It seems most people haven’t fully grasped the idea behind Decentralised Finance — DeFi.
I’ll try and clarify why DeFi is ontologically different from traditional financial technology services — “Fintech”.
I’ll make the case for why DeFi, despite being today a suboptimal choice as a tech layer is actually attracting a growing number of developers and is becoming a focal point for financial technology builders.
Note: I hold a broad definition of “DeFi”, encompassing projects such as Lightning Network, Bisq, 0x, and Set Protocol. Here a non-comprehensive list of DeFi projects.
Fintech is rooted in bureocracy and trust, DeFi is free and trust minimised.
Trust as the new dimension
Fintech is about building on mostly proprietary software.
The software and its execution is entirely trusted, gatekeeped and censoreable.
The ultimate settlement layer for fintech transactions — the truth — is not code.
The truth is a bureaucrat somewhere.
There is no cryptographically guaranteed immutability of transactions, and the entire system is based on a massive political risk and the apps are constantly jeopardised at risk of being de-platformed.
One can conceptualise and visualise any Fintech product as the digital version of a registered instrument.
DeFi is about building with open source software.
The execution of the critical logic — either a BTC/LN transaction or a “persistent script” on Ethereum— is secured as it happens on a trust-minimised, jurisdiction agnostic cryptonetwork.
The ontological difference is that in DeFi there is no bureaucratic or technological gatekeeper between the builder and their idea.
Native DeFi assets — like transactions LN/BTC or DAO/Smart Contract shares/tokens— are effectively bearer instruments.
In DeFi any idea, if technologically doable, can be built. Guess who really likes the idea of building free? Builders.
Builders are compounding towards DeFi because the Trust primitive makes it the obvious preferred choice for other builders — making it a focal point.
What is a focal point?There is no formal definition of focal points, but I’ll borrow one that defines it as a particular strategy to achieve Nash equilibrium that players select due to the salience of that choice.
Game Theory 101 — Focal Points https://www.youtube.com/watch?v=J0MY923XLtY
In the case of DeFi, the red square is red because the risk of being de-plaformed is null.
Builders Know Better
DeFi ideas and tools are open, so the building scales through compounded open source.
DeFi programs are trustless in the sense that the execution of the critical logic is censorship-resistant.
Builders know that in a world of DeFi, gatekeepers can only limit access at the interface layer, but they can’t prevent a hacker coding and deploying the fundamental logic in the first place.
Building on DeFi means dealing with bureaucracy only ex post, and at the interface layer.
You don’t need permission to start building.
The result, at scale, is what we’re witnessing: an explosion of activity and new financial pipes being built, that more builders will (might?) want to use and build on top.
Is Trust so strong to put in motion a strategy achieving Nash equilibrium?
Hard to say no, while witnessing the rush happening towards DeFi at the time of this writing.
Despite being very early, some DeFi projects have already been able to reach quite impressive numbers and growth.
Lightning Network — a second layer payment protocol that operates on top of Bitcoin — has grown from 60 to over 3k nodes in 10 months, with over 11k open channels and $700k of overall network capacity.
Plenty of companies, individuals and informal organisations are helping building and using LN without asking for permission to anyone.
Augur — an open-source, decentralized, peer-to-peer oracle prediction market protocol built on Ethereum— just had a “market” related to the mid-term election breaking over $1M dollars.
For context, PredictIt, the leading prediction market, has $550k.
The creator of the market is a pseudonymous address.
The fundamental freedom and agency provided to builders in DeFi is working as a magnet, and we’re already witnessing a powerful network effect.
We’re still very early though — DeFi still is a suboptimal choice on most dimensions for most of the use cases. The technology is not yet ready to scale and access points are not widely distributed.
It’s wrong, though, to compare Fintech and DeFi from the performance perspective because the focal point is not performance, but trust.
By looking at Trust as a new core dimension, observers should be aware of the ontological difference between DeFi and Fintech, and avoid comparing the two on the wrong dimensions.
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Ps: DeFi can be considered itself a subset of trustless/distributed computing — but that’s for another post.