DeFi Supercycle Squared: 100 Years of Bullrun
What if DeFi went UpOnly like TradFi for the last infinity years?
DeFi is downbad and DownOnly for about 15 months straight. Some (silly) people (wrongly) think that DeFi was a bubble, grift, mistake etc. and the industry is unironically going to zero. Here is why they are wrong (if you are one of these people, maybe read this in earnest and then afterwards do some assessment on your own convictions):
The DeFi Bull Thesis only requires a few assumptions/convictions:
TradFi sucks (more eloquently— TradFi has inefficiencies, externalities, imperfections).
In usecases where DeFi can replicate TradFi, DeFi can do it better.
Compelling evidence exists that DeFi progress is happening— DeFi as a whole gets more complex, mature, nuanced, efficient, etc. over time.
There is some set of benefits DeFi imposes that guarantees its ability to “outcompete” TradFi in the future (to the scale of magnitudes).
If you can agree with each of those, then all other concerns go away (ie: “Better DeFi yield is a myth since it’s just reflection of risk). Let’s dive in.
TradFi Sucks
I am 24 years old so I don’t really know much about the 2008 crisis. But what I do know is a lot of people thought finance sector didn’t behave responsibly and (lobbied) politicians bailed them out instead of the everyday people effected.
And my limited understanding of TradFi is that virtually every product/service/usecase is just some obfuscation layer on top of: capital deposited here gets accessed by a middleman to do something with it.
Let’s take retail banking as an example:
Clients deposit $$ to Bank
Borrowers request loans from Bank
Bank takes client deposit $$ and assigns to borrower, per some criteria (credit score, assets, etc.)
This is an incredibly formulaic business model. Anyone gets to deposit any amount of money, anyone gets to request a loan. Banks assess the loan request according to credit score, collateral, income, skin color, etc. and offer terms or deny the request. They keep all the interest on that loan (or 99.9% percent of it), depositor gets virtually nothing.
In theory, this could all be done in an automated fashion. But it’s not. There are humans that gate these opportunities and vet requests. They get paid to do that. They also fuck up sometimes and cost the bank a lot of money. Banks use lobbying to purchase politicians to make sure that if they fuck up the government will hook them up.
Then they invest a lot of resources to obfuscate this business to protect their ability to take all the fees as a middleman for doing virtually no work.
You can look into any business in the finance sector and you will find the same: Finance is a $20 trillion industry of sub-optimal human middlemen that burn a lot of resources to protect their ability to keep being sub-optimal human middlemen.
Is this an oversimplification? Yes and No. Obviously, there are levels of nuance, and some businesses are more erroneous than others. The most telling figure in my mind is the vast majority of active fund managers (who charge 2% yearly management and 20% performance) fail to outperform the market in a given year.
What if we could eliminate the costs of people (salary, benefits, pension), brick-and-mortar costs, operational expenses, lobbying, lawsuits, insurance… you get the point. Enter DeFi.
Pound-for-Pound, DeFi Works Better
DeFi is still quite nascent, but there are already a number of case studies where a DeFi protocol has replicated a TradFi usecase and done it better (to the scale of magnitudes).
Aave - The World’s Greatest Pawnshop
Luxury Asset Capital LLC allows wealthy clients to collateralize high value items like watches, paintings, and cars for quick liquidity. They boast 2 business day turnaround and 2-4% monthly interest on loans. The company is booming, recently announcing several acquisitions, and likely closing out total loans into the billions of dollars to date. “Luxury Pawnshop” may come across as a misnomer, but the industry increasingly resembles a way for the ultrawealthy to secure quick liquidity without forfeiting ownership of their items.
Despite its success, they aren’t the best or fastest growing in the niche, Aave is. Just like Luxury Asset Capital, Aave enables its users to post their high value cryptoassets for collateralized loans. But Aave’s terms are much better: instantaneous turnaround with 2-4% interest per year.
Aave is responsible for AUM in the billions and is on pace for eight-figures revenue for 2022.
Aave is fully a decentralized, unsubsidized, completed project. In other words, that revenue figure is virtually pure profit. They don’t even need to pay people to handle that revenue—token holders do it for free.
