Lubin

KEY TAKEAWAYS

• Composable, interoperable decentralized finance (DeFi) tooling will unlock billions in previously untapped value.
• Stablecoins will make DeFi accessible in emerging markets and accelerate global adoption of blockchain-based systems.
• Novel smart-contract governed payment structures will emerge, such as intermittent licensing payments or pay-as-you-go parametric insurance.

Stewart Brand famously said at a Hackers conference in 1984, “Information wants to be free.” While he meant “free” in terms of cost, the idea also applies to the movement of information through physical space and across social groups: the Internet enables information to flow better across the planet. The initializing blockchain use case of Bitcoin proved that value, like information, can now move freely across borders, through databases and digital infrastructures.

Ethereum makes digital money highly programmable, enabling distributed users to execute code in the form of smart contracts. Beyond speculation and storage of value, Ethereum enables many aspects of traditional finance to run on open networks, with on- and off-ramps to allow greater interoperability with fiat currencies, other cryptocurrencies, and traditional assets.

Just over four years after Ethereum launched, major markets, major governments, and major banks are all part of the experiment: over a trillion dollars’ worth of transactions have settled on Ethereum. Two years ago, there was practically no such thing as open decentralized finance (DeFi), or the manufacturing of financial instruments using open blockchains. In that short time, we have seen a host of open, permissionless financial tools not just emerge, but explode on Ethereum. These systems make the existing financial system more potentially accessible by way of open protocols and transparent data.

From payments and commerce, to banking and lending, to capital markets, to managing investments, to insurance and asset tokenization, DeFi has begun to reach into every major area of the global financial infrastructure. Today there is just under $700 million invested or staked in the DeFi ecosystem, which has generated over $50 million in premium. The number of new addresses grew 1,589% in Q2 of 2019 alone.

A particularly exciting area of DeFi growth in 2019 was the diverse stablecoin space. This past year saw the announcement of Facebook’s Libra and JPMorgan Coin, while the projects with major traction like Tether and DAI gained further momentum––their combined market cap is over $5 billion as of this writing, more than double what they were a year ago. Signature Bank’s Signet and Wells Fargo’s stablecoin both saw great user adoption in 2019, as did the Gemini dollar and Coinbase’s USDC. The transactional growth of just Ethereum-based stablecoins quarter over quarter is greater than that of PayPal’s Venmo.

The wide variety of stablecoins on Ethereum are making the network increasingly functional as a fiat payment platform, as discussed by Omid Malekan in a recent article titled “The Speculative Case for $1000 ETH.” A user has multiple protocol options to choose from, none of which charge more than a few cents in fees, unlike virtually every legacy payment option, which can cost retailers several percentage points of their revenue. When we consider that the combined market cap of legacy payment providers today is over a trillion dollars, it’s not hard to imagine that Ethereum-based options that make payments easier and cheaper could start to gather considerable momentum.

One of the great attributes of Ethereum, and therefore a core feature and advantage of DeFi, is composability: I might have a bank account, a financial savings account, and another account to bring in equities, bonds, or derivatives, but making them work together or moving value between them is clunky. Now those elements can interact and even be configured into composite structures or flows with interoperable smart contracts and Ethereum DeFi dashboards. Adding a new application to the Ethereum World Computer makes that application available to, and interoperable with, many other applications on the platform. Hosts of financial primitives can be combined like Lego bricks and deployed swiftly, inexpensively and globally with ease. With ConsenSys’s Codefi offerings, along with OpenLaw, the marginal cost of manufacturing and distributing a new financial instrument is dropping towards zero.

A creative and intrepid DeFi explorer (Definaut?) could receive a stablecoin payment, convert it to Ethereum, and use some of the amount to fund a Maker collateralized debt position, or CDP––getting the long-term benefit of growth on the Ethereum while being able to use the money. She might use another piece of the amount on an exchange to purchase a different coin, send that coin to Compound and earn interest on it, cash out that interest to buy yet another coin on another exchange, and use it to invest in a tokenized asset or in a risk-free lottery like PoolTogether, all while hardly noticing the fees. That is a powerful change from existing payment channels and can happen in a fraction of the time, to say nothing of attempting any of this across national borders. Now value can move around as freely (easily and cheaply) as information.

Stablecoins offer emerging markets entry into the DeFi ecosystem and participation in a wide variety of previously inaccessible financial applications. Reduced friction across borders and less volatility than local fiat currencies make stablecoins particularly attractive in these markets. Last year, a ConsenSys partnership with Oxfam used DAI to distribute humanitarian aid delivery vouchers in the South Pacific island nation of Vanuatu, which is prone to frequent natural disasters. The program used a voucher token wrapped around a DAI token, which could only be unwrapped and redeemed by verified members of the program’s whitelist––an AML measure that also took advantage of mainnet security and ensured regulatory compliance.

