People greatly underestimate the power of DeFi; A lesson from Airbnb
Over the past few months, it has become cool – even among crypto-skeptics – to have a positive outlook on Decentralized Finance (DeFI).
DeFi is, of course, the catch-all term for crypto-enabled applications that use software to attempt to disrupt the traditional financial services industry. And recently, mainstream media coverage has been remarkably positive.
- The New York Times
- The Economist in September: “[T]The rise of a financial services ecosystem, known as decentralized finance, or “DeFi”, deserves sober consideration. It has the potential to reprogram the functioning of the financial system, with all the promises and dangers that entails. “
As a forerunner in the space – my company launched the world’s first DeFi crypto index fund in February of this year – it’s wonderful to see the popular media take notice of DeFi’s potential.
But so far the mainstream media has missed half the story. To really understand the power of DeFi, think about Airbnb
The first half of DeFi’s history: streamlined finance
Most of the mainstream articles on DeFi use a project called Uniswap (UNI) to explain what DeFi is. It’s easy to see why: Uniswap is the largest DeFi app today in terms of market capitalization, and also one of the easiest to understand.
Uniswap is a “decentralized crypto exchange”. Investors can use Uniswap to trade one crypto asset for another: BTC for ETH, ETH for USDC, etc. In this way, it functions much like Coinbase, the publicly traded crypto brokerage giant with over 60 million customers.
The difference is that Uniswap is not a business. It has no employees, no offices and no CEOs.
Nevertheless, this remains a very big problem. Last month, investors traded over $ 60 billion in crypto assets on the Uniswap platform. This compares to around $ 150 billion on Coinbase, the largest traditional spot crypto trading platform (with over 1,200 employees). It wows people: imagine doing 40% of the trading volume on Coinbase without any overhead!
It’s easy to look at Uniswap and imagine a financial future without the overpaid middlemen, bankers, and CEOs we all love to hate. It is the vision that the mainstream media fall in love with.
As big and beautiful as this view is, however, it misses a huge part of the story.
The power of bilateral markets: Airbnb, Uber
Over the past two decades, some of the most successful companies in the world have been the ones disrupting established markets by opening up important new sources of supply.
Airbnb, for example, has opened millions of new rooms for accommodation and turned the hotel market upside down. Uber has created a two-way market for ridesharing and turned the taxi industry upside down. Twitter has created a two-way information market and disrupted the media ecosystem.
In each of these examples, people with something valuable – a spare, a willingness to drive, or eyewitness testimony to the news – had no easy way to bring that value to market … until that they do.
DeFi does this for finance.
With Uniswap, for example, you can trade Ethereum for USDC, taking cash from the system. But you can also supply liquidity by offering, for example, to exchange UDSC for Ethereum at certain prices. And if you provide liquidity to the service, you earn a fee when people trade (0.30% of each trade).
This is a major change.
If you think about how the traditional stock market works, most investors buy a stock and then… nothing. It sits in their brokerage account, sometimes for years. Stock market liquidity is provided by a relatively small number of institutional market makers and high frequency traders – extremely profitable private companies like Jane Street or Susquehanna.
With Uniswap, everyone can be a market maker. This includes companies like Jane Streets and Susquehannas of the world. But it also means people like you and me. The result? More liquidity across a lot more assets.
Over the years, financial institutions have been extremely resilient to disruption. One of the main reasons is that in finance there are major advantages to having a scale. The New York Stock Exchange, for example, has been the largest stock exchange in the United States for 250 years, largely because its size gives it a liquidity advantage. DeFi is reversing this by opening up massive new sources of supply.
(And not just for trading: on lending platforms like Aave, you can borrow crypto assets and pay interest, or you can lend crypto assets and earn interest. On insurance platforms like Nexus Mutual, you can can pay for technical risk insurance if you are using other DeFi applications, or provide technical risk insurance and receive fees.)
In other words, yes, it’s cool that Uniswap achieved a $ 60 billion transaction volume last month without any employees. But what’s really cool is that the liquidity on the platform has been provided by thousands and thousands of users scattered across the globe.
To invest, efficiency gains are a gradual improvement. Unlocking a new offer is a game changer.