DeFi risks and the decentralisation illusion | Hacker News Reader

DeFi risks and the decentralisation illusion

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91 pointswallflower132 comments

The decentralisation illusion argument seems weak. One could have claimed the same about the early internet: Early internet wasn't truly decentralized as there were still ISPs, and you still need to register your domain with a centralized entity.

This misses that the big change is one of access. Content creators were able to reach a large audience without playing ball with the big publishers or newspapers.

With defi, the same can happen with finance. Marketplaces, exchanges and new financial instruments can be created by anyone that follows programmatic rules. Complex & expensive relationships with legacy banks are no longer required.

You don't require a bank in the same sense that you don't require a baker. If you want to make your own bread, go head, nobody is stopping you. But in a modern society people engage in division of labour and specialisation, because this allows us to be orders of magnitude more productive and have things that we couldn't dream of making ourselves. People don't want to make their own bread, and they don't want to be their own bank either.

Maybe someone does want to create a very special and expensive type of bread and sell it worldwide.

In order to accept payment, they must become a merchant with some centralized entity (Paypal, Mastercard, Visa). They must hope they live in the subset of countries where this is allowed. They must agree to a one-sided TOS that can be changed at any time. Then they must hope that all their buyers are honorable and trustworthy as those entities favor the buyer in a dispute.

This is not an optimal state of affairs for the aspiring artisan bread maker.

>They must hope they live in the subset of countries where this is allowed.

Although the overlap between this subset, and the subset of countries with reliable international shipping, is pretty high.

Relevant if your product is literally bread. Not so relevant if it's photography or software or news reporting or comedy sketches.

And even if it is bread, having one problem is better than having two problems.

Depending where you live, there will already be restrictions who you can do transactions with (sanctions etc.). So irrespective of technology the world doesn't quite accommodate this at present.

Or they could sell their bread locally for cash only.

Or they could make their own payment processor if the existing ones weren't doing a good enough job for them.

There are a lot of avenues to work around the cartel of the banking industry, and I am a fan of any implementation that ignores the unconstitutional Bank Secrecy Act. Crypto does fall into this category but is not the only method.

'Or they could make their own payment processor...'

Theoretically maybe. Money transmission laws will likely trip them up. Big barrier to entry.

Yes, that's why I stated that crypto was still applicable. You get the benefits of money transfer without the barriers to entry (except maybe in converting to and from fiat).

>People don't want to make their own bread, and they don't want to be their own bank either.

Speak for yourself, I quite like the idea!

> People don't want to make their own bread, and they don't want to be their own bank either.

But they aren't saying you have to be your own bank, by opening it all up, more and more people can be "banks" and that helps to decentralize finances from the handful of Big Banks.

I'm not saying that random person down the road should be allowed to create a bank that others then trust with storing their assets, and I will still keep the majority of my assets in traditional banks, but as a whole, less power concentrated in the few is better for everyone.

I definitely agree that competition is very important, I don't think there are many doubts about that. I just don't see how DeFi can bring competition to the banking sector by allowing people to become banks. Ordinary people becoming a bank is not realistic competition to actual banks. People have jobs, they have work to do, they have to raise a family, they're not going to become competent bankers on top of that and outcompete professionals, even if they tried.

I'm going to preface this with I have no idea how any of this ACTUALLY works, and I'm probably wrong, but the "blockchain" abstracts all the more complicated bits away. I'm not a crypto diehard, and probably never will be. I think they are neat, and I have about 10% of my net worth tied up in a handful of coins. Here is my understanding how we can all be banks without even really thinking about it.

Some coins (PoS specifically) allow staking, which allows you to set it aside a certain amount, which is then used to validate other transactions, and you earn rewards. In traditional banking, this is kind of like a CD, and your money is used to help the bank out and it pays you interest on that.

The Ethernet (and a few other coins Solana comes to mind) ledger allow for the creation of smart contracts (applications that run on the blockchain) that could (probably some already exist) allow you to automate the creation loans on the ledger, witnessed by the world, that automatically pay you back. You can probably use the smart contract to do a modicum of due diligence on the borrower. But instead of paying SynapseFi (or other but first name that came to mine) thousands a month to allow you to build out loans, its all there for you on the block chain. This probably IS the future of peer2peer lending, as it is already a HUGE industry, and this would kind of get rid of the middle man.

One aspect of banking that is not really needed anymore would be the storage of assets. That is a built in part of cryptocurrency.

There is still the question of how do you get crypto, and for now, and until more people use it for everyday actives, that requires exchanges. And Exchanges could be seen as a centralization of sorts, but even they are a dime a dozen so they are effectively decentralized. And most support transferring to a wallet. So... kinda decentralized.

The idea that banking activities can be automated and that therefore people will be able to ditch banks and do their own banking without resorting to professional banking services is unreasonable, for the simple reason that if this could be done, banks would have already done it, since they have every incentive to reduce costs. They would have laid off all the staff and replace it with a smart contract. They haven't done it because it can't be done, because banking has processes which are labour-dependent and can't just be automated away easily or at all.

Have you considered if much of this is due to debt-based currency? If people hold valuable fungible tokens, it becomes possible to make collateralized loan products and even synthetic stable tokens such as DAI.

I don't know what you mean by debt-based currency, but no I don't think that using tokens instead of currency changes anything. The process of granting and managing a loan is exactly the same regardless of whether the loan is denominated in currency or in some token.

And it turns out the only people wanting to make novel financial instruments on crypto currency are scammers.