Aave has more money than they know what to do with. They’ve paid out large grants for contributors in their ecosystem to pursue buildouts in videogaming, social media, and raves (yes raves).
From the above, if you can take this case study above as it is displayed (Aave kicks ass), you can also apply it to other DeFi primitives vs TradFi middlemen: Uniswap (market maker), Synthetix (derivatives), Index Coop (index funds). Go through DeFiLlama and try to iterate through all of the top protocols, what their innovation is vs similar projects, and how you could compare it to a TradFi business in production today.
DeFi Continues to Mature
They very casual DeFi observer might see TVL dominance by the likes of Aave, Compound, and Maker (who have been dominant for the past two years) as a sign that DeFi peaked. They might additionally look at TVL and protocol token trends (down only for a long time) as further justification for this suspicion.
It’s important to dig a layer deeper and understand that while DeFi is still very new, speculation and sentiment will play as big a role as adoption in these trends. And of course, a lot of DeFi experiments ended up failing. This is actually a good thing for DeFi as a whole, which I will explain in the next point.
Either way, look through some of the newer DeFi developments— different protocols and what they do (not how their governance token has performed). I believe the stablecoin niche is a great example of innovation across projects:
A couple years ago, we had DAI (overcollateralized mintage), USDC and USDT (centralized dollar wrappers).
Today, we’ve iterated through countless different stablecoin models and several impactful innovations have come out of it:
FRAX (undercollateralized)
MIM (productive collateral)
AlUSD (self-repaying loans)
OUSD (yield-bearing)
sUSD (dollar + utility)
mUSD (on-chain savings)
Magic Internet Undercollateralized Leverage
Each of these deserve their own deep-dive, but I’d like to focus on MIM and their “DegenBox” as what I believe to be an absolute breakthrough innovation (despite being riddled in ‘protocol politics’).
MIM was originally built to be a DAI-like stablecoin with the quirk of prioritizing yield-bearing collateral. Having an ETH-backed stablecoin loan is cool, having you ETH earn you more ETH while that loan is outstanding is cooler.
MIM is unlike other stablecoins in that it doesn’t pretend to be the greatest dollar out there. It has a clear-cut usecase: Post your productive assets you already hold, get some MIM on top, go sell it and do whatever else you want. Every Abracadabra user minting MIM is basically a MIM shorter. This sounds counterintuitive, but it makes the protocol far more interesting for users:
I can, for example, post my ETH at stETH which earns me 4% APY and take out a loan in MIM. I can sell that MIM to USDC and go farm on it. Maybe this drives my total APY closer to 8%, paid out 50/50 in ETH/USD.
But while I’m farming, I’m also shorting a weak stablecoin. I sell MIM at a dollar. It drops to 97c a month later. I exit my stablecoin yield strategy, buyback MIM at 97c, pay off the loan. I just earned 3% on my loan on-top-of everything else, pushing my real APY up into the 30% range for the duration of that exercise. And in doing so I also protect the peg with what amounts to a buyback-and-burn.
Now, what if we took this a step further. DegenBox asserts that you can get massive leverage on your deposit if you use that deposit to swap MIM into more of your collateral.
Instead of stETH, let’s say I deposit a yield bearing USDC position (for example, MIM can be minted through Stargate USDC). That position earns me 4% APY, but also tracks to $1. I can post Stargate USDC, mint MIM, sell MIM for more Stargate USDC, and loop it over and over.
Abracadabra offers this whenever MIM trades at-or-above $1 with up-to 50x leverage. That 4% APY becomes 200% APY plus a 50x short on MIM.
If you think about the process as a whole, they’ve effectively enabled heavily undercollateralized yield farming. $1 deposit becomes $50 to farm with and a 49x leverage short on a coin that will always be valued at-or-below $1 (they hardcode MIM to $1 in the contract so you can’t get liquidated on a short squeeze).
There are other innovative breakthroughs unlocked by DegenBox. They can charge 0% interest loans by taking a performance fee on the APY (I believe they charge 50%). Roundtrip, it costs them nothing to do this, since all the MIM sold through the strategy open gets bought back and burned on the strategy close.
