A thesis on the future of DeFi, DAOs, and humanity
- The world is on fire, and we need to save it.
- DeFi can fund our world-saving.
- DAOs will do the actual world-saving.
- DeFi needs to unite behind the cause of world-saving starting today, or we’ll still be fucked.
DeFi protocols represent a radically new kind of entity, one that’s almost infinitely scalable in income, and at the same time blessed with the freedom to use that income at will. I claim that yield farming DeFi protocols will be the first for-profit non-state entities in history to be truly charitable.
This is a 4 part series of blog posts on saving the world using DeFi and DAOs.
- Part 0 is context on exactly how on fire the world is. It’s optional if you already agree that the world is on fire.
- Part 1 lays out why DeFi protocols are uniquely capable of funding charitable causes. If you want to be convinced that DeFi can actually save the world, this is the part to read.
- Part 2 talks about how an economy of Impact Certificates, funded by DeFi protocols, can generate startup-level funding for nonprofits.
- Part 3 will be concluding remarks and a call to action.
It’s gonna be a long ride, I hope you enjoy it!
Part 1: DeFi will eat the world, in a good way
In order to save the world, we need to secure a massive income stream dedicated to doing good. Given that the richest 10% hold 81.7% of all wealth, it seems reasonable to somehow get our money from them rather than the bottom 90%.
If we take a look at recent history, Internet startups have been extremely successful at doing this. Web 2.0 companies like Google and Facebook have been able to create revenue streams amounting to tens of billions of dollars annually (Google pulled in $160.74 billion in 2019; $70.697 billion for Facebook), most of which coming from ads. They were able to do this within just 20 years, starting from relatively humble positions. Newer startups seem to be growing even faster:
- Snapchat achieved more than $1 billion of revenue in 2018, 7 years after launching in 2011.
- TikTok achieved more than 100 million installs in under 2 years after their global release, with their parent company ByteDance reaching $75 billion in valuation.
These company are, on the high level, doing two things:
- Firstly, they’re transferring value from the 1% to themselves. More concretely, big & wealthy companies who need advertising pay these Web 2.0 companies huge sums in exchange for ad placements; likewise for SaaS companies.
- Secondly, they’re creating value. Not only are they making products that provide practical value to their users, they’re also pulling value out of thin air by gaining stock valuation: the companies themselves are engines of wealth and impact, so the right to share in their profits and influence their decisions is intrinsically valuable.
If we were able to efficiently transfer value from the 1% and create value on our own, just like the Internet startups, and use this newly acquired value on doing good, then even if we couldn’t obtain enough value to solve something like climate change, it would be a good place to start, and it would certainly be better than what we have now.
Green bonds are an example of a mechanism that transfers wealth from the 1% to do good. Green bonds are issued by corporations as well as supranational organizations like the World Bank, who dedicate part or all of the proceeds to causes that help with climate change and environmental sustainability. In 2018, over $167 billion of green bonds were sold, which is over 15 times the amount sold in 2013.
Why is the green bond market seeing such a high level of growth? Because green bonds provide the right incentives. Not only are green bonds on the same level of security and credibility as traditional bonds, as they are backed by the entire balance sheet of the issuing organization, they are also treated favorably by governments, who often offer tax incentives for investing in green bonds. In addition, including green bonds in your investment fund’s portfolio is a good way to show that you’re environmentally conscious to your investors and the public; good PR is good PR.
The emergence of green bonds demonstrates that the 1% are perfectly willing to spend their money on good–as long as they’re getting a decent profit from doing so. That said, it doesn’t seem like green bonds are providing sufficient incentives, given the fact that the global bond market is over $100 trillion, and the fact that the annual revenue of just Google and Facebook combined easily surpasses the annual green bond issuance. Moreover, the growth of the green bond market is constrained by the balance sheets of the issuing organizations. For these reasons, I don’t think green bonds will save the world, but I certainly hope I will be proven wrong on this point.
DeFi combines the best of both startups and green bonds: DeFi can swiftly innovate and produce incredibly valuable products like startups do, as well as present attractive investment opportunities to the wealthy like green bonds do. DeFi will be a money vortex, sucking in massive amounts of value from the wealthy.
