Robbing from the Poor to Give to the Rich
Not your keys not your coins. If you’re unfamiliar with the phrase, take note. The winds of change look set to carry this sentiment from Reddit subgroups, through Wall Street, and straight into the offices of the billionaires cooped up there. Long have they sat on their heavy stacks, inventing money and trading it between themselves under the illusion of a free market. In the last few years, however, the rug has slowly been pulled from under their feet. A now game is afoot. Built on open blockchain technology, decentralised financial markets (“defi”) have been maturing to the point where most functions previously available to the hedge funds are now available to individuals, and many new instruments not before possible are being invented by millennials in their bedrooms. Even better, the use of decentralised finance does not involve passing custody of your funds to a broker or an exchange. If you control the keys, you control the funds. Not Robinhood, not Janet Yellen, not HSBC — nobody can freeze your money. Not your keys, not your coins.
The most recent story has now been well publicised. Robinhood, a financial exchange that marketed itself on allowing retail investors — ordinary Jills and Joes — to take part in trading stocks, to join the money party that the big boys (for they were mostly boys) had been hosting for 100 years. This precept is the basis of their name, their brand. Many of those same retail investors had received word that the hedge funds had bet against the stock value of Gamestop (GME), a stock that held some nostalgic value. In stepped a subreddit group “Wall Street Bets”, whose members decided to start buying the stock. Many savings accounts were emptied and stimulus cheques spent on GME stocks. The price rocketed and suddenly many hedge funds found their short positions facing massive losses.
You see, making a short position requires you to borrow the stock, not actually own it. You then sell the borrowed stock, then pray the value of the stock falls, so you can buy it back at a discount. However, your potential losses are unlimited, as the price of a stock can skyrocket, forcing you to buy it back at the new high price in order to repay your debt.
The hedge funds, such as Melvin Capital, found themselves in exactly this position. They had collectively shorted GMT and the price skyrocketed, leaving them facing $70 billion of losses. Some of them are financially entwined with Robinhood themselves, acting as market-makers. Robinhood then froze the GMT stocks, allowing retail investors only to sell GMT, not to buy it. Of course, the institutional players were still allowed to trade freely. Removing buying pressure from a stock means that the price will plummet, rescuing the hedge funds from their disastrous short positions. This rescue money — this bailout — has to come from somewhere. It came from the poor average investors. Those that bought into GMT and were left frozen out as the price dropped and their investments dwindled. Robinhood robbed from the poor and gave to the rich. Their brand is forever tarnished, and the masses must start their search over for a way to join the markets.
What is the answer? Reddit users and Twitter personalities can continue playing this game with Wall Street. It is fun, and the governing body of stocks in the US, the SEC, has stated that it is not illegal to talk up the value of a stock, as long as you are not being misleading. If you believe in the free market you believe that the true value of an asset is the value the market is willing to pay for it. The capitalist sentiment in Wall Street has always held that the free market is king. But we have learned time and again that the market is not free. Those that have custody of our funds can not abide losses amongst themselves and their backers. It is clear that money talks, and the powerful will move to protect their own. The social media army can carry on playing the game, but to have a lasting effect the game will need to be changed. This may be the time to do it, as the furore has galvanised support across the bitter divides of American politics.
Perhaps then, the answer resides outside the traditional financial markets. Hidden within Bitcoin’s genesis block, the first transaction to take place on the blockchain, is the following quote:
“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”
Satoshi Nakamoto, Bitcoin’s creator(s), clearly had a dry sense of humour, and sometimes comedy is the most effective weapon against the status quo. We need to see the absurdity of the situation before we can finally dismiss it. Since 2009, the ecosystem of cryptocurrencies has evolved from Bitcoin’s whitepaper to a wide range of cryptocurrencies and tokenised protocols that allow a diverse array of value propositions such as the ownership of data, sentiment, real estate, voting rights, and the use of advanced financial instruments. The real Cambrian explosion in cryptocurrency usage has been the development of decentralised finance that the Ethereum platform has allowed. Ethereum is a blockchain like Bitcoin, except that it allows for the transfer not just of value, but of Turing complete programmes (a Turing-complete programming language is one that theoretically allows for any possible program to be written). It is a true programmable money, and it led directly to development of programmed finance. Unlike traditional finance though, this finance was for the first time decentralised. It involved direct transfer of funds between the owners of those funds, with no cream skimmed by intermediaries.
