be provably yours. A coin, a token, an NFT… whatever it is. You have it and control it and no third party has any say. Alice can own something and then send it to Bob. Alice doesn't have it anymore and Charlie can't interfere. The other core idea is that part of achieving this involves a sufficiently decentralized network of computers, such that no individual, company, or government has a say in what goes on.
But this is where the fork in the road emerges. The Bitcoin vision is to create a new form of money outside the authority of any central issuer. The DeFi vision inverts this, and takes the money creation part for granted. After all, you can spend a dollar on the Ethereum network using a USD-backed stablecoin, so why reinvent the wheel? Instead, the DeFi-based vision is to build unstoppable blockchain-based software and services that then do something with this money.
A couple weeks ago, I wrote that Wall Streeters are increasingly getting ETH-pilled and the above is why. There’s a certain concreteness to the value proposition. If a decentralized network of computers can match borrowers and lenders in some powerful and novel way, then the software and the tokens that power it should be valuable. And in general, this vision jibes much more with the Silicon Valley ethos. Trying to create a new form of money? That’s not really a thing you learn about at Stanford. Writing software to disrupt traditional financial services? That they get. Furthermore, Bitcoin frustrates many people in tech because of the community’s move slow and don’t break things approach.
All this being said, all these different factions and visions… they remain something of an inside game. It’s not clear how much your average crypto investor is paying attention to any of these different modes and models. If you look at the coins, you’ll mostly see a high degree of correlation. Either they’re all going up at the same time or down at the same time. This includes Bitcoin and Ethereum and Solana, but also a bunch of other coins that don’t map to a trendy narrative. (For example Litecoin is still one of the world’s biggest coins despite its founder having peaced out from the project in 2017, and neither has a store-of-value narrative nor a DeFi narrative or anything else really.)
The market strongly gives off a vibe of people wanting to get into crypto and then placing their chips on a bunch of different squares without too much thought. Maybe they buy a few that they’ve heard of, maybe they buy a few with a low nominal coin price because it’s fun to have a lot of coins and maybe they buy a few that just seem interesting. That still seems to be how flows work in the space. And as long as this is all the case, we’ll probably still have these generalized boom-bust cycles where coins rise and fall together along with the animal spirits of investors and traders.
But the differences in approach and philosophy between different coins and projects is very real. The stuff tech people are hyped about right now is radically different from Bitcoin, in both its assumptions and in its purpose. And eventually as this space matures, returns should become less correlated and more distinct, as different approaches win out over others.
This article was provided by Bloomberg News.