I claim that yield farming will bring about DeFi protocols that not only can attract & create more value more efficiently than the likes of Google and Facebook, but also is capable of voluntarily spending a considerable portion of that value on doing good. Yield farming DeFi protocols will be the first for-profit non-state entities in history to be truly charitable.
I don’t want to waste my breath on explaining what DeFi and yield farming are, so here are good places to start:
- What is Decentralized Finance (DeFi) by EthHub
- What is Yield Farming by Zerion
- Yield Farming in DeFi by DeFi Rate
In case you’re too lazy to read them, here is my oversimplified explanation. DeFi, or decentralized finance, refers to financial protocols built on (mostly) the Ethereum blockchain, offering services like lending, exchange, insurance, and so on. Yield farming refers to the practice of DeFi protocols distributing equity tokens to their users based on value-added usage, which has so far allowed the protocols to offer extremely attractive return rates for short periods of time, from 50% to 3000% annually.
1. DeFi can capture the multi-trillion dollar financial market
DeFi protocols are insanely cost-efficient. First of all, once developed and deployed, DeFi protocols require next to no technical maintenance or continuous expenditures. This is because their business logic is implemented using smart contracts, which are run autonomously once they’re deployed to the blockchain. Servers? Databases? Don’t need them. Don’t need to pay for them. If a DeFi protocol was designed by anyone competent, its necessary daily expenditure is exactly zero. You don’t even need to hire more people as your protocol grows, since it can run perfectly fine without your help, meaning teams building DeFi protocols can be very small, consisting of anywhere between 1-20 people.
DeFi protocols not only have zero expenditures, they also have zero cost margins. Namely, providing services to 1 user costs a DeFi protocol the same amount as providing services to 1 billion users: zero. We have seen zero margin companies before: the reason scrappy two-pizza Internet startups have been able to become so successful so quickly is largely due to the fact that they can provide their services at close to zero margins.
Of course, just having zero expenditures and zero margins does not make something automatically successful or powerful: a writer selling ebooks on the Kindle store has zero expenditures and zero margins (at least for the writer), but you don’t see writers becoming billionaires in droves or saving the world. The third element, which combined with zero expenditures and zero margins makes DeFi insanely powerful, is right there in the name: finance. DeFi protocols are zero expenditures, zero margins financial products. Needless to say, the market size of financial products is orders of magnitude larger than the market size of independent writers.
What happens when you’re extremely cost-efficient and fast-moving in a multi-trillion dollar market where your competitors are slow-moving, outdated, and expensive? You fucking win. That’s DeFi.
And no, DeFi is not just fintech. Traditional fintech startups, when compared to DeFi protocols, have become part of the slow ones.
- Fintech products have expenditures that scale with the number of users, DeFi has zero expenditures.
- Fintech products have to spend a shit ton of money on lawyers in order to get all the right permits and maintain regulatory compliance, DeFi doesn’t, because we’re decentralized baby. (What are they gonna do? Sue a DAO containing thousands of random pseudonymous folks from all around the world?)
- DeFi protocols can literally create new assets and classes of assets out of thin air, which fintech products can only dream of doing.
Given these advantages, DeFi protocols can provide better financial products at much lower costs. Moreover, yield farming rewards allow DeFi protocols to provide fundamentally higher returns to investors and liquidity providers. It’s just fucking better. As DeFi matures and traditional investors have a better understanding of it, I wouldn’t be surprised if tens, if not hundreds, of billions of dollars will be deposited into DeFi protocols annually in the next 10 years. I predict that DeFi protocols will make the likes of Google, Apple, and Facebook look like small fries in 20 years. (Don’t email me if I’m wrong)
2. DeFi is uniquely capable of using its income on doing good
DeFi protocols are in a rare situation that makes them uniquely capable of doing massive amounts of good, at least in the near future. For starters, they are competing in finance, a multi-trillion dollar market, making their potential income enormous. In addition, and this is important, DeFi protocols tend to face low competitive pressure, which gives them precious breathing room that the vast majority of traditional corporations and startups can only dream of. It is this breathing room that gives DeFi the free energy necessary for doing good.
