Try to Deny DeFi
Most years are marked by an event or moment that cause markets to adjust in some way or another. Maybe it comes in the spring, or perhaps in the fall (historically a fave), nevertheless, these events are often minor when viewed in the rear-view mirror and are healthy adjustments to capital flows into the markets. Sometimes, though far, far, less often, we receive events that provide a trajectory change. It’s fair to say we experienced such an event in 2020. Unlike other historical moments, this one came at a time of unprecedented pace for both information and capital flows. The combination produced moves in both society and capital markets that are nothing short of incredible. They are generational. And they are perverted unlike we’ve ever seen before.
Both institutions and main street were caught off guard just 9 months ago when global indices and markets melted at a speed we hadn’t seen in recent memory. We had some shelter in the U.S., but it didn’t take much effort to glance at Europe where some markets showed decades of returns wiped out in weeks. Granted, these markets had lagged our domestic tech enforced indices; nevertheless, the numbers and pace were shocking. It was a moment in time, for as quickly as asset values fell, central bankers emerged with their 2009 tool-kits and unleashed more calculated stimulus and asset support than anyone could have imagined. Once more, the pace of capital flow was shocking. There was no big moment of distress and Warren Buffett’s phone didn’t even have time to ring.
The ensuing rally in securities was, once again, unlike we’d seen in a generation dating to the 1930s. Within weeks, many people were expert epidemiologists, global macro traders, and hoarding toilet paper. Many industries were about to advance more in 6 months than they would perhaps in 5–10 years. The use of technology as a means to replace manual activities was ignited, and much of it would never look back. While most in society would see this affect their food or retail shopping, or perhaps their means of connecting and sharing over remote video and content platforms, the ground was quietly shifting beneath a far larger industry: finance.
With the aforementioned monetary moves underway, and with global debt monetization crushing fiat currencies, the pace of adoption of a narrative around digital “hard” assets, in particular bitcoin, rocketed higher. This base layer move is profound and has yet to really play out in this author’s humble view, but it’s not yet technology replacing manual activities, per se. Where that is happening is in the decentralized finance, or DeFi, ecosystem. Somehow, a bunch of young programmers and creatives, many of whom without finance backgrounds, found innovative ways to replicate several traditional financial services, like lending, borrowing, and derivatives, among others…and they did it better. That’s a theme in digital finance we should all get used to: taking legacy financial services and simply making them better (and with less). Combine DeFi with the broader wave of fintech and we’re cooking with kerosene. What used to take armies of manpower and infrastructure on all ends of a transaction in the banking system, can now be done over a smartphone with the code doing the rest (yes, I am oversimplifying).
I’m the first to acknowledge these are very early days in the digital space, particularly DeFi, but the pace of change and innovation is something yet to be appreciated by many. Further, much of this ecosystem is feeding off the growth in bitcoin and employs leverage upon leverage with more than a dash of speculation. It’s a touch of the wild west, but you can see the writing on the wall. Regulations will come and markets will rise and fall. Leverage will be wound up and explode on the way out as networks and protocols are tested and refined. But make no mistake about it, the secular change in traditional finance is underway, and much like the virus in 2020, it will leave its mark in every corner of this industry. Buckle up.
