{"id":15874,"date":"2021-06-26T21:00:00","date_gmt":"2021-06-26T21:00:00","guid":{"rendered":"http:\/\/ci0286a28b10002483"},"modified":"2021-06-26T21:00:00","modified_gmt":"2021-06-26T21:00:00","slug":"bitcoin-decentralized-finance-defi","status":"publish","type":"post","link":"https:\/\/bitcoinmagazine.com\/culture\/bitcoin-decentralized-finance-defi","title":{"rendered":"Bitcoin Is Our Best Shot At Decentralized Finance"},"content":{"rendered":"
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DeFi, a shortened version of the mouthful \u201cdecentralized finance\u201d, is a hot buzzword these days. The term is often associated with crypto tokens and networks, as well as the applications built on top of them for lending, borrowing, asset trading and other financial contracts to be executed without intermediaries. <\/p>\n

Most of today\u2019s financial contracts require central intermediaries which are arguably opaque by design and must be trusted by both parties to execute contracts fairly. Sometimes that trust is broken, like when the largest foreign exchange (Forex) brokers colluded<\/a> for at least a decade to scam their customers \u2014 costing companies, pensioners, investors and savers a yet unknown figure that could easily amount to over $1 trillion. Only one person was arrested and the banks involved were fined a total of $1.7B \u2014 around 0.2% of their total earnings from the scam. The reasons we distrust banks, and the governments and central banks standing behind them, are abundant \u2014 I\u2019m sure you have your own. <\/p>\n

DeFi promises to be a more trustworthy platform, composed of open-source code that\u2019s auditable and transparent. Additionally, DeFi opens the floodgates for innovative ideas. Licensing requirements are replaced with code audits, allowing performance to replace accreditation and opening the financial world to new ideas.<\/p>\n

Truly decentralized finance \u2014 all the way down to the settlement layer \u2014 also promises to be a more sane monetary system. Money is an integral piece of civilization<\/a>, allowing societies to grow and scale without every individual having to trust one another personally. A decentralized financial system can fix the deeply-ingrained problems of our monetary system today.<\/p>\n

A financial system free from many of the burdens and pitfalls created by trusted intermediaries and powerful masters sounds like a beautiful future we should all want to usher in. <\/p>\n

What stands in our way? <\/p>\n

The Trust Dealers And Their Premium<\/h2>\n

Much of the reason banks and financial intermediaries exist today is to create trust between parties: they are \u201ctrust dealers\u201d. <\/p>\n

Escrow services are a very direct example of this: a bank with a reputation to uphold will act as middleman to an exchange of assets, ensuring that both parties stick to their end of the deal. An escrow service can be entirely automated in a DeFi system, leading to lower costs and more predictable execution. <\/p>\n

Trust dealers earn a \u201ctrust premium\u201d for their services, which makes them a lot of money. DeFi takes that trust premium away, and trust dealers won\u2019t let go of that revenue without a fight. <\/p>\n

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Even many functions of modern governments exist to create trust between parties who want to make and enforce contracts with each other. The Securities and Exchange Commission<\/a> (SEC), for example, is partially a trust dealer with a three-part mission:<\/p>\n

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  1. Protect investors.<\/li>\n
  2. Maintain fair, orderly and efficient markets.<\/li>\n
  3. Facilitate capital formation.<\/li>\n<\/ol>\n

    A large part of this involves ensuring that \u201cthose who sell and trade securities \u2014 brokers, dealers and exchanges \u2014 must treat investors fairly and honestly\u201d (SEC<\/a>). Today, the SEC and its enforcement apparatus need to go around demanding information from private businesses to check that they are acting fairly and honestly.<\/p>\n

    In a world where brokers and exchanges are automated pieces of code, open source and auditable by anyone, the need for all those resources required for investigations is greatly reduced. In the SEC\u2019s case, the trust premium is more abstract: not revenue, but power. <\/p>\n

    Central banks and governments also earn a massive trust premium: we trust them to control money supplies with the best interests of the public in mind.<\/p>\n

    Today\u2019s governments and financial firms are therefore cautious about, if not openly hostile to, truly decentralized financial systems. These systems threaten their trust premium \u2014 whether that\u2019s earned in the form of revenue or power over the financial system. <\/p>\n

    Trust Dealers Are Powerful<\/h2>\n

    This is not a small group of rogue states or niche asset managers but the core of the mainstream financial system: the wealthiest and most powerful people and organizations in the world today. <\/p>\n

    These groups and individuals defend their role as trusted intermediaries in the financial system \u2014 and therefore the trust premium they earn in cash or power \u2014 in a variety of ways. What we think of as high-functioning, fair governments claim they need this power over the financial system to combat money laundering and terrorist financing \u2014 nevermind the fact that anti-money laundering (AML) policies have less than 0.1%<\/a> impact on criminal finances (which is less than the \u201ctax\u201d on the Forex scammers!). <\/p>\n

    When governments turn more openly oppressive they resort to raw power over factual reasoning, and enforcement starts to look more authoritarian: blacklisting<\/a> individuals from the economy or simply confiscating<\/a> money from citizens.<\/p>\n

    The incumbent trust dealers are attacking decentralized systems from all angles, claiming they are too volatile, they facilitate criminal activity and they consume too much energy. However, they know they won\u2019t be able to succeed simply by slamming new technology \u2014 they need to offer an alternative or co-opt a new technology to suit their purposes. <\/p>\n

    Before we get into how trust dealers are confronting the threat of DeFi, we need to discuss the trade-offs inherent to any decentralized system. This will shed light on how a DeFi platform might evade destruction. <\/p>\n

    Trade-Offs Of A Decentralized System<\/h2>\n

    One of the founders of the Ethereum protocol, Vitalik Buterin, coined a \u201ctrilemma\u201d about networks that helps us better understand the trade-offs necessary to realizing a decentralized financial system. <\/p>\n

    The trilemma goes like this: a database (or a \u201cblockchain\u201d) must sacrifice in one of these areas in order to gain in another: <\/p>\n