The Breakdown - Is the Decentralization in DeFi an ‘Illusion’?

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The Breakdown is sponsored by Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, December 7th, and today we are doing something of a grab bag episode. There is a bunch of stories that I think are interesting, but maybe nothing that I want to dig in on a full episode with. And so we're going to catch up on a bunch of different news. First of all, if you listen to my show why Bitcoin crashed yesterday, you should know that Bitcoin is back in the low 50,000s, although lull as though you wouldn't already know the price.

Starting point is 00:00:47 Now, what I think that this means is not really anything, except that it suggests that many agree with the perspective that I shared yesterday that nothing fundamental had changed except that there was a little less leverage in the system after this weekend washout. I will note that some hearts are conceding that were unlikely to see 100K Bitcoin this year, but personally I sort of don't mind. Not because I don't want it, obviously, but because I think that this sort of rise, pullback, rise, pullback versus the extreme parabolic rips that we've seen in the past

Starting point is 00:01:18 is just a little bit healthier. I think it's going to help us break out of this mindset that the next bull run will look exactly like the last one. And net net, I think that's good for the space. But let's get into our first topic, which is the Bank for International Settlements coming out for defy. So the BIS released a report yesterday called DeFi Risks and the Decentralization Illusion. Here's the summary. Decentralized finance,

Starting point is 00:01:42 Defy is touted as a new form of intermediation in crypto markets. The key elements of this ecosystem are novel automated protocols on blockchains to support trading, lending, and investment of crypto assets, and stable coins that facilitate fund transfers. There is a decentralization illusion in DeFi since the need for governance makes some level of centralization inevitable and structural aspects of the system lead to a concentration of power. If DeFi were to become widespread, its vulnerabilities might undermine financial stability. These can be severe because of high-leverage liquidity mismatches built in interconnectedness and a lack of shock absorbers such as banks. Existing governance mechanisms in Defi would provide natural reference points for authorities

Starting point is 00:02:21 in addressing issues related to financial stability, investor protection, and illicit activities. So you get a tone for what they're saying right there. They're digging into Defi, but they're basically calling out the fundamental idea of decentralization and effectively arguing that some form of centralized intermediation is necessary to fit within the larger system as it relates to financial stability, investor protection, and again, elicit activities. Those are the three things they mention. So let's look at the community interpretation. Simon Taylor says the big report from BIS on DFI concludes it's too small to be a financial stability risk, but it has middlemen who can be points of failure. But also it doesn't have really big middlemen who can absorb shocks. Central

Starting point is 00:03:04 Banks fixed defy question mark? Jake Chavinsky goes harder, saying when I look at the villains of crypto, those who aren't just uninformed but who are truly opposed to change, I know we're on the right track. A new report from BIS, which is clearly terrified of defy. A slightly different take comes from Joe Wisenthal over at Bloomberg, who writes, The Bank for International Settlements has a new research piece out about defy as part of its latest quarterly review. And once again, it shows the degree to which legacy institutions are taking this space very seriously. So my thoughts. First, on the one hand, I do think context matters. BIS is one of the central institutions of the old system. It is a gatekeeper's gatekeeper. It is of an era where intermediary wasn't a

Starting point is 00:03:48 sanitized word for rent-seeking middleman, but an essential bulwark of a complex system. That doesn't mean a priori anything about their research, but it is important to understand their position in today's global financial system to at least have that color in terms of how you're going to interpret potential motivations going into what they're writing. Second, I don't view this as a defy hit piece. There's much to debate and disagree with, but it doesn't read like one type of institution trying to kill another. It does feel like one type of institution trying to see a new type of phenomenon through the lens that it knows and understands. I think particularly important is our ability to separate diagnosis of concerns from