Most of the "novel" crypto financial instruments aren't necessarily "novel" so much as "made illegal in a century ago because of fraud and scams".

Or at the very least "things with clear risks that crypto plebs are oblivious to"

https://www.bloomberg.com/news/newsletters/2021-05-11/money-...

Care to show one or two financial instruments that were claimed to be "novel" but were made "illegal a century ago"?

https://www.bloomberg.com/opinion/articles/2015-06-19/bitcoi...

This is six and a half years old, wasn't about a novel defi instrument but about derivatives, and derivatives aren't illegal. They're also now well implemented in DeFi.

were they made illegal for my safety?

network effects are real though. That's like saying that anyone can make a blog or anyone can make a facebook , but good luck with that. the problem is that , unlike bitcoin, VCs will control all the dominant network effects.

Instead of having to curry favor with bankers, you now have to do so with a clique of developers, lest they hard or soft fork your crypto out of existence.

“The development community is proposing a soft fork, (with NO ROLLBACK; no transactions or blocks will be “reversed”) which will make any transactions that make any calls/callcodes/delegatecalls that execute code with code hash (ie. The DAO and children) lead to the transaction (not just the call, the transaction) being invalid, preventing the Ether from being withdrawn by the attacker past the 27-day window. This will later be followed up by a hard fork which will give token holders the ability to recover their Ether.”

Vitalik Buterin in response to the DAO Vulnerability on June 17

This is the actual issue with DeFi's "decentralization", not what the article talks about.

Bitcoin remains the only decentralized cryptocurrency that keeps living without governance.

At this stage of maturity, ETH would never survive a fork like that,

which is pretty evident given the umpteen hacks that have happened since going unabated!

First off, this probably only holds if you sort of ignore current rules and regulations in a lot of cases (e.g. KYC, AML, securities laws, clearing requirements, reporting etc.). But to be fair, there is a discussion to be had if all those regulations are fit for purpose.

Second, banks do a lot more than just be middle men in financial markets. They do have risk bearing capacity and they are willing to - crucially - use that on uncollaterized risk and things not netted atomistically. This means the demand for liquidity is kept low - which is good because money can flow towards longer term objectives.

Risk is the only issue. Regulations are to ensure banks have the risk-bearing capacity that they say they do. A formalization of risk-bearing capacity, if you will. However, are banks the only ones with risk-bearing capacity? And if not, and especially if such capacity can be programmatically verified, is there still any benefit to banks?

There is a ton of regulations aimed at proper functioning of markets unrelated to banks.

In uncollateralized situations you cannot verify/verification is meaningless as you might not be able to claim what you verified.

Let me pose the question thusly: Is there any decision making process by a bank, even ones executed by humans, not formalizable programmatically, provided sufficient information? If not, then what's to prevent decentralized finance from working just as well, provided the same information into the system?

Human intervention is required more than you might think in the current banking system. Mistakes, fat fingered numbers, wrong accounts etc. None of it is resolved without humans with authority.

Unless you can build an authority into the system somehow for dispute resolution, the system will always favour bad actors and fraud.

The big push for no-authority, decentralised finance sounds wonderful, but the reality is if the system is inherently biased toward fraud and crime because of a lack of dispute resolution, fraud and crime is what you are going to get.

1. I wonder how much of this still holds in a potential future world where machines are making decisions in most aspects of life already.

2. It doesn't follow that you can't have some recognized authorities within decentralized finance to negotiate fallback cases. For instance, the role of banks could become merely to supply information related to human authentication, not most of market operation.

I guess you could set it up that way, but then you create the problem of competing authorities - it's the same problem that the internet has with DNS. At some point, it has to have a single source of truth. The blockchain itself isn't enough when what is recorded on the blockchain is potentially not what the actors intended (or is what a criminal intended in a fraud scheme).

Competing authorities seem like a feature not a bug. It allows for experimentation and evolution of governance models. International law works this way and is what allows people to “vote with their feet”. There is no actual requirement for a single source of truth.

That seems kind of different in a way, the different authorities cover different countries where laws are different.

It almost seems like to make it work you would need...regulation.

At the sharp end, I'd say there are such non-formalized "processes" in place. For example, market making is not really programmatic for low liquidity stuff (and no, AMMs are not good for price formation absent arbitrageurs). Dealing with sudden changes to the state of the world is another. Heck, simple price formation for shares is totally not formalized.

Also, not clear how defi would do on balance sheet money creation (at least to me) if we are replacing banks. (And what about all the other players in the financial ecosystem?)

What about the most traditional business of a bank: providing security and paltry interest for deposits, intermediated by the bank, as capital for loans. Now DeFi can certainly do each of these, but crucially the traditional system also decouples the risk for depositors. The return of deposits is NOT contingent upon the performance of the loans, by both regulation and deposit insurance. Is there a defi solution for a similar system?

1. The way you'll provide the real-world information won't be decentralized (it'll be some kind of oracle).

2. The costs of decentralized finance are too high.

What I dont understand is how they calculate rates for loans. I dont know much about DeFi and just consider it as scammy as NFTs, but for me a lending rate is always function of a default risk: too high, no loan, high, high rate, low, low rates.

I've worked in fintech and am in a bank now and we've always had our proprietary mapping table with field studies of default stats and long attribute lists (age, immigration status, salary, number of other loans, number of past default, other assets and so on), and the key was to either religiously stick to these or take strategic decisions to open the valves if needed (say to fit a quota, we let the younger people in for a while).

