From the invention of Bitcoin fifteen years ago have sprung a variety of financial and social revolutions. Decentralized finance is one of those inventions along with the Metaverse, blockchain technology and blockchain-related gaming, non-fungible tokens, and more crypto tokens than you can count. DeFi, as decentralized finance is often referred to, is the closest invention in this realm to the original purpose of Bitcoin. This was to provide a way to carry out financial transactions on the internet without paying for the services of or suffering the interference of third parties. Like all parts of the crypto universe, decentralized finance has been affected by the crypto winter.
Decentralized Finance Operations Have Taken Losses
The prices of Bitcoin, Ether, and the rest fell to lower and lower price plateaus over the last 15 months as the Federal Reserve raised interest rates in an attempt to stem the worst inflation in forty years. Over a year or so crypto tokens fell on average by two-thirds. As crypto prices fell, many Defi businesses suffered and even filed for bankruptcy. Large, diversified companies working in DeFi and acting as crypto exchanges, like FTX, have gotten in hot water as their efforts to avoid financial collapse skirted the law and resulted in charges of fraud.
Is There a Problem With Decentralized Finance?
Following all of this from a distance one might be tempted to think that there is a basic flaw in the concept of decentralized finance. We do not think so. The problem with DeFi is not in the concept but rather in the implementation. We have previously likened the businesses and crypto celebrities like Sam Bankman-Fried to the robber barons of American industry in the late 19th and early 20th century. Cornelius Vanderbilt and John D. Rockefeller amassed wealth that when adjusted for inflation made them the richest people ever who were not royalty that owned whole nations (like Genghis Khan) making them about twice as rich as Bill Gates or Jeff Bezos.
Doing Business in an Age of Continual Expansion
Bitcoin started out being worth a fraction of a cent. The famous first Bitcoin purchase was for $25 with 10,000 BTC for two Papa John pizzas in 2010. The same 10,000 BTC were worth $10,000 in 2013 and by the last Bitcoin peak in November 2021 they were worth $67 million! Despite several peaks and valleys along the way, Bitcoin and other tokens “always went up.” We are talking about a rather short investment horizon from early 2017 to 2021 but for the crypto world this was how to view the investment horizon. By comparison the New York Stock Exchange was founded in 1792 and has endured significant down periods like the 1929 market crash that lasted until 1932 and the entire Great Depression that only alleviated with government spending in World War II. The point of this history lesson is that so many people investing in and trading crypto currencies and especially those running DeFi businesses had reason to believe that the best business plans were founded on the belief that crypto values would continue to steadily rise against the dollar and other world currencies. But that did not happen.
What Happens to a Leveraged Business When Leverage Does Not Work?
First there were stablecoins that went bust because they used computer algorithms to manipulate their value instead of having a hard currency to back up the value of their tokens. Then there were Defi operations that made money by accepting dollars, making loans in cryptocurrencies, and profiting as the value of the crypto currency steadily outpaced the dollar. This was, for a time, a very profitable way to do business. Then it wasn’t as companies received loan payments in devalued tokens and did not have the wherewithal to pay back their dollar loans. Folks like FTX moved tokens from one branch of their business to another giving the appearance of solvency when, in fact, they were bleeding capital and already flirting with bankruptcy when giving the appearance of running a profitable business.
Unregulated Industries and Accumulation of Wealth
Back in the 19th century in the US there were no laws against monopolies. Rockefeller owned Standard Oil which drilled for oil, refined oil into gasoline, and owned gas stations. He would move into a state and cut prices below his cost of production until his competitors went out of business. Then he would take over their gas stations, raise prices, and move on to the next state. There was no income tax and folks like Rockefeller, Carnegie, and Vanderbilt became rich beyond belief. When laws were enacted to regulate how large businesses operated and to break up monopolies, such fortunes became more difficult to accumulate until the era of the internet. Although people like Bankman-Fried did not, as of yet, accumulate the sort of wealth seen with Rockefeller, they engaged in questionable business practices that, had their operations been regulated, such regulation could have prevented collapse and bankruptcy.
The Future of DeFi
Decentralized finance is an excellent concept and will not disappear even in a prolonged crypto winter. Companies that apply practical business plans and remain solvent will grow and prosper as they find more and more ways to provide financial services to those who are currently underserved by traditional financial systems.
How Has Crypto Winter Affected Decentralized Finance? – SlideShare Version