Why do DeFi protocols face low competitive pressure? In a word, composability. The most important thing that DeFi protocols compete for is liquidity, but liquidity in DeFi is superfluid, meaning that I could deposit liquidity in protocol A, get some A tokens representing my deposit, and deposit those tokens into protocol B, get B tokens, which I could put in protocol C…rinse and repeat. This is not just theory, it has been going on for months: right now, you could deposit DAI into Compound, get cDAI, and put that into a Uniswap pool to earn trading fees on top of the interest from Compound. You could theoretically go further and put those Uniswap pool tokens into Aave to earn more interest (unfortunately Aave doesn’t support the cDAI/ETH pool token as collateral…yet). The superfluidity of DeFi liquidity means that the competition for it is not a zero-sum game, making collaboration more sensible than competition.
Moreover, the rise of yield farming has made protocol composition more attractive to liquidity providers than naïve protocols. For instance, Compound rewards COMP tokens to liquidity providers, and Balancer rewards BAL tokens to liquidity providers, so what do you do? You put your money in Compound, get cTokens, and deposit cTokens into Balancer. This way, you earn both COMP and BAL. This means that liquidity providers are actually incentivized to put their money in multiple protocols at the same time, further incentivizing DeFi protocols to work together rather than fight tooth and nail. (Further reading: Aquaponic Yield Farming)
Of course, I said “low competitive pressure”, not “no competitive pressure”. So what will competition in DeFi look like? For starters, if two protocols are doing essentially the same thing and can’t be reasonably composed (e.g. Uniswap and Bancor), they’re still gonna have good ol’ head to head competition, and the leanest & meanest one will dominate, just like everywhere else. Where DeFi differs is in the indirect competition for liquidity. For instance, in traditional fintech if your money is deposited in Robinhood, then that money can’t simultaneously be in deposited in Acorns, even though Robinhood and Acorns are two completely different products; this represents indirect competition between Robinhood and Acorns, and between every fintech product and every other. This is not a problem for DeFi, due to the superfluidity of liquidity: your liquidity in Curve can simultaneously be in a Balancer pool, your liquidity in Uniswap can simultaneously be in Aave, so on and so forth.
The presence of indirect competition in traditional fintech means that every company will try to build a product that does everything, so as to keep the user’s liquidity within their system, making cooperation a fever dream and resulting in a battle royale where everyone is trying to kill everyone else. We already see an analogy of this happening in the arena of social networks, where networks are competing for the users’ time and attention by trying to have every imaginable feature; this happens because a user can’t simultaneously watch a YouTube video, read Facebook posts, write a reply on Reddit, and do a livestream on Twitch. (Well, you theoretically could…but why would you live like that?)
On the flip side, the absence of indirect competition in DeFi means that the end state will likely be a large number of protocols who are doing entirely different things cooperating and composing with each other, making it easier for protocols to form alliances for charity, and of course making the competitive pressure much lower.
Because of this low competitive pressure, DeFi protocols can feasibly spend a significant portion of their income on doing good, rather than being forced to spend the money on some silly arms race and falling into the Malthusian trap. This property, combined with being zero-expenditures and zero-margins, makes DeFi protocols a radically new kind of entity, one that’s almost infinitely scalable in income, and at the same time blessed with the freedom to use that income at will. Words cannot describe how important and amazing this is.
3. Ensuring DeFi doesn’t turn evil through democratic governance
DeFi protocols often release equity tokens, which entitles the owner to governance rights and a part of the protocol’s income. Basically like traditional equity, except it’s on the blockchain, and it’s 100x easier and cheaper to create. Examples include COMP, YFI, AAVE, and BAL. Through creating these equity tokens and decentralizing the governance process, DeFi protocols have been able to amass at least hundreds of millions of dollars of valuation within the span of a couple of weeks, if not days. For example, the YFI token, an equity token released by yearn.finance, saw its market cap grow from $0 to $100 million in just 7 days.
