Matt Levine is (kinda?) worried about losing his job over DeFi…

Traditional finance started with funding real-world projects. Decentralized Finance started with trading financial claims & optimizing self-referential speculation. But DeFi could still be the future?

Jul 06, 2021

Continuing from my last email “Matt Levine recaps the GameStop saga...” – another highly interesting part from my interview with Matt is his takes on crypto and DeFi (Decentralized Finance).

It’s hard to sum up what DeFi really is. It emerged out of the crypto ecosystem and recently garnered a lot of attention from legacy financial institutions and top regulators. DeFi is probably the ultimate vision of the crypto space at large – a large number of apps leveraging the blockchain technology to conduct peer-to-peer, decentralized financial transactions without needing centralized counterparties. You don’t have to go to J.P. Morgan to get a businsess loan, or list your stock on NASDAQ – these are all “centralized entities” that could screw you over one day when push comes to shove, and it’s much better to conduct your financial activities on the blockchain, which not one person has control over and which you can trust. So goes the predominant narrative…

Bubbles, frauds, and DeFi…

All quotes are lightly edited for clarity:

Tiger: [00:38:39] Do you think we're in a bubble right now? Because it seems like we're in a structurally different place; narratives play a greater role; and it's hard to have a hypothesis about what's going to bring this party down. You can't really short a technological innovation that doesn't have earnings because there's no way you can disprove the hypothesis that this is or isn't going to be a long term breakthrough, especially when people have a subjective psychological conviction that STONKS will just keep going up.

Like there's no way you can prove that decentralized finance (DeFi) will NOT be the future, but you also don't know what many of these projects are actually doing these, so how do you make of the space? It's just very weird, right?

Matt: [00:39:31] You look at the late 1990s, 2000 tech bubble – things went up and then down. But it's also it's like a period that produced a lot of important innovative companies. And then you could imagine something similar here where a certain amount of froth in the market is what enables capital raising for wacky ideas, some of which would turn out to be rotten ideas.
Like I think DeFi is really cool, and I think every actual project I read about wants me wanna sh*t myself, but you know... I don't know... that's like how it works, right?
I read there's like an ecosystem of 90 percent fraud and 10 percent innovation. We look at the electric vehicle companies and read about these EV SPACs, and you'd think "oh, that's a fraud!" But should we be funding research into electric vehicles? Yeah! That seems very socially viable.
The traditional financial capital is supposed to fund a business, so that they can hire a bunch of smart engineers and create incentives for people to get into that space. The ones who get into that space and succeed will get very rich. And the ones who get into that space and fail will get hilariously rich.
I think in 20 years if we're polluting a lot less because everything is electric, people are going to look back and be like "it's bizarre that we used internal combustion cars, and it's great that we fixed that, and so there were a few frauds, who cares?"

Crypto used to just be literal pyramid schemes…

Tiger: [00:41:27] Maybe in some sense, we should be looking for the frauds. That’s where the change is?

Matt: [00:41:58] I'd be a little careful in saying that fraud is where the innovation is happening. I think one thing that DeFi does is that it's a really good enabling mechanism with literal pyramid schemes. Like a few years ago, in the early days of the second-generation crypto stuff, you go to look at the crypto projects, and “pyramid scheme” would be like the name of the project, and then people put in tokens... just literally explicitly open Ponzi and pyramid schemes.
It's just like “we'll tell you exactly what's going to happen. If you get it at the right time, you'll make money. If you have the wrong time, you lose like whatever you put in.” That was it.

DeFi could take the opposite path from traditional finance

Tiger: [00:43:34] My friend sent me this platform that was like doing online casino in virtual reality with crypto currencies on DeFi blockchain... What is going on? I mean, how is this thing not...?! I mean I can see why certain people would be incentivized to use certain innovations, but don't you look at these things and go, "This is a joke! Whatever that is happening..."