DeFi’s Programmed Success
Everything above is not a fluke. Aave is not the only successful DeFi protocol. Abracadabra is not the only recent (or the last) DeFi innovation. The many failures that juxtapose these protocols is part of the recipe for success, not a forewarning of imminent doom (as critics propose), allow me to explain.
Keeping in theme with stablecoins above, let’s talk through the winners and losers.
Early 2021 there was a huge boom of all kinds of different innovative, experimental, and doomed-to-fail stablecoins. Why? Because the market said this might have value.
Hundreds if not thousands of developers forked successes of stablecoin predecessors and added their own flair on top. Degenerate gamblers interested in stablecoin profiteering aped into these stablecoins at launch and simulated true trials by fire.
If they are right — fortunes beyond their wildest dreams. If they are wrong — funds are permanently lost. MIM, FRAX, sUSD, and the others are the survivors of thousands of failed alternatives. Innovation under this model is guaranteed. Degenerate gamblers will degenerate gamble.
NOTE: It would be irresponsible to parade this culture without acknowledging the Luna fiasco. This formula stops working when developers and their evangelists try to market their degenerate gamble as something safer. We’ve seen this in full effect with Luna-UST, and everyone complicit in promoting UST as anything other than a gamble (Do Kwon + core team AS WELL AS the countless YC incubated “UST wrappers” deserves to be prosecuted to the full extent of law [and then some]). Same goes for other disingenuous crypto endeavors that purposefully target unknowledgeable outsiders).
The way this model is supposed to work is maximum risk and maximum reward to the investors that are happy to take it. In the real world, experimental monetary policy gone wrong means the collapse of a nation. Here it means degens lost money on the wrong race horse.
This model takes place across every niche throughout DeFi, and has rapidly unlocked many previously inconceivable innovations. There is absolutely no way for TradFi to compete here. DeFi will always mature at a rate magnitudes greater than TradFi, until all finance businesses that could work better in DeFi do happen better in DeFi.
Piecing it Together: The Infinite DeFi Bullrun
To summarize each of the points above:
TradFi has a lot of frivolous externalities, and it always will.
DeFi has already shown that it can do some of the exact same stuff with none of the externalities.
DeFi has proven its ability to curate more mature and complex offerings.
DeFi will always innovate at a speed TradFi cannot even dream of.
Understand that this trial-by-fire industry standard means only the absolute cream-of-the-crop have a lasting impact long-term. Bad businesses can’t persist in DeFi the way they do in TradFi.
If you concede all of the above, you additionally reject that:
DeFi is just “governance token ponzi” (the tokens of the best protocols have current and future value, and people have incentive to buy-and-hold)
APY is only higher because it’s riskier (APY is higher because services can be carried out without externalities)
DeFi will get regulated to death (DeFi is global, regulation is local. Trial by fire asserts that the best will surface regardless)
DeFi isn’t sexy so it will never take off (It has to be good, not sexy, and the best of DeFi is already really fucking good)
Since DeFi went down a lot, it has to continue to go down forever! (speculation and sentiment plays an ever-decreasing role as “DeFi as we know it today” continues to improve and grow)
There are many other compelling pieces to DeFi that further bolster the perma-bull thesis. Composability is a big one. Most protocols are designed to compose unto one another, and both are better off whenever it happens. This is unique to DeFi. If you do dig into industry this head-on, other superiorities vs TradFi will make itself apparent.
And alas, we can conclude: Why shouldn’t DeFi completely replace TradFi? Why wouldn’t it? TradFi went UpOnly for close to a century (post-Great Depression to present). Why can’t DeFi do the same?
Okay So What do I buy?
Figure it the fuck out yourself.
The safest bet is betting on where DeFi happens today and into the future. Most people probably conclude this is ETH.
Beyond that, try to find whichever smaller protocols have the best token economics and a strong innovation. Downbad charts don’t matter (you’re actually supposed to buy coins when they are cheap not expensive) on protocols with strong cashflow and a strategy to find product-market fit.
Understand that all tokens still are battling speculation and sentiment in a DownOnly market, so don’t overextend into individual protocols if your time horizon has a deadline. While DeFi as a whole will succeed, not everyone will make it out of this ongoing hurricane. DeFi indices like DeFi Pulse Index (DPI) could make it easy for you.