Decentralised Finance (DeFi)

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Bitcoin and DeFi

DeFi refers to an ecosystem of conventional finance tools built on a public blockchain. It democratises access to financial services and doesn’t need a central authority to operate – users interact directly and maintain full control over their assets. Use cases are exploding. They include low-cost international money transfers, better loan management via smart contracts, and stable coins tied to real assets like gold. 1

On one view, many of these emerging DeFi use cases are competitors to Bitcoin, at least with respect to investor fund flows (the original DeFi). Venture capitalist Mark Carnegie recently called Bitcoin a “sideshow” compared to the new business models appearing on the Ethereum blockchain, describing himself as “a crypto maximalist and Bitcoin minimalist.” 2

On another, DeFi and Bitcoin are allies in pursuit of the decentralised future of money. As one commentator says, “If we want to extend Bitcoin’s ethos of freedom and self-sovereignty beyond just hodling, then bitcoin services must become decentralized. That’s what DeFi is. Bottom line, nobody should be paying more attention and be more supportive of DeFi than Bitcoiners.”3

Bitcoin is widely regarded as a store of value, a hedge against inflation, a portfolio diversification tool, and a way to protect against wealth confiscation. A new DeFi use case is also emerging, wherein Bitcoin evolves into a widely used settlement network. 4 This will require the broad use and acceptance of ‘Layer 2’ solutions like the Lightning Network, which is a payment protocol designed to be ‘layered’ on top of a blockchain-based cryptocurrency like Bitcoin.

The Lightning Network is still in its infancy. As of today, the software required to support real-life transactions for casual users is still evolving.5 In the near future, though, the Network could allow participants to make low or no-cost instantaneous transfers without having to make their transactions public on the blockchain. It could also solve Bitcoin’s ‘scalability problem’ by allowing users to send and receive micropayments quickly and easily (as per the recent announcement by El Salvador outlined in the blog post ‘Trust in Institutions’).

The DeFi Case for Ethereum

A growing number of technology intellectuals, including James Wang and Packy McCormick, support the view that Ethereum represents the future of DeFi. Even Bitcoin evangelist ARK is warming to the prospect. CEO Cathie Wood notes that “developers are migrating very, very quickly [to Ethereum]. I always say to our analysts, ‘Follow the developers, let’s see what they’re doing.’ Because that’s a very loud signal.” 6

So why the bullishness? Wang argues that Ethereum has multiple use cases that reinforce one another. He describes Ethereum, the blockchain, as “a world computer, the backbone of the decentralized internet (web3) and the settlement layer for web3.” Ether, its cryptocurrency, has similar optionality – it’s yield-generating, a store of value, and allows holders to own a piece of the Ethereum blockchain.

Because of the countless DeFi applications that can be built using Ethereum (in addition to games, virtual worlds, NFT marketplaces, etc.), McCormick believes that owning its cryptocurrency Ether is like owning shares in the future internet: “demand for ETH will go up with increased web3 adoption, while upcoming changes will decrease the supply of ETH and let more value accrue to holders. It’s like a tech stock, a bond, a ticket to web3, and money, rolled into one.” 7

 McCormick also observes that Ethereum has reached a narrative inflection point. Its potential has seeped into mainstream awareness “and narrative reflexivity is more important for blockchains than for almost any other company or asset.”

Bitcoin maximalists often point to the fact that Bitcoin can’t be changed, whereas Ethereum is liable to revision. But this capacity for change may ultimately prove a competitive advantage for Ethereum. As noted in earlier posts, Bitcoin mining’s carbon footprint and intensive energy usage represent a serious and growing social licence risk for Bitcoin which is now being addressed with some urgency.

Ethereum faces similar environmental challenges and has implemented ‘Eth2’ as a result. Eth2 refers to a set of interconnected upgrades that will make Ethereum more scalable, more secure, and most importantly, more sustainable.8 If implementation works as intended, shifting Ethereum from a proof-of-work to a proof-of-stake cryptocurrency will reduce its carbon footprint by as much as 99.95 percent.9 Ethereum’s proof-of-stake chain is already live and is expected to merge with the main chain sometime in late 2021 or early 2022. 

A growing number of technology intellectuals, including James Wang and Packy McCormick, support the view that Ethereum represents the future of DeFi. Even Bitcoin evangelist ARK is warming to the prospect. CEO Cathie Wood notes that “developers are migrating very, very quickly [to Ethereum]. I always say to our analysts, ‘Follow the developers, let’s see what they’re doing.’ Because that’s a very loud signal.” 10

So why the bullishness? Wang argues that Ethereum has multiple use cases that reinforce one another. He describes Ethereum, the blockchain, as “a world computer, the backbone of the decentralized internet (web3) and the settlement layer for web3.” Ether, its cryptocurrency, has similar optionality – it’s yield-generating, a store of value, and allows holders to own a piece of the Ethereum blockchain.