Decentralised finance has allowed for the development of protocols (through tokens that exist on the Ethereum blockchain) that facilitate borrowing and lending, options trading, and even never-before-possible financial instruments like flash loans.
Rather than putting your savings in a bank, having the bank take custody of those funds, generate money from them through trading, and pass a small pre-determined percentage back to you, you can now cut out the middle man and choose the profit generating strategies that suit you. There are even protocols that will choose the strategies for you — all while you retain complete custody of your funds. You never get frozen out. Not your keys, not your coins.
Despite these huge advantages, these financial instruments have been very nascent. They have been cumbersome to use, and require much personal research in order to navigate the ecosystem safely. Also, with personal custody comes a level of personal responsibility that is alien to many people used to having their funds cared for.
A gap has opened, then, for new protocols — a defi 2.0 — that bring this functionality to the masses, but with a user experience fit for mass adoption. Uniswap is the first attempt at this, and will continue to do well. It allows the trading of cryptoassets (and there is nothing from stopping someone tokenising Gamestop stock and trading it here and thereby circumventing the wolves of Wall Street) without ever taking custody of those assets. However it requires a fair bit of knowledge to use and can be time-consuming to monitor all the changes going on in the market.
So problem for Defi 2.0 is to create a user interface that gives all the functionality of traditional exchanges like Robinhood, but does not take custody of your funds. Limit orders have been a feature that decentralised exchanges have found difficult to implement, as centralised exchanges can use market-makers to ensure a sale goes through. Decentralised exchanges (exchanges that do not hold your funds, only possible in crypto), do not have these market makers, instead they rely on algorithms known as “automated market-makers” that access pools of tokens and trade them in response to demand. As with any developing technology however, such obstacles are there to be overcome, and new platforms are appearing that seek to do just that.
One such product that is seeing a meteoric rise is CyberFi, which not only implements a user interface to simplify trading through Uniswap and other decentralised exchanges, but it allows you to manage your funds much in the way a bank manages them. For example, you can choose investment strategies, automate them, and trade assets with limit orders, stop losses and similar. All the while those funds are controlled by you, and nobody else. Again, this non-custodial use of financial instruments has never before been possible.
Protect yourself, not Rekt yourself
It uses “price oracles” — such as the massively popular Chainlink — to observe price movements, and feed these back to the platform. Orders are then executed at the best times according to your strategy. You can receive notifications when prices move, or even set strategies according to price movements. Crypto trading is 24/7 — there is no end of day buzzer — and prices can jump massively while your sleep. Having a price oracle watch over you at night will give users massive peace of mind.
Another use case for CyberFi is in the defi concept of yield farming. Yield farming is the process of moving your funds into different protocols that are offering the most attractive annualised percentage yields on your funds. This can be through staking your funds for lending and borrowing, or providing liquidity for the automated market makers mentioned earlier. However, as more users flock to the next popular protocol, that APY gets diluted out. It can be a full time job keeping up with the fluctuating returns available on the market. CyberFi helps solve this by giving you automated entry and exit points — ie if this APY drops, move the funds.
Another problem facing mass adoption of decentralised finance is that to the new user it resembles the Wild West. New protocols spring up yesterday. Investors want to jump in as early as possible before the price goes shooting up on a newly hyped project, so they inevitably don’t do much research. They also try to get in before the project is released — in the ”presale” — giving the creators of fake projects an excuse for not having a working product available. Just yesterday multiple of these presales were rug-pulled. Investors placed their funds into the smart contract, however they did not see (the contract was available, but written in bytecode to obscure the functionality) that the contract was programmed to funnel the funds straight to another address. This address collected the funds from each of these projects, and moved the collected funds through Tornado cash, a protocol designed to mix funds.