Starting point is 00:04:31 suggestions for solutions. In other words, you could agree that the fundamentals of how DFI protocols are designed create challenges that, for example, amplify volatility because there aren't these big backstops in the system. But maybe your answer is, that's worth it, where they say let it be run by banks. Third, for those invested in the DFI space, I think it's sort of healthy to push on these themes of decentralization in a way that makes us more articulate in understanding and communicating what decentralization means in practice, why and where it matters, how to get more of it where it's needed, and make arguments around where it's sufficient as it is. In other words, I think those invested in defy can see this as sort of a blueprint for how the

Starting point is 00:05:14 traditional financial establishment currently sees the space and proceed as such. If Defi folks take that approach to this type of engagement from the traditional system, I can't imagine how Defi as a whole doesn't get stronger, either by pushing protocol and governance design in the space to answer some of these key questions to the extent that they're actually seen as important, or by finding clearer voice in arguing where the values of this new system, the fundamental design principles of this new system, differ, and in fact give people an opportunity to subscribe to that new way of looking at the world.

Starting point is 00:05:47 NIDIG sponsors this podcast and they're integrating Bitcoin into everyday life, not only for Wall Street, but also for Main Street, because NIDIG is built for Bitcoin and Bitcoin is built for everyone. Learn more at nidig.com slash NLW. That's nydig.com forward slash NLW. Next, a little combo cocktail of regulatory things. First, digital assets got a mention in a Biden administration report on, quote, strategy on countering corruption. The report said, quote, advances in digital technology have

Starting point is 00:06:26 dramatically improved the efficiency, convenience, and reach of digital alternatives to cash, and accelerated the usage of and commercial trading in digital assets across the world. At the same time, digital assets have been used in support of a variety of illicit activities, including proliferation financing, ransomware attacks, human and narcotics trafficking, fraud, corruption, and sanctions evasion. So a little bit on the crypto is for criminals side, but it didn't go farther in terms of recommending courses of action. And I think even those who are rightly frustrated with the continuation of the Crypto is for Criminals' narrative can countenance a report on these criminal areas saying,

Starting point is 00:07:00 sure, we can figure out how to understand where digital assets roll in all of this is and how to make it better. Now over to Japan, where it seems that their FSA plans to introduce new legislation in 2022 with rules around stable coins. The idea appears that it will only be banks and wire transfer companies that would be allowed to issue them. In addition, and this is a quote from Niki Asia who had the first report on this, the FSA will also toughen regulations meant to prevent money laundering.

Starting point is 00:07:27 Intermediaries like wallet providers involved in stable coin transactions and management will be brought under the agency's oversight. They will also be required to meet obligations under Japan's law and preventing transfers of criminal proceeds, including verifying user identities and reporting suspicious transactions. Now, fascinatingly, NICA Asia's reporting on this brought the Evergrand Tether Connection, A connection I will continue to remind you does not exist except in theory. Quote, the debt crisis engulfing property developer China Evergrand has brought renewed attention

Starting point is 00:07:57 to the claims of stability by these cryptocurrencies. Tether, the biggest stable coin in circulation, is backed partly by commercial paper, a type of short-term corporate debt. Under scrutiny, the company said in September that it did not hold any commercial paper or other debt issued by Evergrand. I think that it is a marker of how little trust there is in Tether specifically, that this narrative has got such traction. This, I will remind you, isn't some random Dumburg publication or something like that. This is the Niki Asia. Finally, it's worth noting that Japan's new approach seems definitely to be influenced by the President's Working Group report on stablecoins, which came out recently and said,

Starting point is 00:08:35 quote, to address risks to stablecoin users and guard against stablecoin runs, legislation should require stablecoin issuers to be insured depository institutions, which are subject to appropriate supervision and regulation at the depository institution and the holding company level. Next, let's move over to the UK where there's not direct regulatory news, but an interesting development. Remember how earlier in the year, the UK's FCA, the Financial Conduct Authority, effectively told Binance to take a hike. Well, this week, Binance CEO, CZ, told the Sunday telegraph that Binance is working to become a registered crypto asset firm within the next

Starting point is 00:09:08 six to 18 months there in the UK. He went on to say that they've hired, quote, a couple hundred compliance employees. I sort of think it's quite positive that exchanges are willing to put in the effort even with tough regulatory regimes. It reinforces the notion that it's more than just a game of global regulatory arbitrage. Finally, India. A Reuters piece is making massive headlines today saying, quote, proposed India bill banning crypto payments could mean jail for violations. The source here is a source and a summary of the bill seen by Reuters. And my feeling on this is that I've now shared reports that this is going to be a ban, reports that it isn't going to be a ban, reports that it is going to be a ban again, reports that it isn't going to be a ban, reports that it's going to lead to arrest, and frankly, I'm just calling BS.