Because of the countless DeFi applications that can be built using Ethereum (in addition to games, virtual worlds, NFT marketplaces, etc.), McCormick believes that owning its cryptocurrency Ether is like owning shares in the future internet: “demand for ETH will go up with increased web3 adoption, while upcoming changes will decrease the supply of ETH and let more value accrue to holders. It’s like a tech stock, a bond, a ticket to web3, and money, rolled into one.” 11

McCormick also observes that Ethereum has reached a narrative inflection point. Its potential has seeped into mainstream awareness “and narrative reflexivity is more important for blockchains than for almost any other company or asset.”

Bitcoin maximalists often point to the fact that Bitcoin can’t be changed, whereas Ethereum is liable to revision. But this capacity for change may ultimately prove a competitive advantage for Ethereum. As noted in earlier posts, Bitcoin mining’s carbon footprint and intensive energy usage represent a serious and growing social licence risk for Bitcoin which is now being addressed with some urgency.

Ethereum faces similar environmental challenges and has implemented ‘Eth2’ as a result. Eth2 refers to a set of interconnected upgrades that will make Ethereum more scalable, more secure, and most importantly, more sustainable. 12 If implementation works as intended, shifting Ethereum from a proof-of-work to a proof-of-stake cryptocurrency will reduce its carbon footprint by as much as 99.95 percent. 13 Ethereum’s proof-of-stake chain is already live and is expected to merge with the main chain sometime in late 2021 or early 2022.

The DeFi Case for Ethereum

In conclusion, both Bitcoin and Ethereum will play important roles in the future of DeFi and the adoption and scaling of the decentralised internet (web3). As the world’s premier blockchain technologies, both coins boast compelling DeFi use cases, growing network effects, and are evolving quickly to mitigate environmental risks.

Megatrend summary: Decarbonisation
  • DeFi is the future of finance.
  • Bitcoin and Ethereum are well positioned to underwrite DeFi, and by extension, the adoption and scaling of the decentralised internet (web3).

Footnotes

[1] Kalsi, Ralph, What you Need to Know about Decentralised Finance (DeFi), Blockchain Australiahttps://blockchainaustralia.com.au/what-you-need-to-know-about-decentralised-finance-defi/ 

[2] Eyers, James, Bitcoin Just a Sideshow: Carnegie’s Crypto Warning, AFR, 21 May 2021, https://www.afr.com/markets/currencies/bitcoin-just-a-sideshow-carnegie-s-crypto-warning-20210521-p57tv9

[3] Yago, Edan, Forget Ethereum, DeFi is Being Built on Bitcoin, Coindesk, 22 October 2020,https://www.coindesk.com/bitcoin-defi-a-response

[4] Schiller, Ben, ARK’s Cathie Wood Blames Crypto Crash on ‘ESG Movement’, Coindesk, 28 May 2021, https://www.coindesk.com/ark-cathie-wood-crash-esg-movement

[5] Coin Telegraph, What is Lightning Network and How it Works, https://cointelegraph.com/lightning-network-101/what-is-lightning-network-and-how-it-works

[6] Schiller, Ben, ARK’s Cathie Wood Blames Crypto Crash on ‘ESG Movement’, Ibid.

[7] McCormick, Packy, Own the Internet – the Bull Case for Ethereum, 24 May 2021, https://www.notboring.co/p/own-the-internet

[8] Upgrading Ethereum to Radical New Heights, https://ethereum.org/en/eth2/

[9] Ethereum Foundation Blog, A Country’s Worth of Power No More, 18 May 2021, https://blog.ethereum.org/2021/05/18/country-power-no-more/

10 Held, Dan, PoW Is Efficient, Medium, 11 August 2019, medium.com/@danhedl/pow-is-efficient-aa3d442754d3 

[11] McCormick, Packy, Own the Internet – the Bull Case for Ethereum, 24 May 2021, https://www.notboring.co/p/own-the-internet 

[12] Upgrading Ethereum to Radical New Heights, https://ethereum.org/en/eth2/ 

[13] Ethereum Foundation Blog, A Country’s Worth of Power No More, 18 May 2021, https://blog.ethereum.org/2021/05/18/country-power-no-more/

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