How is DeFi doing lending rates ?

Edit: got it, over collateralized with valuable collateral confiscated rather than promised so not fit for the same purposes as normal consumer loan. You wont pay your daughter's sweet 16 mega party in mexico or your son's wedding in Singapore or your first car in France with a DeFi loan :D So it's not exactly decentralized finance, it's more decentralized leverage, I guess. At least you cant default a DeFi loan, which sounds reassuring on paper.

All loans are overcollateralized, and basically used for leverage: put up your bitcoins as collateral, borrow stablecoins, buy more bitcoins.

So the risk is limited as long as the loans can be liquidated in time in case of a price crash.

The rates are determined the ratio of all stablecoin liquidity provided vs the amount actually borrowed. Liquidity providers can remove liquidity at any time, and so the smaller the remaining liquidity buffer gets, the higher the fees gets.

Most of the rates are dynamic: i.e. the interest rate on your existing loan can increase drastically if there is a liquidity crunch. In practice your interest is charged as though it was extra borrowing and so lowers your liquidiation threshold.

On the flip side, the dynamic rate also means that as the liquidity gets thinner, the interest rate paid to liquidity provider gets higher, meaning it incentivizes liquidity deposits when they are most needed.

> put up your bitcoins as collateral, borrow stablecoins, buy more bitcoins

Nothing could possibly go wrong with this, right? Tether is found to not have the reserves they claim and it plunges, and the artificial demand for bitcoin disappears and it plunges as well.

DeFi loans are over-collatoralized usually by 1.5-2x.

If you want to borrow $100k, you put up $200k in collateral.

Sorry I don't get it. Why would you lock up 200k in order to borrow 100k? Why not just use part of the 200k you already have?!

If you believe that the value of Bitcoin is going to go up, it makes sense to lock is as a collateral and spend the borrowed fiat instead of selling the Bitcoins.

Is there a part of the system that keeps working even if the value of bitcoin stops (being believed to keep) going up all the time?

If ETH or some other new token takes more and more mindshare from btc isn’t that a big inflationary pressure on the crypto ecosystem as a whole? More tokens = less valuable tokens.

At some point buy the dip will turn into cash out.

If the value of Bitcoin stops going up, sooner or later your debt grows larger than the amount you were allowed to borrow and your collateral gets liquidated by someone who implemented the fastest liquidator bot.

https://docs.aave.com/developers/guides/liquidations

To lever gains. Now you can "own" 300k worth of bitcoin gains with only 200k worth of bitcoins. Of course the downside is that loses are levered too.

To retain the price exposure of the asset worth 200k while avoiding selling or spending it.

Different tax treatment. Locking up to buy something with the loan doesn't expose you to gains.

You gotta pay the upline!

> So the risk is limited as long as the loans can be liquidated in time in case of a price crash.

If I may guess, it seems unlikely there are too many folks in DeFi circles who have ever heard acronym LTCM.

(TL;DR: A bunch of actual Nobel laureates (no kidding, or at least as much as Nobel price in economics is an actual Nobel) founded a huge and famous hedge fund with a trading strategy assuming they can liquidate their position at market prices. At this point you may guess that it ended tits up and was kind of a mess. Time will tell if DeFi folks were smarter than that.)

It really sounds like fun and games until it all comes crashing down...

Then again if it's all crypto and everything goes down at once, I suppose there isn't too big issue. Apart from losing some fiat, but they who cares about that in cryptoworld...

Collateral is sold off automatically once they breach some threshold (varies, but it's always > 100%), and there are bots that compete to do this as quickly as possible. This is in no means perfect, but it is quite responsive, and did survive crypto's March 2020 price crash.

There were some denial of service issues that on Ethereum during the March 2020 crash that caused Maker DAO to have some Zero bid liquidations and the protocol had to mint and sell off some of Maker's token to keep all the issued DAI properly backed. This did not happen again in the crash in May, which was nearly as steep, but the protocols all kept functioning as expected.

Loans are overcollateralized, so you need to put in the same or more amount of capital that you're loaning out. That may not seem useful at first, but it allows you to have exposure to multiple assets. For example, you may want to use ETH temporarily, but you only have BTC. But you want to keep your BTC investment for the long term. So you're putting up BTC to borrow ETH. You keep your exposure to BTC, but you have liquid ETH.

It's the same concept as putting up your house as collateral. You don't want to sell your house just because you need some liquid cash temporarily.

> It's the same concept as putting up your house as collateral.

The crucial difference is in a mortgage loan the borrower keeps the collateral and gets to use of it, e.g. live in it, while they pay off the loan, whereas in a DeFi "loan" the lender has to keep the collateral the whole time.

Surely the DeFi loan should be a "smart contract" that just locks the asset from transfer until either default or repayment.

Yes, the "smart contract" keeps it. The point is the borrower doesn't get to keep the collateral. This makes DeFi loans unsuitable for a large number of purposes.

What's an example of something you'd want to "do" with your crypto asset while using it as collateral? Obviously you can't spend it, give it away, use it as collateral for another loan etc as that would conflict with the first loan.

But you can do other stuff. For example you could covert ETH to one of the many tokens that represent staked ETH (rocketpool rETH for example) and use that as collateral. Now you are have collateral and staking revenue with the same funds.