Developed markets, too, could soon rely increasingly on price-stable currencies as the major monetary systems of the world are challenged. We’ve seen the yield curve inverting and central bankers around the world have been engaging in quantitative easing for quite a while. As they try to stimulate national and global economies, more rapid quantitative easing will eventually cause a loss of trust in these centralized fiat currencies. Various configurations of price-stable blockchain-based currencies built on top of state-issued currencies or other instruments could prove to be a promising new model.

Countries are already becoming increasingly comfortable with the notion of minting their own digital currencies, pegged to some fiat asset, as a means of reducing transaction fees and increasing transaction speed. The British Virgin Islands recently announced the development of a digital currency pegged 1:1 against the US dollar. Their goals are to reduce transaction fees and increase transaction speed. The central bank of France will soon begin testing a central bank digital currency (CBDC), while the People’s Bank of China and the Marshall Islands are also set to roll out plans for digital currencies next year.

We will see other payments innovations in the coming year. Apple’s latest push into mobile payments, Apple Pay, and Facebook’s rollout of Facebook Pay to support in-app payments on WhatsApp, Instagram, and Facebook are part of a larger trend towards mainstream comfort with mobile payments, not to mention massively popular platforms like AliPay and WeChat Pay in Asia. Mobile payments through Apple Pay and services like Venmo and the Venmo card are already familiarizing consumers with the idea of money existing on their phone, and will act as an on-ramp towards the download of a mobile wallet. Consumers and businesses alike will begin to realize that money transmission can, and should be, as simple as sending a text message. Cash flow is so important to small businesses that they are eager for a way to cut settlement time, and digital currencies will provide that solution. It takes days for ACH transfers to settle, whereas blockchain-based payments are received nearly instantly. Such payments effectively settle in a few minutes on a highly decentralized and secure network like Ethereum and a bit more slowly on the Bitcoin network.

Blockchain-based payments provide users with more granular control over how merchants are able to use their funds. Whereas with a credit card there is an implicit understanding that the merchant will not charge you for a recurring subscription service more than you initially signed up for, you are entrusting the merchant with your credit card, rather than with that amount of money. With a smart contract agreement, the buyer has complete certainty that the upper bound of a payment will never exceed the authorized amount, and can authorize the cancellation of that subscription at any time. Blockchain-based payment platforms, such as ConsenSys Codefi’s Daisy, allow anyone to accept recurring payments without absorbing credit card fees or requiring the customer to trust merchants with their credit card data.

Novel payment structures such as state channels mechanisms, which let parties interact directly off-chain and settle when ready on the mainnet, can allow merchants to nimbly process micro-transactions of fractions of a cent. Other payment structures will emerge that are uniquely suited to smart contract-governed payments, such as regular subscriptions payments, intermittent licensing payments (for music or other content, perhaps), or an auto insurance provider offering a parametrized insurance policy that charges fractions of a cent for each second behind the wheel of a covered car, adjusting the rate based on time of day and region travelled.

All of this is happening on the Ethereum blockchain. These areas of innovation, combined with increasing momentum in enterprise applications of Ethereum, tokenization of assets, and software contained within these new subsystems as they mature, will all begin to combine to form the substrate for the new global digital economy––and they will amplify one another.

The global economy needs an objectively trustworthy frame of reference to coordinate logic and transactions between business networks. That frame of reference is shaping up to be the Ethereum mainnet, which will function as the global settlement layer for digital assets of the future web. In order to be maximally secure, it must also be maximally decentralized in its architecture. If the goal is building, or re-building, a more secure, reliable, and interoperable global financial system, it is suboptimal to architect it on centralized, open platforms subject to censorship, single points of control and failure and other kinds of potential improper manipulation.

Atop and alongside the maximally decentralized trust foundation and global settlement layer of the Ethereum mainnet, the future of decentralized protocol technology will consist of many functional elements: for trusted transactions, automated agreements, smart software objects, storage, bandwidth, heavy compute, identity, reputation, proof of location, legally enforceable agreements, certificates, equity and real estate tokenization and ease of fractional ownership, financial inclusion, clearing and settlement in the instant of the transaction, and more.

So many aspects of our global financial infrastructure are built on outdated software platforms, and vulnerable database architectures, use antiquated and sluggish cross-border settlement systems, and little of it is fluidly interoperable. Financial institutions are, of necessity, reconciliation companies that fix misunderstandings and broken transactions between disparate databases that each house a fraction of the understanding of a transaction. When things go right, they are able to offer financial services to their corporate and consumer customers. It doesn’t have to be this way. Blockchain financial infrastructure will allow such institutions to interoperate with one another on a new trust foundation that represents a single share source of truth.  Trillions of dollars in wasted or untapped value is waiting to be unlocked by this new decentralized protocol financial tooling.

But the potential for blockchain in 2020 goes far beyond DeFi and payments: it is about automating trust to facilitate collaboration, and enabling digital scarcity to allow for the creation of digital assets; it is about convergence of platforms, reducing inefficiencies, doing business faster and better than ever while creating healthier economic dynamics in the process. I have no doubt that this will be an exciting, and likely defining, year for our ecosystem.

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