Starting point is 00:09:50 I'm not saying that the source is wrong or that this summary is off, but there is clearly a hell of a lot of confusion, and some things still very much unfigured out in the background. And for me personally, I'm not going to take anything seriously when it comes to the India crypto situation until we see the actual text of the bill that will be debated. Sources and summaries are just confusing the issue. Now to some Bitcoin market stuff. The block is reporting that institutions taking profits was part of the catalyst for the liquidation-driven crash last weekend. They wrote, the price of Bitcoin plunged below 43,000 overnight Saturday, falling from highs near 57,000 during Friday session.

Starting point is 00:10:30 While the price of Bitcoin has since paired some of those losses, trading executives tell the block that large institutional selling triggered a broader market shift. Specifically, one trading executive said that there appeared to be an institution that sold more than $500 million in Bitcoin. on Friday morning. The block goes on to quote Aya Kenterovich, who's an executive at Falcon X, who said, everyone has had a good year. And with this player coming from traditional finance, they have their eye on the macro environment, which currently looks shaky. That said, Aya went on. Across our desk, we are seeing a lot of OTC with primarily buyers coming in to take long exposure. Speaking of a good year, Grayscale did a survey that found that 25% of Americans they surveyed owned Bitcoin, and of those 55% said they started investing this year.

Starting point is 00:11:13 Now, all respondents in this survey were involved in investing with at least 10,000 in household investable assets and 50,000 in household income. 80% said they would be more likely to put money toward the asset class if a Bitcoin ETF existed, and there also was some show of shifting preferences in terms of how people interact with Bitcoin. In 2020, 75% said they preferred buying via exchange, while now almost 60% say they use a crypto-buying app. Finally, are NFTs headed to Wall Street? That's the speculation after Brian Roberts, the former CFO for the last seven years at Lyft, left to join OpenC as the new chief financial officer. In an interview with Bloomberg, he said he voted with his feet and that, quote,

Starting point is 00:11:54 I haven't been this excited about something in a very long time. It reminds me of 1995 eBay. Now, OpenC is speculated to be outraising a current round, and reports are that it's seeking about $1 billion at evaluation that's higher than $12 billion. Still, the real focus of this news is the idea that this means that OpenC is looking to go public. Bloomberg said that Roberts is, quote, known for shepherding Lyft through rapid growth to a successful IPO and adjusted profitability. Roberts, for his part, said,

Starting point is 00:12:22 I've seen a lot of profit and loss statements, but never a P&L like this. When you have a company growing as fast as this one, you'd be foolish not to think about it going public. It would be well received in the public market, given its growth. Now, the community has shared some pretty intense feelings about this possibility, and basically it comes down to a governance token versus an IPO.

Starting point is 00:12:43 It seems many have wanted OpenC to head into a deeper Web 3 direction and decentralize itself through community ownership. For my part, I'm completely agnostic to whatever decision OpenC wants to make and what is right for themselves, for their community, etc. What I think is notable is that this is now a conversation that companies will have more and more, a choice that they'll actually face. that alternative to a public market route through community-driven liquidity in the form of a governance token is a pretty monumental shift in corporate structure. I don't think that this will be

Starting point is 00:13:16 the last example that we'll be discussing that choice being made and having pretty big significance for a company in this space. So as you can tell, tons going on, lots of exciting stuff in this world. I think more fireworks to come this week. But for now, I appreciate you listening. And until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Is the Decentralization in DeFi an ‘Illusion’?

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