Well, that's the point, 1) you need 100% collateral, 2) the collateral needs to be in the form of digital tokens and 3) it needs to be kept in custody by a third party (the "smart contract"). Yes, you can still do useful things despite these limitations, but at the same time be aware that 99% of the borrowing/lending activity that goes on in the real world is not possible with this technology.

This really sounds most like gambling. And not a financial instruments that is very supportive for economy. Like let's say company loaning money to purchase equipment.

Yes, these loans can't be used to fund investment or consumption in the real economy. The only use-case of crypto-loans, as far as I know, is making leveraged bets on the prices of crypto-currencies.

Why not? One can easily borrow USDC or another stablecoin with crypto collateral, withdraw to USD and use it for non-crypto investments..

Because if I already have $10,000 to put as collateral, to get a $10,000 loan to buy a $10,000 car, it means I didn't have a need for borrowing funds to begin with. I can go straight to buying the car without borrowing money. Whereas if I need to borrow the funds, I won't be able to get the loan because I don't have the 100% collateral required.

Using the BTC as collateral lets you stay long BTC and get the car. You also avoid paying capital gains since you aren’t selling.

The positions are fundamentally different. If you take the loan you are long BTC and short dollars. If you sell BTC for the car you have zero of both.

Yes, we had already established that. The point is that requiring 100% collateral does not allow the borrower to trade future consumption for present consumption, which is the whole point of borrowing as far as consumer and businesses are concerned. This is why DeFi loans are unsuitable when it comes to funding consumption or productive investment.

Uncollateralized lending in DeFi is very nascent (right now primarily targets crypto businesses, and are typically ran by centralized companies who have launched a protocol on chain).

TrueFi, Maple Finance, and Goldfinch are the biggest and primarily have permissionless lenders and kyc'd borrowers. Some of those borrowers may make consumer loans (Goldfinch is like this).

Permissionless uncollateralized borrowing has yet to take off (even though contracts for this already exist and are live), but I suspect it will once decentralized stablecoin on chain supply gets decoupled from current centralized stablecoin supply (decentralized credit based stablecoins built on top of incentivized permissions management of on <-> off chain flows [via over collaterlized decentralized stablecoins and centralized stablecoins alike] and on/off chain risk [via derivatives]). Decentralized derivatives protocols will be key to permissionless uncollateralized lending growth imo, but we are not there yet (I think we need to continue to see global markets break down more in OTC/CCP IRD's and tradfi counterparties continue to lose trust with one another in derivative transactions for this to grow faster in DeFi).

I can see that in the next 10-20 years, 20% of the eurodollar system with be contained within (multichain) permissionless DeFi protocols as HNW individuals and tradfi institutions outside of the US abandon CCPs and typical OTC derivatives txs.

I won't have to argue with folks at ihsmarkit like I do now for making EOD CDX data public (like it was before they were acquired by shit & pee global), when I can pull it from on chain contracts in real time.

I think you're not understanding the fundamental problem that uncolletarelised DeFi lending faces, which is the fact that the borrower can simply walk away with the money. None of the companies that supposedly offer uncollaterilised borrowing do what they claim to do. This is obvious if you read the fine print. And it's to be expected, because if they did, borrowers would borrow all the available funds and walk away, never to be seen again. That's not a sustainable business model.

> I think you're not understanding the fundamental problem that uncolletarelised DeFi lending faces, which is the fact that the borrower can simply walk away with the money.

I understand it very well, that's pretty much the risk to be mitigated (or not) by who the loans are extended to on the protocol level (when not trying to do it in the KYC/ofchain legal agreement way which is how its done now for the most part). Pools of capital can be lent to specific actors in a non permissioned way that can be governed by the the protocols users or on/off by the on chain contracts themselves automatically when certain on chain conditions are met.

Also, for the non corporate uncollateralized lending in defi now through flash loans (i.e. via Aave), it is impossible for the borrower to walk away from borrowing the funds because the loan must be paid back in the same transaction or entire transaction reverts. However this isn't appropriate for typical consumer loans.

Currently, a lot of the centralized companies with their protocols on chain mitigate the risk just by restricting the pool of borrowers to those who they can legally go after to recoup any losses in the event of a default (just like in tradfi, but still the risks remain).

In the case of a derivatives protocol, writers can borrow against buyers deposits (instead of having to put up their own stablecoin deposits to back the writing) to open positions with the expectation that the writers can write enough volume to net out the delta most of the time while capturing a spread. If/when they (the writers in the derivative liquidity pools) can't and if enough addresses choose to withdraw the decentralized overcollateralized/centralized stablecoins from the protocol (rather than transferring/swapping their protocol credit to another address who wants to buy or write derivatives, or use as a unit of accounting outside of the protocol) and there is a shortfall, decentralized overcollateralized/centralized stablecoin yielding debt tokens can be issued by the protocol automatically (as well as raising decentralized overcollateralized/centralized stablecoin collateral requirements across the board for writers who haven't been cleared by protocols risk management contracts or by some kind of on chain governance) to those trying to withdraw who can sell it on a dex at a premium or discount to par value of the stablecoin yielding debt token.

The risk doesn't go away in tradfi with all the uncollateralized lending now, it gets spread throughout all the actors of the system in various ways, much of which isn't very transparent to all actors in the system (and even for those in the know, it is not in real time). The same (spreading risk through various actors that engage with the protocol) can be done in a DeFi context minus the opacity we have now (we all can see what addresses have/done what, regardless of whom/what is behind the address).

There isn't going to be a one size fits all approach to uncollateralized lending in DeFi. Protocols will do it differently based on what the users see fit to do with their funds and will manage the risks in many different ways (some of which will be better than others).

