One of the overlooked misnomers of Decentralised Finance (DeFi) is that for all the technology enables peer-to-peer transactions free from intermediaries, many aspects remain dependent on centralised service providers and old-world finance.
DeFi provides financial services without centralised intermediaries, by operating through automated protocols on blockchains. Many popular stablecoins however depend on collateral being deposited with a custodial service provider, they often depend on fiat currency deposits matching the equivalent value of the token they claim to represent.
In practical terms this means large sums of fiat currency (or gold and silver) are deposited with a centralised deposit service provider. These stablecoins are also bought and sold on exchanges that are themselves highly centralised entities that are sometimes listed on traditional equities markets, further removing them from the vision of a decentralised ecosystem.
Technology isn’t living up to the rhetoric or potential that DeFi advocates would have you believe. This “decentralisation illusion” stems in part from the need for governance making some level of centralisation inevitable and structural aspects of DeFi leading to a concentration of power.
Should mass adoption of DeFi come to pass as many of its advocates hope, current vulnerabilities could lead to less stable financial ecosystem for people to participate in. Issues relating to excessive leverage, liquidity mismatches, built-in interconnectedness and the lack of shock absorbers such as banks with liquidity pools could lead to volatility and mismatches between exchanges for certain assets.
Cryptocurrency users also depend on being able to cash out their holdings into fiat often through centralised exchanges and depend on publicly provided services such as broadband.
Perhaps the time has come for the industry to devise alternative, more flexible models for a decentralised digital currency architecture? Bonded stablecoins provide an example of how maths and not physical assets can be used to ensure assets are secure and available to people wanting to avoid centralised third parties.
The general idea behind bonding curves is to allow minting of some new token in exchange for a reserve asset, with minting happening strictly according to a mathematical formula – a curve – that connects the total supply of the token issued and the total sum of the reserve deposited to back the issue.
The opposite operation – redemption of the token for the reserve currency – happens according to the same formula. The issue and redemption of the token as well as storage of the deposited reserve is managed by an Autonomous Agent (similar to a smart contract). At no point is there a centralised point of failure or reference point, it’s the community and participants who set the terms for engagement.
The stablecoins are backed by people’s collective belief in mathematics and the set rules of engagement, the more people engaged in the ecosystem and trading, the more efficient and dependable it becomes. Constraints related to gas fees, energy use and collateral to back up the assets are eliminated.
Few could have predicted a decade ago that DeFi would evolve into a two trillion dollar asset class and it would be a brave person who could predict where this industry will be in 10 years time.
That being said the industry has a lot of work to do before cryptocurrencies and DeFi lives up to its namesake. Engineers and technologists should recognise that pegging assets to fiat currencies undermines the very ideals that this technology aims to support and adds serious flaws by depending on government backed or private third parties.
DeFi’s future architecture will need to take a more imaginative approach and avoid reliance on centralised entities. Bonded stablecoins might well show the industry how an alternative DLT infrastructure can deliver on DeFi’s promises.
By Anton Churyumoff, Founder of Obyte, a distributed ledger based on directed acyclic graph (DAG).