A recent explosion of DeFi applications has caused gas prices to soar and made Ethereum all but unusable for anything else. As a result, the network feels more and more like a casino. Remember: at a casino, the house always wins. (Photo by Carl Raw on Unsplash.)
The Rise of DeFi
I remember clearly when, a year or two ago, the Ethereum community collectively made fun of the fact that most applications built on the nascent Eos and Tron platforms were gambling applications. By contrast, we took great pride in the “real” things being built on Ethereum, from DAOs to stable coins to satellites, asteroid mining, and space exploration. There was an understandable tendency not to take the other platforms seriously because they lacked serious, mature use cases.
Fast forward a couple of years and Ethereum, too, has become a casino, albeit one by a different name: DeFi. Short for Decentralized Finance, DeFi refers to financial applications, from stable coins to exchanges to lending platforms, that are built on smart contracts. As of today, 24 of the top 25 Ethereum dapps are DeFi applications.1 These applications have driven an explosion in transaction volume and average gas prices over the past few weeks, making it difficult, slow, and expensive to use the network.
While these applications may someday evolve into more mature, sustainable products and platforms, at the moment nearly all of them feel like gambling. Tokens with no intrinsic value, many without sound economic design, are suddenly issued out of nowhere, explode in value overnight, then collapse just as quickly.2 Those who have a lot of chips on the table, are well-connected, in the know, or just lucky, can make huge sums of money in this market, but there is someone less fortunate on the other side of each of these zero-sum trades. To describe the situation charitably, it’s distasteful and unsustainable.
How did this happen? In retrospect it’s both obvious and predictable. While its advocates make noise about a lot of other potential use cases, blockchain is really, fundamentally only good at asserting ownership of digital assets—and low throughput and high transaction cost means that it’s only really well suited to transactions of high value assets, at that. Billions of dollars of VC money have flowed into blockchain over the past few years. What’s more, finance applications like exchanges and lending platforms are among the only blockchain applications that have a stable and growing user base. Their business models, which allow quick revenue generation and return on investment, are relatively easy for investors to understand. Pioneers like Maker, Compound, and Uniswap laid a lot of the groundwork, from developing tools and standards to educating users and investors.
Finally, there’s the libertarian bent among many in the Ethereum community, inherited from Bitcoiners and from the cypherpunks before them. There’s an admirable desire for Ethereum to be a “big tent” and to act as a neutral, unopinionated platform for all sorts of innovative applications. Unfortunately, this lack of a guiding set of principles or values means that, rather than thinking big and investing in the sort of projects that will create real social value over the long term, the community tends to fund and back low hanging fruit: get-rich-quick schemes (e.g., PoWH), clones of existing projects (e.g., Yam, SushiSwap), and projects that serve those who are already wealthy, well-connected crypto-insiders (e.g., well, pretty much all of DeFi). These projects have little appeal to mainstream users and are more likely to recycle funds already invested in crypto than to attract outside capital, attention, or interest. The Ethereum community is okay with this because one of its biggest taboos is censorship, and to favor one class of application over another is perceived as censorship.
Even the most influential, well-connected members of the community have gotten involved in the DeFi game. I’ve heard several brag about how much money they’ve already made.3 In the best case, DeFi may just temporarily distract everyone and make the network more crowded and more expensive. In the worst case, it may be a slow, pernicious form of capture, as influencers themselves benefit from DeFi and, intentionally or unintentionally, act to support it, thus implicitly making it harder to do other things on Ethereum.
The result is a self-fulfilling prophecy. The more we build things for ourselves, the less we try to build things that make sense to other people. As DeFi applications have proliferated, the network has gotten busier and gas has become more expensive. As gas has become more expensive, non-DeFi applications have begun to shut down due to high costs. Others have begun to migrate onto side chains or other networks entirely. High-value DeFi transactions have rapidly become the only type of transaction worth paying for, since it doesn’t make sense to pay $25 in gas fees to buy a Cryptokitty. Ethereum has become a DeFi network, and DeFi has become a game of whales, aptly described as a process of gentrification.
Even as a casino, we’re failing. A casino can’t survive or succeed by recycling capital among a small group of gamblers. It needs to successfully market itself, attract new participants, and grow capital inflow. DeFi applications, at least in their present form, aren’t up to this task.
There is no easy way out of this predicament. Eth2 has been making rapid progress, but even in the best case scenario it’s still years away from being able to run the sort of applications that run on Ethereum today. The upgrade path for existing applications is unclear and will likely require major redesign to support new paradigms like sharding and rollups. While other, more scalable networks have already launched, network effects and lack of interoperability have so far kept most applications, developers, and users on Ethereum in spite of the costs.4
There are two ways to look at the situation. On the one hand, DeFi has led to a lot of innovation, especially in finance, cryptoeconomics and governance. Even if this isn’t the sort of innovation that directly impacts many people today, we will learn a lot and it might conceivably result in products and services for everyday people down the road. Financial primitives being developed today could find a place in useful products such as insurance, remittances, or micropayments in the future. Automated market makers, yield farming, and governance tokens are genuinely interesting building blocks that are likely here to stay, and they could be used to build more sophisticated financial products and services. There’s nothing inherently wrong with speculation or an initial bout of money-grabbing and this is a natural process that plays out with every new, disruptive technology.
On the other hand, it’s unclear how we get from where we are to where we need to be. When and how do the current crop of gambling apps evolve into legitimate products that generate real value for ordinary people? To be frank, I don’t see any DeFi projects today pursuing this sort of value creation and I’m not sure it’s even possible given existing barriers of adoption, usability, scalability, and governance. To me, the novel, exciting thing about blockchain is not its ability to make already-rich, advantaged people even richer and more advantaged, which is what is happening right now. Rather, it’s the possibility of empowering the unempowered, enfranchising the disenfranchised, and giving a voice to ordinary people everywhere. Which teams are building products and services that do this? And what do we still need to do to enable this sort of innovation?
