The previous article introduced the Ethereum ecosystem and the role played by some protocols regarding the diffusion of the DeFi concept and its application in the real world. The parallel economy made possible by those decentralized applications indicates a strong potential to downsize traditional economic and social superstructures, opening up new scenarios.
Entering the web 3.0
First, to access the services available, someone needs to find a way to buy Ether which is the currency that allows us to obtain Gas that in turn funds the computational power needed to run the Decentralized Applications (dApp) on Ethereum. Purchasing Ether may sound very easy and immediate to many of those who are dealing with cryptocurrencies daily and live in democratic countries, we cannot say the same about those people living in dictatorship regimes or extremely poor areas of the world. Access to cryptocurrencies in these areas of the world could be difficult for a variety of reasons such as internet censorship, the governmental ban to hold and exchange cryptocurrencies or restrictions imposed by banks on fiat funding of exchange accounts. If we want to avoid these problems, we need to find peer-to-peer solutions and find an individual who is willing to sell us cryptocurrency. Such a service is offered by providers like Localbitcoins, this way it is possible to stay anonymous. In this matter, it is worth mentioning that the highest level of anonymity is still obtained through the usage of banknotes.
When using an exchange, the problem arises when we have to wire fiat from our checking account: in this phase, a dictatorship state could prohibit all transactions to those IBAN addresses associated with cryptocurrency exchanges, therefore, preventing the citizen from gaining access to certain services. This scenario appears far away from our reality thought the truth is that there have been cases like those in the USA and Europe as well.
Once we own Ether and we have the cryptocurrency in our wallet we can access a variety of services and products. Through our smartphone, we can enter Web 3.0: this term refers to the decentralized internet, resilient to censorship, where it is possible to transfer valuables over the blockchain. To navigate Web 3.0, we can use specific browsers such as Chiper or Status. These browsers allow us to access the dApp using the wallet we placed Ether in. Now we have a series of available decentralized products that we can choose from depending on our needs. One example of the services we can access is MakerDAO that allows us the creation of a Collateralized Debt Position (CDP) which is an operation where you freeze your ETH in a smart contract and receive DAI which is a stable coin that keeps its value pegged to the dollar. In this case, ETH is placed as collateral to instantaneously obtain up to 60% of the collateralized value (MakerDAO foundation arbitrarily decided this ratio). In the scenario where ETH increases in value the credit will be paid back by the margin obtained from the surge. In the opposite case where ETH plunges, we need to deposit more ETH to avoid the liquidation and subsequent auction sale of our position. The management of these positions can be carried out by specific dApp.
MakerDAO is a truly innovative project and had a significant impact on the blockchain world so much so it triggered the whole DeFi revolution. Nevertheless, it has two main problems a) the scalability of purchasing power b) usability.
The stability of purchasing power is a relative problem that is more theoretical than practical and has a tangible impact in the long term rather than in the short term: historically the “stable” value of the US dollar has not proportionally followed its purchasing power. $ 100 in 1913 is worth $ 3,87 today, whatever cost $ 100 in 1913 today would cost $ 2,679.25. Pegging DAI to the US dollar does not protect us from inflation which is affecting the dollar just like every other currency in the world.
The second problem is usability. This aspect has a much shorter time window than inflation has, therefore, its impact is present in the immediate short term. If we go to any shop and want to pay something, the shop employee will most probably accept dollars or euros rather than DAI. We already have solutions to this problem such as Mycrypto and Monolith that are providing debit cards allowing customers to pay in crypto thanks to immediate exchange systems that convert crypto into fiat almost simultaneously. The issue about these solutions, again, is that access is forbidden in many areas of the world. Many researchers say that 2020 will be the year of stable coins: if this is true and global adoption will increase, it will be more plausible for shops to start accepting these alternative methods of payment thus solving much of the problematic.
