June 23, 2022
3 min read
May 31, 2022
8 min read
To really understand the nature of DeFi, one needs to grasp its fundamental ethos. The ethics of DeFi matter because they grow from a specific idea about the nature of wealth. While the technology behind DeFi receives much of the attention, it is DeFi’s conception of wealth that is truly breathtaking and perhaps its more disruptive aspect. After millennia of assuming that resources were scarce and that centralized, hierarchical systems were the best method to capture and protect value, DeFi’s focus on harnessing the power of human imagination in a digital realm has created a vision of economics where wealth is abundant, perhaps even limitless. The core ideas of DeFi like Composability and Transparency emerge from this understanding of the world. Therefore, DeFi is both an alternative not just to centralized and traditional finance but also to the worldview that underwrites the structures necessary for their existence.
For at least the last 5,000 years, resources were assumed to be both difficult to obtain and scarce. Want more arable land? Take some of your neighbors. Want more silver? Capture a silver mine. Need more people? Conquer a neighboring country. In a zero-sum world, once wealth was acquired, one needed to protect it from those who would, in turn, try and take it from you. The ancient world was dominated by autocratic, hierarchical, and centralized civilizations in more or less constant warfare. One component of this worldview was an outright hostility towards merchants. How can they make money except by, in essence, stealing it from someone else? Prohibitions on lending, trade, charging interest, travel, ports, and foreign goods that were present in nearly every ancient civilization grew from a belief in a world of scarcity.
Indeed, the assumption of scarcity continued until the modern era. The Physiocrats of 17th Century France argued land and agricultural labor were the true source of all wealth and hence, more and better land was needed for an economy to grow. Many of their ideas were taken from China’s agricultural policies and outlooks that similarly held land and agricultural labor to be the source of wealth. Merchants were seen as, at best, necessary evils. And because arable land was a finite resource, it followed that wealth was also finite.
The Mercantilists of the 16–19th Century argued wealth equaled gold and silver. They recognized the value of trade but, again, the idea was that there was a fixed amount of bullion in the world so trade needed to be regulated to maintain healthy balances. One simply pursued policies to beggar-thy-neighbor to maintain positive trade balances and ensure growing reserves.
Or consider the Labor Theory of Value which holds that value is produced through work. The more work something takes to produce, the greater its value. Again, a finite resource, labor hours, is used to underwrite the production of wealth and, hence, constrain economic growth. An economy can only grow as quickly as its working population.
In each case, the overriding assumption was that wealth is scarce and derived from finite resources that needed to be managed accordingly. Given the glacial pace of economic expansion until the industrial revolution, this was a perfectly reasonable, if inaccurate, view of the world.
In essence, wealth was a zero-sum game in which one person’s gains come at someone else’s loss. Further, those gains needed to be protected from the predations of neighbors who were doing precisely the same economic calculations. Hence, the centralization, management and protection of resources were seen as the only way a country could survive. Closed, hierarchical and general autocratic systems grew inevitably from this worldview.
However, since the advent of the industrial revolution and contemporaneous changes in social organization, wealth has become shockingly un-scarce. A world of starvation transformed into a world of obesity. Death rates from famine have plummeted over the last 150 years and almost all current deaths from hunger are related not to lack but to civil unrest and war. Of course, this abundance is not equally distributed and some resources remain scarce. Still, in the last 60 years massive gains in wealth have spread throughout most of the world.
The transformation in material prosperity is awe-inspiring. Yet, thousands of years of privation shaped a worldview that has not changed so swiftly. While everyone recognizes that our current prosperity is derived in part from innovation, the free movements of goods and ideas, investment vehicles of all kinds, the world of CeFi remains amazingly hierarchical, concentrated, opaque, and hard to access. In a world where everyone is battling for scarce wealth, these kinds of financial systems only make sense. It is, after all, a dog eat dog world.
Unless it isn’t.