The interesting part, and what differentiates DeFi protocols from traditional corporations, is how these equity tokens are distributed. Yield farming distributes equity tokens to users of the DeFi protocol, based on the amount of liquidity or value-added usage they provide. This can be done in different fashions. On one side of the spectrum, we have protocols keeping large chunks of equity tokens for the developers and their investors, nominally decentralizing their protocol but not really, making their setup not much different from traditional corporations. On the other end, we have protocols giving the entire supply of equity tokens is given to the users, resulting in (purported) fair distribution, true decentralization, and emergent grassroots governance, which is best exemplified by yearn.finance with YFI.
This kind of “yield farming” is interesting, but nowhere near revolutionary or even new. Both Uber and Airbnb had plans for distributing equity to their drivers/hosts, though eventually were stopped by the SEC. The idea of distributing equity to users of your product is still operating within the paradigm of corporations, shareholders, and directors. As long as you’re still using equity–transferrable and tradable–the distribution of the governance power will eventually resemble the distribution of wealth which, as I’ve extensively shown in part 0, is stupidly unequal. It will be the same story all over again: a couple of wizkids build an incredibly valuable thing in a garage and become filthy rich, along with their early backers, and choose to spend the new wealth on not saving the world, not solving world hunger, and not fighting climate change.
However, it’s a step in the right direction. Giving significant governance power to a large number of people with diverse interests makes the governance system far less likely to do obviously evil things, and opens up the possibility of the system actively doing good things. For example, if the vast majority of Uber shares were held by drivers and riders, it seems far less likely that Uber would still refuse to pay above minimum wage to its drivers, and it might even dedicate a significant portion of its income to providing driver benefits and improving service quality, if the economy permits. Therefore, what yield farming DeFi protocols should implement is actually democracy, where every user has the right to participate in the governance process and no individual should have significantly more power than the others, rather than a corporate plutocracy where power lies with the already rich and powerful.
If we want to ensure that DeFi protocols become engines for doing good, we must first pull our heads out of the corporate paradigm. We must start treating DeFi protocols not as corporations but as nations, and start treating the users not as shareholders but as citizens of these new digital nations.
What does this mean concretely? A few things:
- Governance power should be far less liquid. This is for preventing a wealthy party from straight up buying a large amount of legitimate power in the governance system. There are many possible ways to do this, each with different tradeoffs:
- You could use non-transferrable reputation tokens rather than transferrable equity tokens, though this negatively impacts the yield farming aspect.
- You could still use a transferrable token, and have a vesting period for the newly minted tokens generated in yield farming. This is not ideal though, since whales could still buy governance power.
- You could use quadratic voting with a transferrable token to limit the power of whales, though an identity system is required for sybil-resistance.
- You could use a transferrable token with conviction voting, which is designed to amplify the voice of voters with persistent preferences, prevent plutocracy, while being sybil-resistant. It has some other nice properties too, such as not having last minute vote swings. I’d say this is the best solution of the bunch, except there’s no way to vote against a proposal, so it wouldn’t work for many systems. It also can’t guard against takeover by persistent whales.
- Governance power should not be distributed solely based on the amount of liquidity provided. This is also for the sake of preventing the dominance of whales. There should be multiple ways of being rewarded governance power, such as making code contributions, organizing community events, writing analyses of governance proposals and so on. Something like SourceCred could also be used for automatically incentivizing community contributions.
- Rather than merely focusing on nurturing the DeFi protocol, governance systems should have a clear purpose or ideology regarding what it hopes to achieve in the wider world. For instance, a protocol might put “bank the unbanked” as its purpose, and therefore it spends funds on reach-out programs in developing countries. The governance system should never make nurturing the protocol the ultimate end, but a means to achieve its purpose, for a system focused solely on its own perpetuation will never amount to anything great.
If we are able to build a DeFi protocol with a democratic rather than plutocratic governance system, we will unleash a force for good the likes of which the world has never seen. If, on the flip side, DeFi protocols are allowed to grow exponentially while still using a plutocratic governance system, I fear the force we unleash will be one of evil, the likes of which the world has also never seen (well, we kinda have an idea of what it would look like, based on how Facebook etc. turned out). These are two equally plausible worlds, the one we end up in is up to us.