When The Revolution Comes, It Will Be Decentralized

The Real Lessons From History And The Need To Start Planning For Decentralized Financial (Defi) Markets

When we are thinking about where the trajectories of Bitcoin and cryptocurrencies, “smart” “contracts” and decentralised finance (or “defi”) will lead to, it can be helpful to find historical analogies. These can provide a shared narrative both to facilitate communications between stakeholders and to provide foundations for strategic planning. But it’s important to find the right analogies and even more important to derive the right lessons from them.

Here’s the obvious example: people discussing Bitcoin will often refer to the famous “tulip bubble” in 17th century Holland. But if you study this episode, what you discover is not a mass market mania that devastated the economy but speculation by a small group of rich people who could well afford to lose money. And you will also see that it led to the creation of a regulated market that played a role in the financial revolution leading to a Dutch golden age which meant that balances at the Bank of Amsterdam became a pan-European currency and, as noted in an interesting paper from the Atlanta Fed last year, meant that the florin (the unit of account for those balances) came to play a role “not unlike that of the U.S. dollar today”.


I am very interested in learning from a) history and b) smart people so I set up a room to discuss the topic on Clubhouse. I have to say this transformed my view of Clubhouse, because I was blown away by the quality of the discussion that ensued and how much I learned in such a short time. Truly, arguing with smart people is by far and away the fastest way to acquire actual knowledge!


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Aside from tulips, one of the other well-known bubbles is Britain’s 19th century railway mania. This particular example is worth studying because I agree with Nouriel Roubini and Preston Byrne’s observation that that the cryptocurrency mania of today “is not unlike the railway mania at the dawn of the industrial revolution in the mid-19th century”. If you want to read more about this, I wrote a detailed article about it a couple of years ago and, in fact, noted the incredible scale of the railway mania in Financial World magazine a decade back: The first railway service in the world started running between Liverpool and Manchester in 1830 and less than twenty years later the London & North Western railway had become the Apple AAPL AAPL of its day, the biggest company in the world! This boom in turn led to a colossal crash in 1866, which then led to a revolution in accounting and auditing.

In the Clubhouse chat, my good friend Maya Zahavi drew attention to the parallel between railway mania driving the introduction of accounting and auditing standards that led to new global capital markets in Victorian times (which in turn led to new kinds of regulation and institutions) and defi: The world of financial services, including lending, exchanges, investment and more that are built on shared ledgers and smart contracts. I think she is right and I have long held the view that while cryptocurrencies themselves may or may not have a future as money, the evolution of digital assets that are secured by the underlying networks (“tokens”) points towards new services, markets and institutions that may well lead to a better financial sector.

Tokens Are The Future

The view that digital asset tokens are where the next generation of financial services will be forged was reinforced for me in a new paper published in the Federal Reserve Bank of St. Louis Review. In it, Fabian Shar explores the evolution of markets based on tokens that sit on blockchains of one form or another. He looks at three models for what he calls “promise-based” tokens: tokens with off-chain collateral, tokens with on-chain collateral and tokens with no collateral (what others would call “algorithmic” tokens).

  • Off-chain collateral means that the underlying assets are stored with an escrow service, for example, a commercial bank. There are already several examples of off-chain collateralised stablecoins. The most popular ones are USDT and USDC which are both USD-backed tokens on the Ethereum public blockchain. (And before anyone bothers e-mailing me, yes I know there are questions about what constitutes “backing” but it’s not the point of this article.)
  • On-chain collateral means that the assets are locked on the blockchain (in a smart contract). So, for example, I might want to obtain token XXX but I don’t want to sell my Bitcoins, so I will lock up the Bitcoins and borrow XXX against them.
  • Algorithmic tokens’ value is maintained by wholly algorithmic market interaction around supply and demand. (This was, incidentally, the original meaning of the word “stablecoins” that has now been hijacked by imprecision.)

The trading of these tokens, if it were to take place in existing market infrastructures, would be interesting enough. But to Maya’s point, this is not where we are going. We are heading into an explosion of business models, institutional arrangements and transactional complexity which, when it settles, will leave us in a different kind of financial world. I strongly agree with the view of Jay Clayton (when he was chairman of the U.S. Securities and Exchange Commission) that “everything will be tokenised” and for me and a great many others, the obvious corollary to this is that everything will be decentralised.

The argument isn’t only about liquidity and efficiency. It also, and most importantly (for reasons I have discussed before here in Forbes), means a more transparent market with accountability as part of the infrastructure. The St. Louis Fed’s paper concurs, noting that defi may contribute to a more robust and transparent financial infrastructure. In the long run, I think this (and the lessons from history are clear) will be much more important and lead to much greater structural change (and therefore opportunities) than cryptocurrencies.

Revolution Is Justified

While defi is now mainly used for speculation between tokens of many varieties, in the longer term it offers the promise of much reduced costs in financial intermediation by both removing middlemen and automating them, it opens up the possibilities for new financial instruments better suited to the new economy (instruments built for bots to trade, not for people to understand). In summary then, there are good reasons to welcome what is a genuine paradigm shift in financial markets. The word “revolution” is, in this case, wholly justified because the instruments and institutions will be unlike the ones that have grown up since the industrial revolution.

Don’t be put off by the Wild West of defi as it stands now, begin your scenario planning for defi as it will (inevitably) become.

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