Thanks for the information, but none of that addresses the problem I described earlier. All these pseudo-decentralised lending platforms that you mentioned happen to rely on a central party that "approves" borrowers. Once a borrower gets "approved" they sign a loan agreement with the central party. In the case of default, the central party can initiate legal action against the borrower. This is how these "decentralised" loans work. The only reason they work is because they aren't decentralised at all. They're conventional loan agreements that are enforced by courts of justice. The pseudo-decentralised platform plays the same exact role as a financial intermediary in conventional finance. Decentralised lending platforms where borrowers can get uncollateralised loans DO NOT exist. The technology does not allow it. There are no mechanisms through which make the borrower repay the loan.

> Decentralised lending platforms where borrowers can get uncollateralised loans DO NOT exist. The technology does not allow it. There are no mechanisms through which make the borrower repay the loan.

They do exist, Aave allows for this, there is no one to approve the flash loan. Just that you can only borrow the funds for specific context that I described and the borrower will have to pay off the loan or the loan wont be made and will fail. You can't do this at all in tradfi.

> They're conventional loan agreements that are enforced by courts of justice.

And even if these happen traditionally, no defi involved, the borrower many not be able to pay of the loan. Risk will be eaten by someone. Courts of justice can't squeeze blood from stone. But Aave doesn't face this risk. Maybe other protocols will, but thats the risk people have to accept when they engage with the different protocols.

As a curiosity, a "flash loan" is a loan in which the principal is received and repaid simultaneously and therefore has little practical utility, other than facilitating wash trading and other forms of market manipulation, which are prohibited in regulated markets.

I guess there's those like yourself that would deem it of little practical utility for anyone to borrow permissionlessly and without a large pool a capital of their own to take advantage of arb opportunities that arise in markets (and make those markets more efficient for those that use it). Luckily, defi participants are not bounded by your opinions.

It's unclear whether these flash loans can even be used to exploit arbitrage opportunities. Arbitrage involves simultaneous transactions in different markets, whereas flash loans only allow simultaneous transactions in the same blockchain. Anyway, arbitrage is not a sufficient condition for market efficiency. There's plenty of evidence showing that crypto-markets are rife with fraud and are anything but efficient.

The borrower does keep the collateral in that it's only use to them is the gains it provides. Those gains still belong to the borrower.

CeDeFi (Centralized Decentralized Finance, websites like Coinbase, Nexo, Blockfi, Celsius. Registered companies with licenses that will often advertise as being the same as onchain DeFi services) offer fixed rates to customers, while they earn much greater variable rates in DeFi platforms, they pocket the difference. Just like TradFi (traditional finance) lenders we are all familiar with, the spreads are just much bigger right now, as expected in growing economies.

DeFi platforms are offering variable rates based on how many farmers and how much value is deposited that is trying to earn the same fixed amount of tokens, and those tokens current exchange rate. They are using present/historical data, as well as current exchange rates. These are not projections. Also do notice that APY, and APR are used interchangeably and inaccurately and not in any uniform way across platforms. Platform developers typically just choose whichever number shows the greater percentage.

Some DeFi platforms are just diluting their own token for some time, or indefinitely, and people earn that and hope the exchange rate support the greater supply long enough to convert out. Some DeFi platforms are successful at building a demand model and utility to offset the supply. Other DeFi platforms are doing something monetarily productive that earns the platform money which is distributed to stakers or farmers.

Hope that helps. There is no one way to evaluate or dismiss all defi products with a yield, but there are some patterns to look for and to understand why they attract so much capital on deposit so quickly. Much of the capital comes from CeDeFi looking for yield that won't cause them to loose all the customer money.

Small nitpick but CeDeFi is a term coined by Binance to make them appear more palatable and competitive. Binance is a centralized network so it's a CeFi foundation with all the controls that come with that, but with a DeFi coat of paint.

Coinbase is a centralized exchange (Cex, not a Dex) so it has little to do with DeFi in general.

a) who cares who coined it, it is a classification used by many and quickly conveys the shared concept that matches that classification, which is the overall point of language

b) Coinbase is many products. Coinbase Staking is the one that matches what was described above. Don't conflate the front facing CEX for everything they offer. No different than Amazon not being a bookstore, nor just an ecommerce platform. It is many products. The context was solidified amongst several other products with similar offerings. Coinbase's various CEX products have nothing to do with their Staking product (or the Lending one they were going to try, of Vault or several others)

a) it does matter because despite what you think CeDeFi is only there to create confusion in the industry. Centralized decentralized finance. Which is it?

b) staking has nothing to do with DeFi

so for anyone passing by (this isn't a response to you any more I no longer care what you think but I do care what others think)

Banks and brokers that offer exposure to the defi market are called CeDeFi because you could interact with DeFi yourself with no restrictions but the organizations that help you are just banks and brokers so it is a centralized company layer on top of the defi market. Those come with restrictions.

Their staking products allow you to provide them with liquidity, similar to a deposit at a bank or certificate of deposit (CD) at a bank, where they take your balance and put it in DeFi products to make a better yield for themselves.