Matt: [00:44:00] I think the knock on DeFi is that it is mainly a venue for self-referential speculation. People are not building factories and financing them with DeFi. It's hard to point to a real world object that was funded by DeFi.
But, you know, I think the counterargument is like if you make a really good system for trading financial claims, and then you go to people who issue financial claims to fund real projects and say "look at our really good system for trading claims," and maybe they will come!
You build the system first, which is the opposite of how traditional finance was built. In traditional finance, we kept optimizing the system for financial claims that started from issuing financial claims to fund world projects. But that doesn't prove that the DeFi approach is wrong.
An arguable problem with the DeFi approach is that because it is so hermetically sealed from the real world, you're optimizing exciting gambling, rather than the trading of financial claim, but the optimization in a world constrained by your financial claims to fund real-world projects is going to be different from the optimization of your pure abstract claims.
You build a really, really good exchange, and maybe some stocks will list on it. And you see some of that: I wouldn't say a lot of companies have listed their stocks on decentralized exchanges, but you'd see DeFi-curious companies doing so. I think there's promise to that. It hasn't really yet been achieved, but it's early days.

Matt is (kinda?) worried about losing his job over DeFi…

Tiger: [01:21:07] If your column is no longer popular in a few years, what do you think could be the reasons? When we have entrepreneurs on the show, we often ask “if your company fails in five years, what would be the reasons?” So maybe I could entertain this question with you.

Matt: [01:21:27] Gosh, I hope it's because I sell a book that becomes a movie and become too rich to write every day.
To me, the biggest risk is that you do this too long and you repeat yourself in various ways. You repeat arguments and themes and topics and stylistic text, and then eventually people get sick of me, and I get sick of myself, or some combination thereof.
There's a good argument that an op-ed columnist shouldn't have that job for more than five years, and I don't think of myself as an op-ed columnist – like I'm explaining things, butI do worry about people getting sick of me, and I worry a lot about getting sick of myself. Those are the big risks.
The other weirder risk is – when I started, I wrote a lot about [banks]. Five or six years after the financial crisis, as the statute of limitations was beginning to expire, the regulators brought all these cases against banks for doing stuff in the financial crisis. And it was this enormously illuminating period, because you learned about all these trading strategies and weird things that banks built that were not really publicly available but then they got publicly exposed by regulatory actions.
It was a great time to learn about how banks worked, and banks were really interesting in 2007; they were doing a lot of really complicated stuff. In 2021, banks are generally less interesting; they do less complicated stuff for competitive reasons, but also because regulators really tried to make them less interesting and succeeded.
So some of my expertise in what I write about comes from banks. Relatively little of my expertise is in DeFi, and now I write about I guess you'd call it a DeFi protocol. In five years, if all of finance is run on the blockchain and DeFi protocols, I hope that I will adapt. But I will have less native advantage over other people in doing that. So I think that's that's a risk, too.

It’s really fascinating how Matt didn’t just actively bring up DeFi just as a discussion point, but cited it as a specific (albeit “weird”) risk to his career. He also mentioned that his colleagues at Bloomberg are all fascinated by crypto and trying their best to learn about it.

I had previously written about the explosion of crypto reporting in financial media. Listening to Matt’s response – perhaps a large factor of that explosion is because financial journalists see this DeFi space as something that they have to understand, before it’s too late and they lose their job for not getting it? The threat probably isn’t immediate, but it seems that whoever gets a headstart on actually understanding the crypto space will be… maybe even the next Matt Levine?

Not much is happening with DeFi beyond finance?

We shall talk about DeFi in greater detail in another post, but indeed as Matt said, what DeFi is mostly doing today is just self-referential financial transactions. I remeber reading this Substack post by Bankless titled “7 Things You Can Do on Layer 2 Today.” Layer 2 is supposed to be the great technological breakthrough that powers the Ethereum and DeFi ecosystem, but the 7 supposedly great things listed in that post are all very esoteric and mostly finance-centric:

Borrow & Lend on Polygon with Aave
Trade Decentralized Perpetuals
Earn SNX Staking Rewards
Yield Farm LRC Rewards
Trade DeFi Tokens on DeversiFi
Donate to Ethereum Projects on Gitcoin
Stream Money on Superfluid

It’s great if you’re really into crypto, but all this is still very much distant from the average person. Perhaps one day DeFi will take over the financial system, but they will have to make the leap to having something to do with the real world at some point, or they will just stay being exciting for a very small group of passionate enthusiasts.

The saga of crypto is to be continued…

Disclaimer: Needless to say, my emails are just casual commentaries. I try my best to write them thoughtfully and with care to provide some alternative perspectives on various issues, but please do not treat them in any way as financial advice for your own investment.

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