DeFi Mania Proves We Learned Nothing From the ICO Run-Up

10 September 2020

Last week, the eminent anthropologist and co-founder of the Occupy movement, David Graeber, passed away aged just 59. His tome on the origins of money and finance, “Debt: The First 5,000 Years,” should be required reading for anyone involved in crypto. Ranging from Mesopotamia to Manhattan, just about every page is filled with a salutary lesson or insightful parable on how over the millennia value came to be represented in either physical form or on a credit and debit ledger. 

Take this from Page 348. Detailing Londoner’s stock mania following the meteoric rise of the South Sea Company of the early 1700s, Graeber quotes this contemporary account of one of the many very profitable start-up stock swindles that followed in its wake. 

“The most absurd and preposterous of all [the schemes] which showed more completely than any other, the utter madness of the people, was one started by an unknown adventurer entitled, ‘A company for the carrying on of an undertaking of great advantage but nobody to know what it is’.

The entrepreneur promised that for 100 British pounds (GBP) a share, investors would earn dividends of 100 GBP per year thereafter – an amazing return, which in theory should have left everyone incredulous. 

Shiv Malik is the author of two books, the co-founder of the Intergenerational Foundation think tank and a former investigative journalist for the Guardian. He currently evangelizes about a new decentralized data economy for the open source project Streamr

And yet, by the first morning of the “IPO” in London’s Cornhill (its original financial center) the man had raised deposits of 2,000 GBP to secure a fifth of all the stock – the fear of missing out was simply too great. Of course, by that evening, the entrepreneur had gotten on a boat to Europe and was never heard from again. 

Graeber writes that if the story is true then “the entire population of London conceived the simultaneous delusion, not that money could really be manufactured out of nothing, but that other people were foolish to believe that it could – and that by that very fact, they actually could make money out of nothing after all.”

See also: Redel/Andoni – DeFi Is Just Like the ICO Boom and Regulators Are Circling

To anyone following the DeFi tumult, all this should sound disturbingly familiar. Rather like the South Sea Bubble, the DeFi bubble may have just gone pop. Certainly there are those with egg (or sushi) on their faces, and others who seemed to have fled with the loot. 

At the heart of the Defi attraction lies the ability for people to make extraordinary returns (25% per year) simply by becoming a lender. The promise from the platforms has been that lendings are safe: smart contracts will guarantee collateralization of more than 1:1. In other words, more money is locked into a platform than is being lent out at any given moment. 

As people hopped from platform to platform looking for the best rates to “lend” their crypto, a new term – yield farming – popped into existence to give the whole enterprise a feeling that “real” work was being done. You, too, the subconscious messaging went, could be back on the land, wholesomely farming on a wide-open digital prairie. A classic hipster fantasy was being realized. Digital nerds could finally, like their grandparents before them, engage in authentic, meaningful work. 

Trying to make money out of nothing by believing other people will fall for the trick is, in the end, still trying to make money out of nothing.

And yet, few have wanted to zoom out and ask the simplest question: What is actually going on to make lenders so rich with credit card-style interest rates? What real value is being provided by all this money sloshing around? Or to put it in 18th century terms, what is the “great advantage” here that is powering the money making machine?

The two main advantages to DeFi seem to be tax avoidance and providing liquidity to borrowers. 

Let’s take tax avoidance. How does that work? Under most tax systems, profitably cashing out of an asset creates tax liabilities. So being able to hold that asset while simultaneously being able to borrow against it reduces your tax liability while creating liquidity in another asset. Investor 1, Taxman 0. 

But at the macro level (and despite what accountants may tell you) avoiding tax isn’t actually “useful work.” It’s just avoiding investments and payment for services of one sort (the government kind) over those preferred by an individual – most likely further investment liquidity for another crypto asset.

See also: Shiv Malik – Data Ownership Should Be About Software, Not Lawsuits

So is lending money real work? Well, lending is of great value to an economy. But only when the lender is assessing whether the money is being plowed into something that itself produces value. U.S. and U.K. banks used to do this sort of thing fairly well, especially for businesses, but no longer. 

DeFi platforms are even worse at it because the decentralized nature of these platforms means the purposes for why people borrow can’t in fact be checked. That’s the whole point. There is no central party to do the checking. So where is all that borrowed money going to, to create those fabulous interest rate yields? As best as anyone can guess, more token speculation. 

It’s worth remembering here that the 1930s Wall Street crash was brought about in part because banks were opening lines of credit to individuals so they could go on to invest in shares. That pumped up the prices, which only served to make even more people eager to borrow more money. It was classic bubble behavior and later outlawed. Of course, the same thing is happening now on Wall Street with quantitative easing (QE). It’s just that the funds are restricted to those closest to the money printers. (Printers switched on to avoid mass investor bankruptcies the last time speculation went off the charts.) 

So in both cases, DeFi is fueling the behavior of traders. Is that real work? If they are day traders and not long-term investors (which is highly likely; otherwise, why borrow at such high rates?) then the only work that is being done at a systemic level is to ensure a more accurate price for an asset. People win and lose money based on what they think others think that price should be. 

See also: William Mougayar – For DeFi to Grow, CeFi Must Embrace It

For assets underpinned by huge economies, getting such prices right is very useful work. In that respect, stock markets, and the various financial by-products that are created from them, have genuine value. But what if there is no real economy under the assets? What if a lot of money is being pumped in to determine the price of a business or software project that doesn’t itself have a business model, revenue, consumer interest or any sort of foreseeable use? And, in that case, how much speculation is too much speculation? What, in other words, if there’s no actual coffee under all that froth? 

Given 2017’s initial coin offering (ICO) mania, you’d think those in the space would have learned a lesson. Instead, we’re here once more nursing bruises born of foolishness. And it’s likely that this isn’t done yet because believers need to believe. And god knows that you have to be a believer to exist in crypto. All those food-branded DeFI lending platforms have done to date is pump up various fantasies on offer. 

Like the investors of 18th century London, Graeber’s wisdom would serve us all well. Trying to make money out of nothing by believing other people will fall for the trick is, in the end, still trying to make money out of nothing.

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