I recommend reading Compounds white paper. They are a big player and have a decentralized protocol which establishes money markets with algorithmically set interest rates based on supply and demand.

https://compound.finance/documents/Compound.Whitepaper.pdf

Borrowing money in exchange for a promise to pay it back isn't really a thing in defi (and I'm not sure it ever could be?) All DeFi i'm aware of is based on borrowing less than the value of some asset you stake to assure your repayment. It's definitely a different thing than most people think of when they think 'loan'

The comparison to banks as shock absorbers is pretty rich. It has been only 12 years since banks caused global recession due to secrecy and greed. At least the decentralized options are more open, despite any flaws, which would be shared by centralized finance anyways.

A mix of centralized and decentralized seems the safest.

Their entire point about defi not being decentralized is almost entirely false.

Uniswap the company is entirely disconnected from the uniswap router which is what defi really is. The uniswap router is what completes transactions on the blockchain. Not the uniswap website. The uniswap website simply provides a front end for interacting with the uniswap protocol.

You can easily, like less than 100 lines of code, write your own implementation of the uniswap swap functionality. This is why it truly is decentralized. Uniswap the company has no way of preventing you from doing that in their v1, v2, or v3 router.

Further they themselves are not running the router. Anyone who is running an eth node, or miner is running the router. So yes, uniswap has a financial interest in making a commercially successful product. But that product is uniswap.org/app

It is not the smart contract. The smart contract is what makes it decentralized.

Their only argument besides the financial interests of the companies who created the first defi products is claiming that blockchain rewards lead to concentration. Which is the same argument that has been made since bitcoin was first launched, but every single day the likelyhood of any sort of attack related to concentration becomes less likely. As more people start their own mining operations and start hosting their own node.

If someone wanted to centralize the chain they missed their opportunity. Because it is simply not feasible for it to occur at this point.

Like usual, old school economists desire to control crypto markets. But they know they aren't able to and won't ever be able to so they write ill informed articles filled with factually incorrect claims in order to misled policy makers to implement laws to attempt to regulate the industry. Which will also fail.

Agreed, you see this misunderstanding constantly here and it makes it hard to take the valid parts of any counter-arguments seriously. De-centralization doesn't mean that there are no centralized UI winners. It's that if those winners disappear overnight (https://nftplazas.com/hic-et-nunc-finds-a-solution-after-sud...) or start to abuse their power, people can just move to alternatives and the company has no power to lock them in. HackerNews would love this kind of "data portability" hedge against the classic google deletion of chat apps and other services.

The blockchain just provides a decentralized trusted authority to ensure that the portable data is authentic. Without this, any data portability solution would have a problem with spoofing, or the data would require another centralized authority to validate the data which defeats the purpose. I guess you could argue the government could be that authority but idk how that works in a global sense.

Having a data portable chat app is sketch if someone can just make up messages and import them into their new 3rd party app. it's dangerous/unworkable if the application is something with more consequences like defi.

Lost me at "lack of shock absorbers such as banks" - DeFi has lots of flaws, but it takes truly a sheltered economists to think that banks absorb shocks!

I will pay attention when Goldman Sachs starts to hand out stimulus money or even loans in a crisis to absorb the shock

Banks hand out loans to mitigate localized shocks all the time, which is one thing that prevents them from turning into more macro shocks.

Exactly - for instance, if the commercial paper markets don't function, paychecks don't get issued.

You make it sound as if the ability to create loans is an intrinsic property of banks, as opposed to it being a licensed monopoly granted to such institutions by the state.

Anyone can give out loans. Having enough capital to give out tons of loans simultaneously, though, is yes a semi-unique feature of a bank.

> Lost me at "lack of shock absorbers such as banks" - DeFi has lots of flaws, but it takes truly a sheltered economists to think that banks absorb shocks!

My car has a bumper. It's not valid to claim it doesn't absorb shocks because it can't absorb all the shock of a 20mph collision. A similar situation might be the case here. It's quite plausible that banks absorb all kinds of shocks all the time, but we have a distorted view because the shocks we tend to hear about are the ones they didn't absorb (or didn't absorb as smoothly as usual).

> I will pay attention when Goldman Sachs starts to hand out stimulus money or even loans in a crisis to absorb the shock

Isn't the fed a bank and hasn't it done things similar to "hand[ing] out stimulus money or even loans"?

The US government responded to the 2008 financial crisis with the Dodd-Frank Act of 2008 to protect everyone against the kind of speculation that caused that financial crisis.

Much of the financial legislation that regulates banks, payment systems, and other intermediaries is created in response to fraudsters and scammers.

There are lots of "shock asorbers" that you might not be aware of. In the US payments system, a pull-based payment system, when a merchant makes a request to pull funds from your bank account, your bank is liable for the funds if they authorize the transaction. This protects the merchant from not receiving their money. The whole network is filled with debits and credits and liabilities.

In fact it already is a distributed system that mirrors the social and political structures of moving value.

Another shock absorber is that state chartered banks that handle a certain volume of transactions must first prove they have enough funds in reserve to serve their liabilities. Again to protect consumers.

It's quite a fascinating industry and if you want to learn more about it there is an excellent book to get started [0].

However don't take the US system as the ideal model. There are more modern payment networks and protocols that enable transaction settlement in near real-time that is much more convenient and common in places like the EU and Canada.

[0] https://www.amazon.com/Payments-Systems-U-S-Third-Profession...

> The US government responded to the 2008 financial crisis with the Dodd-Frank Act of 2008 to protect everyone against the kind of speculation that caused that financial crisis.

Let's review the 2008 financial crisis.

The was a thing called a credit default swap. It's a type of insurance. If you make a loan, and the borrower fails to pay you back, the insurance pays you instead.