This might engender fear in new investors, but there may be solutions to this too. To put it into perspective: Robinhood and the hedge funds appear to have conspired to rob billions of dollars from investors, the scams above involed a few hundred thousand. The defi ecosystem is crying out for some kind of regulation, but it does not want to betray its core principles by leaving itself open to censorship.
DAO stands for “decentralised autonomous organisation”. It is like a company that has the same structure as the internet. It exists everywhere and nowhere. Anyone can belong to it — it is permissionless — and no individual has sole authority. Instead its members are incentivised to act in the interests of the DAO. One emerging example is Beast DAO, whose proposed mission is to become a gateway for a safe defi ecosystem. It aims to have projects launching through its platform, and those projects will be thoroughly vetted by Beast DAO before they offer their tokens to investors. It is in the interests of Beast DAO token holders to do this properly, as trust is the metric by which they will be measured. A portion of funds raised through the platform get distributed among the Beast DAO token holders, so as the ecosystem grows, holding the beast DAO token becomes more profitable. They have a vested interest in projects launching through the platform succeeding and delivering on their promises. Investors in launching projects have the security knowing that a decentralised organisation is overseeing the launch and that promises made during presale and the projects get to make use of a highly configurable launch, interoperability and much more.
To see the utility of a platform like Beast DAO, take the example above. The presale contract — whose backdoor methods were obfuscated — would have been thoroughly vetted by experienced hands. The people behind the project, in order to release on Beast DAO would also have been thoroughly vetted (these details aren’t made public unless they try to do a runner with funds, or law enforcement requires them). In short, the fraud would not have happened, the Beast would not allow it.
This is the future of financial regulation, and over time Beast DAO will evolve to a point where users demand that projects launch through this platform.
Printing your savings away
Inflation is another travesty of the financial system on which we have all been dependent for so many years. Traditional finance is a system based on debt. In a process called fractional reserve banking banks use deposited funds to pass to the next person, who then deposits it again. This way a single deposit gets spent many times over, meaning the money is multiplied. However, the position is precarious, and banks that overreach may need a bailout. Unfortunately all holders of fiat currency foot the bill, because in order to bail out the banks, the central banks simply print more money. This way, the holders of the money have their value diluted away based on the whim of the government (they also print to fund bloated public projects and costly foreign wars), or the greed of banks.
The World’s First Valuecoin
Through years of inflation, the purchasing power of the US Dollar has declined dramatically. By keeping savings in fiat currency, the value of those savings dwindles over time.
But now it appears that defi might once again have a solution. One of Bitcoin’s original value propositions was to act as a store of value. While it has been the best performing major asset in the last decade, it’s volatility has meant that using it as a day to day store of value is too risky. Now, developers of the Maha DAO protocol may well have created a solution. They have created an asset — called Arth — that is a stable store of value that does not depreciate over time.
Arth uses price oracles (mentioned above) that observe the value of multiple fiat currencies, as well as gold and volatile assets like bitcoin, to create a stable store of value. As funds flow through these markets, Arth’s value stays stable in respect to each of them. If you measure the value of Arth in dollars, it will increase over time as the value of the dollar declines, but the absolute purchasing power of your fund will stay stable. Holders of the Maha token are the DAO that governs decisions regarding Arth, and they are rewarded with a percentage of the fees of using the Arth ecosystem. Again, the members of the DAO are self-governing. They have a vested interest in seeing the Arth ecosystem thrive and see mass adoption.
Wall Street and traditional financial institutions have created growth of the financial markets, and lots of people and industries have been supported by their success. However, it is the big players who have been the biggest beneficiaries, and the incentive system will keep it that way. First Bitcoin, then Ethereum, and now defi have given new hope that this unjust reality may not have to continue. The biggest rebalancing of wealth and financial activity the world has ever seen is about to take place, and it should belong to everybody.
If you enjoyed this, feel free to check out this article on using arbitage bots to farm ETH.