Over the last three weeks, I have been hearing more and more chatter about DEFI — “Decentralized Finance”, which is centered around the idea of making high interest rates by lending out your crypto.
Could lending your crypto be the killer app of crypto? Interest rates worldwide are low and the idea of making 10% by lending out your Bitcoin, Ethereum or even Stable Coin is appealing. Several wallets, including Monarch now have big “LEND” buttons, and other services like Celcius are growing to over 400MM in assets under management. The numbers are starting to be big.
So why worry? In short, black swan events. As a young quant trainee at Salomon Brothers on Oct 12 1987, I watched on the Salomon Brothers trading floor as the idea of “portfolio insurance” got destroyed in 24 hours by the stock market crash. https://www.nytimes.com/.../a-computer-lesson-from-1987...
The problem is feedback effects. Collateral is lent to companies which face margin calls, which cause liquidiations, which cause things to fall further. DEFI promoters will note that DAI survived the ETH fall from 1500 to 150. But DAI was not a big percentage of ETH at the time. The DEFI numbers are starting to get big. We have yet to see a daily CRASH of ETH in the sense of the fall of Lehman, Enron, etc.. This could absolutely happen, and if you ask me, is actually LIKELY to happen.
Consider the following scenario. ETH flash gaps 30% for some exogenous reason (ETH 2 delayed etc.). DAI faces liquidations. There are insufficient buyers. We now start liquidating the underlying token. That too finds few buyers and crashes. Panic sets in. ETH is (for the time buying) down 80%. Billions (potentially) that were thought to be invested in “high yeild” are wiped out. The authorities step in and start putting everything on lock down.
I don’t want to channel Taleb, but we are potentially setting ourselves up for something very ominous. I don’t know if it is happening in 2020 or even 2021, but I feel that it will happen and that (as Rob Behnke says) it “won’t end well”.
Furthermore, to me the idea of ETH being a store of value as a backer of DAI is too meta. ETH needs its own value story. I can tell you that ETH is not going to work for apps in the next 12–24 months. I had hoped EOS would work, but I am pretty certain that it won’t either, which is why we built LynxChain.
Of course there are platforms Tron, Flow etc.. We are at the beginning of the “crypto app” story. This thing has already changed massively in the last 12 months, and I am sure it will continue to change. But it’s a clear use case of crypto. Games and dGoods seem to be a great use for crypto. Stable coins backed by real assets like MetalPay, Libra and Carbon seem very appealing to me. ETH as sole value being backing for DAI and Compound seems like a recipe for disaster,