The insurance actuaries did the math on how much these should cost based on the historical rate at which homeowners paid back their loans. They also calculated that most of the claims would be offset by the ability to foreclose on the house, so they'd only have to pay to the extent that the homeowner owed more on the mortgage than the house was worth. That seemed pretty unlikely, right?

Enter moral hazard. If you're a bank buying credit default swaps, you don't care one bit whether the borrower can pay back the loan, so you issue loans to everybody. Banks issuing loans to people who can't afford them inflates a housing bubble.

The regulators who should have seen this and said "hey wait a minute" instead said "neat, they're promoting home ownership" and just let it happen.

Then when those borrowers, in fact, can't afford the loan payments, they default.

Around the same time, the insurance companies figure out that they fucked up real bad, so the price of credit default swaps goes way up and banks stop buying more of them. Which means they stop wanting to loan money to people who can't afford to pay back the loans, and the housing bubble pops. That puts the existing loans underwater, which would bankrupt the insurance companies, which would in turn bankrupt the banks.

Then the "solution" became to set interest rates to zero to reinflate the housing bubble, where they've been ever since, and we now have an even bigger housing bubble than we did in 2007.

The cause of this was not a fraud or a scam. It wasn't "buffers" or anything like that. It was incompetence. Nobody wants to admit that, because anyone could have asked the question, what does a credit default swap do to a bank's incentive to vet creditworthiness? But they didn't.

A good deal of US banking legislation came into being in response to various crises. Like the Federal Reserve Act in response to the Panic of 1907. It's pretty normal.

A lot of this legislation exists to provide buffers to protect people from all kinds of situations. That's why we have legislation and regulation.

> A good deal of US banking legislation came into being in response to various crises. Like the Federal Reserve Act in response to the Panic of 1907. It's pretty normal.

It's also the financial equivalent of invading Iraq in response to 9/11.

Anyone with sufficient capital and willing to take risks can be a shock absorber. The particular organization of such individuals such as into banks is merely an abstraction.

And this means ... What exactly? If it takes individuals willing to take risks then the crypto space has plenty of them. Are you saying that the point the authors are making is therefore not valid?

It's real plank-in-your-own-eye stuff that all the crypto-huggers will dismiss the BLS analysis so readily at the line about banks acting as a risk buffer. Yes, to be sure! Banks present risks, massive risks, risks which should have been and still should be much better managed, at both bank and government levels — but boy howdy, are you in for a treat, you should see what happened to a financial system in the bad old days, when there were banks but no deposit insurance, and there would sometimes be a run on the banks, and they lose all their customers' cash, and the shock waves ripple through the whole economy.

Now let's do the exact same thing in the crypto-verse, except with even dodgier loans, even more pathetic capital buffers, and, by the way, rampant fraud and bank robberies. It is only by the grace of obscurity and irrelevance to anything that matters that crypto-finance as a whole doesn't suffer widespread derision and fear a hundred times worse than the banking crisis.

Crypto: Capital buffers? What's that.

We didn't see it in our due diligence list.

Here is a summary of that list:

i mean yeah, that is one of the reasons why people are into crypto

>"you should see what happened to a financial system in the bad old days, when there were banks but no deposit insurance, and there would sometimes be a run on the banks, and they lose all their customers' cash, and the shock waves ripple through the whole economy."

It is my understanding that there was never a run on a solvent bank; runs were the consequences of bank failures, not the causes of them. It should also be pointed out that most bank failures were clearly caused by so-called 'unit banking', where the government prohibited banks from having multiple branches in diverse areas. Less-regulated banks (such as those in Canada and Scotland) suffered fewer failures, and had no issues with runs.

Historical bank runs were associated with a variety of causes; while some were caused mostly by bank failure due to asset shocks, others (e.g. the panics of 1893 and of 1933) were clearly marked by contagion, and even healthy banks were ruined by runs. https://eh.net/encyclopedia/banking-panics-in-the-us-1873-19...

(+ Postscript for original post: I typoed BIS as BLS because I'm used to the latter, oops)

> [...] crypto-huggers will dismiss the BLS analysis so readily at the line about banks acting as a risk buffer. [...]

For the past decade we've found out -- annually -- that internationally regulated financial provider X/Y/Z is banking narco terrorists, or sheltering funds for politicians, or being the final off-ramp for ransomware.

> Now let's do the exact same thing in the crypto-verse, except with even dodgier loans [...]

Guess it depends on your definition of "dodgier". I grew up with unregulated pay-day-loans being in every strip mall in Ohio.

> [...] rampant fraud and bank robberies.

The IC3 report <https://www.ic3.gov/Media/PDF/AnnualReport/2020_IC3ElderFrau...> on state-side fraud implies the per-capita rate of Americans scammed in 'normal banking' far exceeds the rate of Americans scammed by crypto.

> For the past decade we've found out -- annually -- that internationally regulated financial provider X/Y/Z is banking narco terrorists, or sheltering funds for politicians, or being the final off-ramp for ransomware.

A scandal, to be sure! You have, indeed, identified the mote of dust in your brothers' eye. But while it's certainly bigger in absolute terms, you should try it as a percentage of transaction volume. The only reason that crypto doesn't blow it totally out of the water on crime volume is that crypto remains obscure, only marginally relevant to the real world.

It's like telling me that there's more crime total in the US than there is in Haiti. It's technically true — and yet, Haiti is much dangerous.

