We should change the name of DeFi to DePawn. It’s just a pawn shop

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Credit: Rick and Morty

Everybody in the the Ethereum world is fascinated with the apparent success of Maker Dai, the latest “pivot” in the never ending ETH story (see Footnote).

Finance is such a BIG part of the economy. It includes banking, insurance, securities trading, wealth management, retirement planing, mortgage loans etc.. So the idea of “decentralizing” it sounds .. amazing.

But like all things ETH, there is the vision and the reality. This grand unified field theory can be summarized in graphs like this one:

In other words: its all moving to a pyramid with Ethereum as it’s base. Well, not actually Ethereum, because that doesn’t work. Instead a new, improved ETH 2.0 that’s not even in beta yet.

OK, so what actually do we have. We have Maker Dai, which operates pretty much like a pawn shop. You give the pawn shop your collateral (Rolex watch, Gun) and you get a chip that you can cash out for $100 at the counter. If you want your watch back, you have to pay interest. And like DAI, the interest rate is set by the Pawn Shop Management.

Not surprisingly, a number of people in the ETH ecosystem are in need of cash loans. Despite ETH’s trajectory from $1,500 to $130 there are still quite a few hard core believers. Some of them are “ETH Rich / Cash poor”. When Dad gets sick or taxes are due, the idea of selling their ETH at a “distressed valuation of 15 billion” is distasteful. They would prefer to take a short term dollar loan against their ETH. Some are even so bold as to want to use that loan to buy more ETH.

Maker DAI serves this need via smart contract. If the ETH in the smart contract collateral dips below 150%, it is automatically liquidated.

A total of 3 Million ETH, or about 450 MM USD is locked into these DeFI contracts. That may sound impressive, but there is a total of 109 Million ETH in circulation making this percentage (2.7%) basically a rounding error. The only thing it is saying is that people need loans, and there is a demand for a “decentralized stable coin” with no KYC.

Note that Maker DAI really has nothing to do with ETH at all. It’s just a smart contract that was first deployed on the ETH Blockchain. A similar contract, Equilibrium, has been deployed on the EOS Blockchain.

Also note that the fact that there is a demand for ETH DAI does not imply upward pressure on ETH price. In fact, while the the ETH locked into DeFi went from 2.2 to 3MM in the above graph, ETH went from 185 to 130. The correlation is, if anything, negative.

Pawn Shops use rolexes and guns to produce cash. The fact that people like cash and can use cash does not increase the demand for rolexes and guns. In fact the only reason this occurs on ETH is because ETH has a high market cap. The arrow goes this way

High, Liquid Market Cap → Demand for Loan Product

Not the other way.

Also note that FinCen has determined that “It does not matter if the stablecoin is backed by a currency, a commodity, or even an algorithm — the rules are the same,” Which means that this non-KYC DAI could be regulated out of existence just like Libra.

Footnote: Short History of ETH Pivots

  • 2016 ETH first positioned as a “World Computer”. This “new decentralized Internet use case” never actually took off. At all. What did take off was
  • 2017 ETH as a vending machine for ICOs. That lasted 12 months.
  • 2018 ETH still held hopes as a “dApp” platform. No actual dApps ended up getting deployed to ETH. Too slow, too expensive.
  • 2019 fourth “pivot to DeFi”.

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