New possibilities for a decentralized economy
If instead of liquidity, we need to maintain our capital and obtain a little return from it, similarly to a classic checking account that allows investments in bonds, we can choose to use one of the protocols specifically designed for this purpose. Making use of one of the lending dApp such as Compound or Dharma we can lend ETH at a favorable rate that allows me to generate returns from my capital: rates of return are particularly favorable because of the absence of these fees generally applied by intermediaries in such operations. It is immediately clear how this possibility is extremely useful in poor regions of the world. It is now possible to access affordable and practical financial instruments able to defend citizens from bad monetary policies. We should always consider that cryptocurrencies are in general extremely volatile assets. Nevertheless, it is improbable for cryptos to get to a purchasing power equal to practically zero as it happened in Venezuela. It is also possible to lend crypto on a centralized exchange but again we have a couple of problems here as well: exchanges usually ask for Know Your Customers (KYC) procedures where the user needs to prove his/her identity. For this reason, access to the exchange may be problematic in those countries banning cryptocurrency transactions. Similarly, this is a limit also for those people that for whatever reason want to elude state control. The other issue is about the actual control over the asset when we deposit cryptocurrency in exchange. What we are doing is putting our assets into the hands of the exchange therefor exposing ourselves to risks such as theft by hackers, asset freeze, fraudulent bankruptcy, etc.
Let us continue our walkthrough Web 3.0. In case you were not confident about the value growth of Ethereum over time, you could hedge the risk with diversification buying other cryptocurrencies. In case the user does not want to use a centralized exchange there are decentralized options like IDEX, Uniswap o Air Swap we can use to exchange ETH with other cryptocurrencies. The most recent evolution of the MakerDAO protocol, the Multi-Collateral DAI (MCD), allows us to use those cryptocurrencies exchanged for ETH as collateral for the credit we need. This process sounds complicated but it is not. It takes most of us little time to understand it. Nevertheless, it always requires attention when using it. For this specific reason, decentralized insurances will become very popular among people as hedging instruments against liquidation risk of CDPs or against possible bugs in the smart contracts: Etheriscs or Nexus Mutual are companies that will cover you up to 100 ETH in case something goes wrong. The decentralized insurance sector is still in an early stage, better applications will be developed in the future.
Another disruptive aspect of DeFi economy that made the sector very popular is the possibility to tokenize real assets. In other words, it is possible to tokenize assets that are not on the blockchain therefor the token is a representation of the asset that in turn allows the creation of “synthetic assets”. These new types of assets can be created on a platform such as Synthetix that will allow access to investments that have been prohibitive to most of us. Let us consider the real estate market as an example. Up until now, it has been a prerogative (often with speculative purposes only) of a small group of people with high financial availability. Thanks to blockchain technology and DeFi projects such as RealT, it is now possible for common people to take part in fractional real estate investments whose returns are equally redistributed to all investors. The innovative impact of solutions of the kind has huge potential because this innovation enlarges the investors base in this sector that used to be an opportunity for a chosen few.
It is now time to introduce the topic of the granularization of assets. It refers to the fractional division of a token representing into micro shares. That token represents a real asset that normally could not be divisible. The granularization of assets is possible with financial instruments that are not a physical asset. Let us consider a bond issued by a private company: just until recently, high minimum denominations of financial instruments prevented access to most investors, only wealthy individuals were practically able to buy those financial instruments. Nowadays, granularization allows the inclusion of all those people that are interested in real estate investments and are not driven by speculative objectives only. An inclusive economy of this kind can have massive implications that are difficult to foresee. This new approach has the potential to spark interest in financial responsibility among average people and to enlarge the investment opportunities beyond those offered by financial planners from the banks.
Regarding this context, in 2017 we witnessed the bubble of Initial Coin Offerings (ICO) that is a new funding channel characterized by extremely innovative mechanisms. The topic about ICO is extremely vast and again it would deserve a whole article, we will briefly discuss a few points about ICO to provide a complete vision of DeFi phenomenon.