Nonsense. Free banking systems worked fin in Scotland and Canada on a gold standard, and would arguably work even better in an internet connected society. Central banks exist purely to give governments full control over money.

About BIS: The BIS mission is to support central banks' pursuit of monetary and financial stability through international cooperation, and to act as a bank for central banks.

> It is difficult to get a man to understand something when his salary depends upon his not understanding it.

This, but applied to crypto bagholders

no one depends on their cryptocurrency like their salary or retirement savings. the total market capitalization of cryptocurrency is basically the total amount of wealth humanity is willing to just throw away

Weird how every time there's a crash there's suicide hotline posts on all the subreddits and crypto news websites then

The psychological momentum of BIS far exceeds that of crypto. BIS and affiliated parties are comprised of thousands of old guard who have built their career and sense of self worth on the belief what they are doing is necessary and beneficial for society. Crypto participants are at max involved a few years and overwhelmingly young 20-somethings.

Just as science advances one funeral at a time, so too will this whole industry. It will help if we just stop debating whether crypto assets are real to begin with, and accept that this stuff isn't going away.

The psychological momentum of cryptobros far exceeds that of central bankers. Cryptobros and affiliated parties are comprised of thousand of vanguard who have built their entire financial future and self worth on their very limited life experience and ignorance of even the most basic economic principles and history, and a technological screw driver behaving as a hammer looking for a nail. BIS participants are, at minimum, involved for decades in global finance and markets with exceptional educations and understanding of the forces at work, unpredictable and unstable they may be.

Just as popular ignorance driven by hype, buzzwords, and FOMO has lead to bubble after bubble, victimization by ponzi schemers, and endless financial fraud, so to will the crypto space. It will help if we just stop debating whether crypto assets function in any way differently than a ponzi scheme and acknowledge they have zero capability of scaling as a currency to meet the demand of global finance, particularly while providing no security or recourse against basic human error like incorrect payee, charge backs, identity theft, etc, and are nothing more than a speculative asset with zero intrinsic value waiting for the next greater fool to come along.

"Just accept that my bags will always be around and eventually worth more than I paid for them"

No, I don't think I will

Your comment takes me back to the 90s when fax machines were superior to email.

You're clearly not paying attention to the space.

Everybody in this space is 20-30 years old. Bet against demographics, I dare you.

Email and crypto are definitely comparable in their utility, usefulness, and technological advancement /s

Your comment takes me back to the late 90s in the dotcom bubble when everything was revolutionary and definitely not a scam

For a hot minute I thought there might be truly scalable and cheap POS DeFi system with validation running on my phone. If this was an easy technical problem, an answer would already exist. There are plenty of POW/pre-mined/centralized coins, but even ETH/DOT have little to show in terms of progress here. POS/POW DeFi blockchains haven't scaled so far despite plenty of tries. This is fact, and hard to refute. Just look at transaction fees, TPS, and level of centralization.

"Little to show"? You're not paying attention.

You seem to like Helium, and I see that their gateways cost ~$1000, where as The Things Network seems to point you to RPi hats at ~$200. If the crypto innovation is effectively making the network more expensive to use and increasing the cost to build it, all so the operators/miners can earn a little on the side, this doesn't seem like innovation at all. Seems like you could do this with some sort of micro payment scheme (where the initial cost can be paid off), especially since LoRa seems to cater to industrial IoT mostly.

If you had a solar powered Things Network, it would be effectively free to use, and you could add more nodes as required at a cheaper cost.

Helium has solved the coverage problem through creating deployment incentive. You're missing the point of helium to such a large degree your post almost sounds like satire.

Someone looking at TCO might think differently. Someone looking at expanding the network at 5x the cost likely would think differently.

LoRa also seems to be a proprietary standard owned by a single company, regardless, there have been mesh networks built with public and private funding that do not artificially keep costs high for longer than needed. If this isn't the goal for Helium, it would be tough to recommend or use.

Just in: The central bank of central banks (BIS) is propagandizing against the decentralization of the banking system. To the surprise of no one.

I have been saying this for a while: DeFi depends on CeFi (Centralized Finance). Coinbase depends on people connecting their bank accounts or credit cards to fund their accounts. Coinbase's value was created through an IPO on the NYSE - the mecca of centralized finance...

It seems however that defi can be redesigned to be truly free from centralization.

I guess this is related to @jack's tweet today. He was talking about VC-funded web3 however, not about defi in general

> it is impossible to write code spelling out what actions to take in all contingencies

It sounds like two economists are struggling with the concept of software and systems engineering.

It sounds like economists are much more realistic about the feasibility of bug-free immutable software.

If their argument was about the insanity of no-one doing model checking, I'd be on board. But that's not their argument.

it's not fair to say that all economic transactions are going to have unaccounted contingencies. There are plenty of transactions which are just dead-simple, and when automated they don't need a middleman

How do so many coins offer absurd APRs for staking?

It's the same principle as junk bonds. The less people believe that their principle will be recovered, the higher the APR to incentivize buyers. If some $100 coin offers you 100% APR, you best believe it's not likely that your original coin is still going to be worth $100 at the end of the year. More likely you'll have 2 coins worth $50 each now.

There's a massive bubble with people throwing money into anything and everything.

The APR is paid in the coin itself, not dollars, so they just inflate the supply to pay the "yield".

So is it popcorn time now? :)

Looks like the banks(and some countries) are sharpening their swords against cryptocurrencies.

This report has been written by old-school economist. I would suggest not pay attention much.

Why?

Reply on news.ycombinator.com