I left a career in traditional finance because, far from improving things for everyday people, I felt that it was exacerbating existing socio-economic problems. When I discovered blockchain, cryptocurrency, smart contracts, and Ethereum, I thought that they were different. I was awed by their potential to effect positive change in a world sorely needing it. When I joined the Ethereum community a few years ago, I had a clear vision for how it might change the world.
While I still believe blockchain has this potential, I no longer think that, as a community and as an industry, we’re heading in the direction of improving the world. Extrapolating based on present trends, neither Ethereum, nor cryptocurrency, nor blockchain is going to make a dent in the any of the long and growing list of existential crises that humanity faces today, from war to inequality, access to education, climate change, disinformation, toxic politics, and now pandemics.
It would be bad enough if the billions of dollars flowing into blockchain and cryptocurrency were simply wasted building things that don’t work, don’t scale, and/or don’t appeal to everyday users. In fact, the situation is far more precarious than this. The things being built on blockchain are working, but they’re working in precisely the wrong direction. My vision of a better world is not digital casinos where know-nothing retail investors, excited by the allure of cryptocurrency, get picked off by sophisticated investors at games they don’t even fully understand. This sounds way too similar to traditional finance! To date blockchain has mostly entrenched existing power structures on chain, enforced by the cold, dispassionate logic of infallible smart contracts and immutable ledgers. If this trend continues, the outcome is frightening.
Where Do We Go From Here?
A few years ago, I found this frustrating. Today I find it deeply troubling because blockchain has matured a lot as a technology and we’ve come a long way as a community, but we’ve still mostly failed to have a real-world impact outside of a few niche use cases. We’re running out of time to change this. Blockchain is of course not a panacea for the complex social, economic, and political challenges we’re facing, but neither is it destined to forever remain a digital casino for the already-wealthy, privileged, and well-connected. There are important things we can do today to turn things around and maximize the chance of having a wide scale, positive impact.
The first thing we must do is to boldly engage with and learn from existing institutions and experts. The tools we’re developing are powerful and have great potential, but they are not a panacea for the ills of the world. In particular, while democracy is in global decline, we’re not going to magically invent something better than democracy anytime soon. Putting people together, face to face, in a room—or, failing that, in a Zoom chat—may seem old-fashioned and may not be an especially sexy technology, but it’s still by far the best tool we’ve got for working out our differences and reaching consensus on important issues. To think otherwise is hubristic and dangerous.
DAOs, conviction voting, and other pseudonymous, on-chain governance tools are novel and fascinating, and we should continue to experiment with them. However, we must recognize that their real potential is as tools that augment existing liberal democratic institutions. They are not and should not be thought of as replacements. One of the big lessons of the past few years is that democracy is more fragile than it looks. If we don’t treat our existing institutions with due reverence, respect, and care, we may lose them forever.
In particular, as we continue to design, build, and test blockchain-based governance tools, platforms, and solutions, we must be careful not to throw the civic baby out with the “broken institutions” bathwater. We can get much further by engaging boldly and confidently with existing institutions and by working to strengthen fraying social and civic institutions than we can by naively attempting to jettison them entirely. The future looks more like Taiwan-style e-governance than a hyper-libertarian, techno-utopian, transhumanist, Galt’s Gulch on Mars. (At least, I hope it does!)
Another essential task is to engage much more closely with the rest of the world. We must escape our ivory tower echo chamber, “get out of the building,” engage in design thinking, and make sure we’re building apps and services that the rest of the world cares about. We must design and document our tools well so that they’re accessible, approachable, and legible to as many people as possible.
At the same time, we have to escape the savior mindset long endemic in the blockchain and cryptocurrency space. The goal of cryptocurrency should not be to “bank the unbanked.” It should be to build a powerful, useful toolbox of well-designed, well-documented, permissively-licensed, accessible primitives that anyone, anywhere can use to build better products, services, and institutions. Local communities around the world are far more likely to use these tools to develop their own solutions than we as outsiders are to develop solutions that work for those communities, a colonialist mindset exemplified by the Libra project. To this end, it’s essential that we include as diverse a population of voices as early in the design and building process as possible.
We must support the small number of teams and projects that are doing this important work. And we must start more. There’s no doubt that blockchain and related technologies can move the needle for humanity. But that won’t happen automatically. We’re at a crossroads, and we can still steer things in a different, more positive direction—but maybe not for much longer.
Finally, and perhaps most importantly: remember why you started. I’ve written about why I chose to work on blockchain technology (and it had nothing to do with building a casino). Why did you start? What’s your vision for what blockchain, cryptocurrency, and Web3 are capable of? Leave a comment and share your story!
This is not an exaggeration. One recent example, YAM, was launched on August 11. By the following day, it had attained a market capitalization of around $60M, with over $400M of token deposits. The developers announced a bug in the unaudited code the same day, and its market capitalization collapsed to zero in 35 minutes. (source) ↩
This might not be so bad if there were clear disclosure of conflicts of interest, but these are vanishingly rare and there does not seem to be a shared ethical code that requires them. ↩
Next generation networks that have launched recently include Celo, Avalanche, NEAR Protocol, Polkadot, and Solana (still in testing as of publication). While few applications have migrated away from Ethereum thus far, this is clearly not sustainable in the long-term. If gas prices remain as high as they are today, more and more applications will be forced to migrate. However, DeFi applications are more likely to remain, further exacerbating the situation and further cementing Ethereum as a “network for DeFi.” ↩