DeFi’s rapid rise to prominence is in part technological but, more importantly, conceptual. The development of blockchain protocols, large computer networks like Ethereum and new programming languages all make possible the innovations that are reshaping the global financial landscape. They are driven by the conception that the world is abundant.
Assume, for the moment, that we live in a world of potentially endless wealth limited only by our capacity for creativity. The origin of this wealth, the human imagination, means that freeing individuals to communicate, cooperate, experiment and explore is the surest means of wealth creation and improving global society. Stated this way it seems hopelessly naive. Still, this utopic thinking drives many of the major players and projects in the DeFi world.
Consider Vitalik Buterin’s original argument for the Ethereum network:
What Ethereum intends to provide is a blockchain with a built-in fully fledged Turing-complete programming language that can be used to create “contracts” that can be used to encode arbitrary state transition functions, allowing users to create any of the systems described above, as well as many others that we have not yet imagined, simply by writing up the logic in a few lines of code.
Stated differently; “Let’s build a factory full of tools and let people build whatever they want, they’ll build cool stuff, things we can’t even imagine, and good things will happen. Oh, and we will let those folks participate in deciding how to manage and upgrade the factory as we go along.” Stated this way, it seems naive to the point of stupidity. Factories are built for a purpose, specific tools are necessary, certain people are allowed in, most everyone is excluded and careful management by highly trained executives extracts maximum value from any complex process. In the traditional model, it is assumed good ideas are scarce, protection of those ideas is paramount, competition is fierce and chances for success are fraught. In Vitalik’s vision, the world is so rich with unrealized possibilities that creating an abstract set of tools that anyone can use will surely produce great results. What idea could be crazier than that?
Satoshi Nakamoto’s claim that inefficient systems destroy value was not new. His solution, however . . . was, and perhaps still is, crazy. A digital currency to facilitate electronic trades that would have no backing, no intrinsic value, no issuer and no centralized control maintained through a system of distributed consensus? This truly does seem mad.
Where does the value, then, originate? The most simplistic argument is use value — it is valuable because people use it. More fully, its value comes from everyone. The value of Bitcoin is realized by adoption — the value is created through the association of ideas, use, technology and people. At some level, Satoshi must have assumed that the inefficiency of the current system — it’s centralization — inhibited growth or even destroyed it. In a world of abundance, centralization still seemed to be the arbiter of value because . . . well because thus it had always been so. Within Bitcoin’s earliest conception is an assumption that value does not rise from, and, in fact, may be inhibited by, centralization. Wealth does not need to be controlled because it is better realized through free flow and maximum participation. Satoshi is not the first thinker to recognize that improvements in efficiency can create returns on investment. But his improvement of efficiency was not to create a better control system — it was to imagine that a controlling authority, in fact, is not a dependency of viability. The US dollar is not, in theory, backed by the people who use it but by the authority of the government of the United States of America (and its largish military). The earliest Chinese paper currency was backed by a death threat — refusal to accept payment in the currency was a capital offense. But a decentralized currency issued by no one in particular and backed by . . . use? This was a new idea and one that seemed crazy until it stopped seeming crazy.
So when we consider the major components of the DeFi world it is important to remember they are a series of related ideas that grow from an assumption about the nature of wealth and the world. Not all projects share all aspects of this vision and many of the people who implement aspects of DeFi are neither aware of or interested in these issues. However, at its heart is an assumption that the imaginative capacity of people is the main driver of value. If you can create systems to unleash human potential, you will create nearly limitless wealth. While not the first utopic vision of this kind, it is the first to create a series of protocols and put them into action that is visibly shaking the world. Understanding those protocols in the light of this shift in values underlines the radical nature of what DeFi is attempting to accomplish.
To explore these new ideas we will look in turn at several of the major values: Composability, Accessibility, Programmability, Transparency, Speed, Privacy, Cost Reduction, Communal Governance and Trustless Contracts. Together, these interrelated ideas grow from a different sense of the world and, when put into practice, transform human interactions far beyond the financial sector.
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