To foretell the future of decentralized finance (DeFi), the exploding new field in which decentralized governance protocols set and execute the terms for lending, borrowing and stablecoin issuance, one should look to the past.
Specifically, look to Wall Street’s past.
By some measures, DeFi is nothing new. It extends a four-decade cycle of ever-more sophisticated financial engineering – from junk bond financing to collateralized debt obligations to algorithmic trading. These waves of technological evolution have delivered spectacular profits to some, giant losses to others and lasting change to Wall Street, albeit while strengthening its large financial institutions’ dominance of our economy.
DeFi will face the same pattern: engineering, hype, speculation, bust and consolidation. (Yes, folks, the boom in “yield farming” and in the tokens loved by “degens” will end in tears.) Yet, it, too, will have a lasting impact, in ways we don’t know at present.
In eschewing the need for intermediation, the DeFi innovation wave lies, for now, outside of the traditional banking system. It’s a separation that should allow DeFi pioneers to experiment without grave risk to the wider population, enabling rich, real-world learning. Regardless of how much money investors win or lose, this iterative process will, hopefully, deliver more structural change than the financial engineering that’s come before.
DeFi definitely won’t free us of volatility. But it could free us from Wall Street’s version of volatility, in which powerful banking intermediaries, backed by regulatory privilege, perpetually co-opt technologies to cement their stranglehold over our economy.
Four decades, four innovation bubbles
Looking at four past financial engineering waves in traditional markets, it’s worth noting they did not necessarily involve digital technology. Periods of change are as much about new ideas in legal structures and risk management as they are about the…