May 31, 2022

Stop Comparing DeFi to Napster

Defi

6 min read

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In a complex world, we often rely on analogies to help us understand new phenomena. The first automobiles were called horseless-carriages to bring them into a mental context with which most people would be familiar. However, this habit obscures more than it illuminates when the chosen analogy is weak or misleading. Bloomberg, Forbes, Coindesk and others have run articles in which Napster is used as an analogy for DeFi. This is a poor analogy but helps illustrate what people are misunderstanding about DeFi and points towards a clearer example: the printing press.

Bloomberg’s article from a few days ago catches the general tenor of the coverage:

In 1999, at the height of the dot-com boom, a 19-year-old college dropout named Shawn Fanning introduced Napster, a website that allowed users to share digital music files for free. Suddenly millions of users were downloading MP3 files of songs by Dr. Dre, Eminem, and Metallica instead of buying compact discs . . . Twenty years later, one of the goals of the so-called DeFi movement is to disrupt the financial industry in a similar way — by using peer-to-peer technology to connect users directly with lenders, [and] borrowers.

The articles share this view and Bloomberg and Forbes go on to point out that Napster was shut down by the courts because of copyright infringement and hence regulatory pressure will likely spell doom for the world of DeFi even if DeFi goes on to shape aspects of the financial markets. This comparison is wrong both on the history of Napster and on the meaning of DeFi.

First, Napster was a file sharing site that made peer-to-peer connections easy. Napster did not represent a technological breakthrough but rather a friendlier UI that attracted more users. Because of their popularity they garnered media and legal attention but what they did was neither unique nor groundbreaking in comparison to the magnitude of DeFi’s impact. While their business failed because of copyright settlements and court costs, file sharing sites did not go away. If anything, Napster demonstrated the attractiveness of file sharing in general and sharing music in particular — ITunes, Soundcloud, BitTorrent and many others can be seen as the successful descendants of Napster.

Second, DeFi is not one thing. The ever growing uses for DeFi applications means no single court case, regulation, or government crackdown will have the impact of Napster losing its case, which, it should be noted, did not shut down Napster. Just the simplified chart of the Ethereum ecosystem demonstrates how diverse the DeFi world has become.

Third, Napster had very limited financial resources whereas DeFi has a $2 Trillion market cap including billions of dollars from mainstream financial institutions like Blackrock, Goldman Sachs, and Morgan Stanley. The cumulative world of DeFi has financial, legal and lobbying resources that dwarf anything Napster could deploy.

So while it is a poor analogy, it does tell us something about attempts to understand the world of DeFi. Primarily, the complexity and diversity of DeFi is consistently misunderstood. Indeed, the ‘Finance’ in DeFi is part of the confusion. So many non-financial uses of blockchain-based smart contract technology have evolved that finance is too limiting a name. DeFi is not a single thing, it is an idea that can be applied in a vast myriad of ways.

Also, particularly in the US, there is a strong tendency to think that US regulatory moves or court decisions are the final word. However, DeFi is a global movement and while the power of US authorities, particularly in the world of finance, is immense, it does not control the world. For instance, the privacy coin Monero, despite being illegal in Japan, South Korea and China and under tight regulatory restrictions in the US, sees at least $250,000,000 a day in transactions. The very nature of DeFi makes it difficult to regulate.

DeFi is a disruptor much more like the printing press.

A more enlightening analogy is the printing press. The movable-type printing press was actually a series of related innovations that came together to transform culture. Three of the most important elements were cheap paper, movable-type and growing literacy. Together, they dramatically lowered the cost of producing books at a time when increasing literacy meant a ready and expanding market. Governments were quick to understand the implications of the printing press and sought to regulate, license, and/or outright ban both the presses and the books they produced. Famously, this had little impact. Why? Competing jurisdictions meant that books banned in one regulatory area could be produced somewhere else. Voltaire’s Candide, banned in France, was printed in Geneva and went through 17 editions in its first year. (It was eventually banned in Geneva, but this did nothing to reduce its popularity). Also, different printers pursued different business models. Some sought stability and government approval and prospered by offering officially sanctioned works. Others specialized in surreptitiously printing banned works. Still others printed works that were legal in one jurisdiction while working with networks of book smugglers to get them to market in banned areas. Meanwhile, as governments tried to license, limit and sometimes even ban presses, they were simultaneously using presses to print material they wanted to disseminate. Once the idea of movable-type printing existed in an environment of pent-up demand because of increasing rates of literacy, the book could not be stopped.

Similarly, DeFi is the expression of an underlying technological innovation. Blockchain security protocols combined with a global digital communications network cannot be ‘banned’. Any particular dapp or even a network like Ethereum is an expression of these innovations and can certainly be interfered with, but the underlying principles do not change. Just as banning any single book or author or even banning presses altogether had little impact on the development of print culture, so there is no company or use that can be ‘banned’ that will put the genie back in the bottle. Further, as the rapid increase in capital in DeFi applications indicates, there was a huge pent up demand for these services and that demand has clearly not been met and is, like literacy, also growing as better dapps, more use cases, and cultural awareness increase. Just two weeks ago, China banned all crypto exchanges and mining. Rather than tanking the crypto markets, it drove a spike in use of decentralized exchanges like Uniswap or Sushi as users migrated from more centralized platforms like Binance and Coinbase. Banned in Paris? Print in Geneva. If outright sanctions in the world’s second largest economy does not slow DeFi, what will?

Further, while China has banned cryptocurrencies and trading, it is pressing forward with a digital yuan. Many governments around the world recognize the value of digital currencies and while they on one hand may be trying to regulate or ban them, on the other hand they are also moving to capture some of the value for themselves. Like the printing press, the underlying power of the development is so great the desire is as much to co-opt as to destroy.

Finally, like the printing press, the fight over DeFi is likely to be long and complicated. Almost 500 years after Guttenberg’s innovation, books are still banned, presses shut down by governments and authors threatened, detained and killed. DeFi is not like Napster, a four year experiment that went bankrupt, but like the printing press, a cultural and technological transformation that will likely shape finance, economics and the digital world for generations.

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