Decentralized finance, the dream of “DeFi” freeing the monetary system out of the control of governments and banks, has helped launch 20,000 cryptocurrencies.
However, 2022 proved to be a cryptocurrency nightmare, including the most promising rival of the central bank-issued currency, the proud “Stablecoin,” and was devoted to DeFi. I have a question about whether there is a future.
It is predicted that the crypto market, which lost more than half of its value in the first six months of 2022, could collapse further or be at the point of rebound. This speaks to the fact that cryptocurrencies are great for gambling, but still poor as available currencies. There are no other useful attributes either.
To assess your DeFi outlook, it’s helpful to consider how your finances were centralized in the first place.
Origin of money
Money is a hallmark of increasingly sophisticated human networks. It was rarely needed when we lived as a group of hunter-gatherers. You can maintain an informal aggregate of benefits.
As the complexity of the settled community, where people specialize in activities that suit their skills and tastes, has increased, barter systems have become the norm.
But bartering required a double match of desire. Those who had extra food and wanted to help build a house had to find a hungry builder. Then they needed to negotiate how many hours of work was a fair exchange for food.
That is where “money” was invented.
Money can be seashells or some useful storable goods. It could be a securely recorded debt aggregate somewhere (the earliest document dating back to 3000 BC was a cuneiform financial record). Later, artificial tokens appeared, which led to rare metal coins.
The origin of the bank
Money meant that people could save their labor rewards and lend it to others. However, it was difficult to connect the lender with the borrower and guarantee the lender that the borrower would repay. This is why banks have developed.
Banks did more than just issue convenient forms of money in the form of coins and banknotes. We also provided four basic banking services:
- bundle: By collecting a lot of small deposits, they were able to make a big loan
- Diversification: By lending to different borrowers, one default has become less important
- risk assessment: Expertise in assessing reliability has reduced defaults
- Changes in Maturity: Most depositors were able to offer loans for longer than they wanted to deposit money in a bank.
The oldest bank still in operation is Montedei Pas Kidisiena, Italy, founded in 1472.
Dealing with banking problems
However, private banks holding their own currency were not a stable system. The so-called “bank run” occurred when depositors lost their trust in banks and tried to withdraw funds. A panic occurred when the bank was unable to redeem all the requested banknotes or deposits.
Bank runs were often contagious. People found it difficult to distinguish between bank-specific problems (such as fraudulent managers) and general problems (such as recessions leading to bad debts). Execution in one bank often triggers execution in another bank.
In the 20th century, most countries solved these problems by having government-owned central banks issue currencies and regulating private banks to guarantee depositors’ solvency. These regulations included requiring banks to keep a minimum percentage of their assets available for withdrawals and to take out deposit insurance.
Decentralized finance movement
However, the bank’s process of centralization has not been widely admired. Liberals suspect that the system relies on government-issued monopolies and licensed banks. They hate banks as much as the government. They see centralized finance as inefficient and compulsory.
Their dream is decentralized (or unmediated) finance that allows direct transactions without the need for bank intermediaries. By eliminating “middlemen”, their marketing will lower transaction costs and curb the state’s power over individuals.
With the internet and blockchain technology, these dreams have launched over 20,000 cryptocurrencies and are the first and still the largest Bitcoin.
“Illusion of decentralization”
However, DeFi has not yet proven it to be a viable alternative to centralized banking systems, as evidenced by the huge losses in the crypto market in recent months. It remains unclear how the above four banking services can be provided without a trusted financial intermediary.
Indeed, according to economists at the Bank for International Settlements (Central Bank of Central Banks):
The main vision of DeFi supporters is non-centralized mediation.
In substance, we argue that some form of centralization is inevitable. Therefore, there is a “fantasy of decentralization”.
Has little use other than speculation
As BIS economists have pointed out, decentralized finance has little use in the real economy yet. Mostly it made guessing easier. But what attracts speculators, that is, large fluctuations in prices, makes the currency worse.
A useful lesson can be learned from the experience of two (previous) top 10 cryptocurrencies, TerraUSD and its stable companion, Luna. TerraUSD was considered a “stablecoin” and its value was fixed at US $ 1. That was true until the beginning of May. By the end of May it was trading for less than 3 US cents. During the same period, Luna’s price dropped from $ 82 to $ 0.02.
These examples show how cryptocurrencies such as Bitcoin, which lack basic value, are speculative gambling.
Therefore, the central bank’s currency is unrivaled in the day-to-day business of buying and selling goods, and is a store of much safer value than cryptocurrencies, even if inflation reduces purchasing power.
This article has been republished from Conversation under a Creative Commons license. Please read the original article.