After 2017 the ICO market experienced a progressive contraction caused by multiple factors that discredit this new type of funding. ICO market flourished in a non-regulated context and turned into a bubble. Too many of those projects seeking funding through an ICO turned out to be frauds, exit scams and products that never saw real development, all this inevitably jeopardized the reputation of this funding strategy. To regain some reputation after the incredible amount of ICO scams some opted for the Initial Exchange Offering (IEO) where tokens are not issued directly by the company but by an exchange instead that has the role of supervisor of the validity of the project: the bigger and more famous the exchange where the operation is carried out, the safer the investor will fell about the investment. Unfortunately, even IEO failed quite miserably and that further deepened the aversion of investors towards these types of funding, especially after the case of Matic (more info here). It all goes back to one crucial aspect that was missing during the ICO bubble: adequate investors protection. Many of those projects were exploiting the positive sentiment about cryptocurrencies of 2017 and proposed nothing more than an idea on a piece of paper without a functional product or MVP (Minimum Viable Product) and investor protection: numerous whitepapers even stated that “the product may not conclude”. Due to a deregulated and extremely exploited context orchestrated by double-dealing people that were running these projects only to get money from inexperienced investors, the ICO bubble inevitably burst. Much of the responsibility belongs to regulators that were late in creating laws to regulate this new type of funding, some of them simply banned the system (this is the case in China). CONSOB (Commisione Nazionale per le Società e la Borsa, the Italian banking authority) issued guidelines about ICOs only recently on January the 2nd 2020.
The ICO bubble generated bad consequences in the cryptocurrency market and the confidence of investors. Nevertheless, the potentialities offered by this instrument exceed the contemporary funding apparatuses. The community should be proposing practical projects with a broad scope whose tokens are truly useful within the project. Over time, it will be possible to build up again the confidence around ICOs that are extremely useful and inclusive funding tools but unfortunately, they become popular in the wrong way.
A new kind of bank?
We complete the picture mentioning those projects whose objective is to enhance User Experience (UX) regarding DeFi tools. Projects such as Instadapp, Zefiron, DeFiSaver or DeFiZap. The ecosystem introduced in this article could be not appealing to those that are not exactly tech-savvy, either because of their age, social class or simple laziness.
We can create and interact with CDP using a simple and clear dashboard with Compound and lend ETH, through DeFiSaver we can monitor the whole process and leverage the automation and control potentialities over CDPs. Beyond the aggregation of these protocols, we can also access automated management operated by smart contracts to facilitate the initial financial choices of the users based on each one’s necessities.
At this point, we can clearly understand the magnitude of innovative change brought by DeFi protocols and the impact they potentially would have on an economical-social if adoption was widespread. Certainly, widespread adoption will start from those countries that will benefit the most from DeFi protocols. These protocols represent the base for a more inclusive economy that theoretically can bring financial wealth also in those areas of the world where a considerable share of the population does not have a bank account. This phenomenon allows those people to start planning long-term (this concept is well explained in “The Bitcoin Standard” by Saifedean Ammous).
The arduous road towards adoption
Mass adoption is not easy to achieve and there are several obstacles of different kinds on the way. Economic frameworks and economic-social status previously mentioned could represent significant entry barriers. These barriers would be implemented by those governments scared of losing monetary/financial control over the masses. The consequences of such a shift in the economic behavior of individuals would have social outcomes possibly exceeding economic ones. Just try to think about a world where everyone can make use of financial instruments that used to be a privilege of a chosen few. On a financial and economic level, the friction implemented by governments and financial institutions against the spread of DeFi protocols is the most difficult barrier to overcome. Further, the pressure is carried out by the big four (Google, Facebook, Amazon, Apple) on both governments and financial institutions. In this matter, it immediately comes to mind the stable coin proposed by Facebook and how financial institutions immediately implemented defense policies aimed at blocking the company from Silicon Valley from becoming an alternative to banks.
In addition to influence by governments and institutions, we have regulatory uncertainty that could be critical in the achievement of success of the projects belonging to the DeFi ecosystem.
The second problem that can be found is adoption. That needs to go through some kind of simplification of the UI/UX to facilitate access to services also to those people without technological expertise. The availability of these services is not completely achievable by everyone but focus on the topic has been placed. The arrival of aggregators and managers of DeFi protocols or crypto banks previously mentioned are making more accessible and simplifying the DeFi ecosystem.
Nevertheless, we must keep in mind that DeFi is not the solution to all the economic problems we need to be aware of the limits of the projects. This is because in this world there are still people who do not have access to proper nutrition and drinkable water therefor these same people are not able to buy a smartphone and access the decentralized Web 3.0. For these individuals DeFi does not represent an opportunity therefor it has to be considered, for the moment, an instrument for that part of the population that can enjoy a decent level of wealth.
In conclusion, we can affirm that these protocols and in general the DeFi ecosystem lay the groundwork for a new economic system that wants to be more inclusive and aims at wealth redistribution to balance the huge economical-social gap we can witness today.