$The past year was calamitous for people speculating on cryptocurrency, as the largest firms that emerged from “DeFi summer” co-immolated after an orgy of accounting fraud and prodigious magical thinking.$ But the grand casino of 2020-2022 was damaging more because of what didn’t happen than because of what did. Speculation was so profitable, and centralized financial businesses so well-equipped to capitalize on it, that the latter vacuumed up talent and funding. Businesses focused on building real, long-term value didn’t receive the resources required to make long-term bets.

I for one am excited that it all came crashing down. Perhaps pump-and-dumps and rug-pulls are finally out and the hard work of building real, boring financial tools is in.

The purpose of finance is to allocate resources to productive activities. The returns form smart investments should flow to yet more smart investments, allowing every other participant in the economy to create and benefit from useful goods and services. If done efficiently, its success is not that managers of financial mechanisms get rich, but that all of us do.

This is the promise of transparent, public ledger technology that doesn’t require trusted intermediaries: instantly accessible markets with minimal regulatory friction and reduced dependence on intermediaries. Transparency should ensure that all market participants have access to detailed, real-time market information. Trustlessness, the ability to rely on a service without having to trust another actor, should eliminate the need for many escrow, banking, and brokerage functions. Public ledgers should ensure that investors no longer need intermediaries to access markets. These factors should combine to automate reporting and limit the opportunity for market manipulation, reducing the need for regulation. Regulators, with much higher visibility into financial transactions, could dramatically streamline reporting requirements. Money should get to the right places more efficiently.

At a fundamental level, this does appear to work. Lost in the apocalyptic coverage of the crash is the fact that true DeFi “institutions” kept chugging along as expected, programmatically liquidating collateral and balancing their markets as designed. Three Arrows Capital, Nuri, Celsius, BlockFi, and FTX were all centralized firms and all imploded. MakerDAO, Aave, Balancer, and Uniswap - all decentralized - remained very much functional, transparently, without any indication of fraud.

Decentralized markets are largely disconnected from the economic activities that really matter. This is the result of a set of related challenges:

Blockchains can only enforce agreements concerning purely digital assets. If a borrower offers bitcoin as collateral for a loan, a smart contract can easily liquidate that bitcoin when the borrower defaults. Loans against real estate, commodities, commercial revenue and other economically fundamental assets, by contrast, require physical contract enforcement. A building used as collateral cannot be programmatically liquidated; liquidation is a bureaucratic process, ultimately ensured by use of physical force. This is by design, given the potential harms of real-world enforcement. It should therefore be the domain of (ideally democratic) states.

We therefore depend on traditional entities, grounded in traditional law, to bring real assets into digital space, in short: to tokenize. Banks turn homes into mortgages, real estate funds turn properties into investment offerings, corporations turn future profits into shares, artists turn imagination into intellectual property, and yet…

We haven’t focused on creating value for these asset originators. Broadly speaking, they want more access to capital, but usually the need is more nuanced. For example, the majority of tokenization projects emphasize high liquidity as part of their value proposition, but small to medium-sized real estate syndicators, which generate $50 billion in assets per year in the US alone, don’t usually want their offerings to be highly liquid. They want their investors staying put. Their investors, meanwhile, would love more liquidity. DeFi could square this circle, but it hasn’t paid enough attention to it (spoiler: Cooperativ Labs has). Fundamental to the success of DeFi is an intense focus on often subtle and highly varied needs of asset originators.

$The past year was calamitous for people speculating on cryptocurrency, as the largest firms that emerged from “DeFi summer” co-immolated after an orgy of accounting fraud and prodigious magical thinking.$ But the grand casino of 2020-2022 was damaging more because of what didn’t happen than because of what did. Speculation was so profitable, and centralized financial businesses so well-equipped to capitalize on it, that the latter vacuumed up talent and funding. Businesses focused on building real, long-term value didn’t receive the resources required to make long-term bets.

I for one am excited that it all came crashing down. Perhaps pump-and-dumps and rug-pulls are finally out and the hard work of building real, boring financial tools is in.

The purpose of finance is to allocate resources to productive activities. The returns form smart investments should flow to yet more smart investments, allowing every other participant in the economy to create and benefit from useful goods and services. If done efficiently, its success is not that managers of financial mechanisms get rich, but that all of us do.

This is the promise of transparent, public ledger technology that doesn’t require trusted intermediaries: instantly accessible markets with minimal regulatory friction and reduced dependence on intermediaries. Transparency should ensure that all market participants have access to detailed, real-time market information. Trustlessness, the ability to rely on a service without having to trust another actor, should eliminate the need for many escrow, banking, and brokerage functions. Public ledgers should ensure that investors no longer need intermediaries to access markets. These factors should combine to automate reporting and limit the opportunity for market manipulation, reducing the need for regulation. Regulators, with much higher visibility into financial transactions, could dramatically streamline reporting requirements. Money should get to the right places more efficiently.

At a fundamental level, this does appear to work. Lost in the apocalyptic coverage of the crash is the fact that true DeFi “institutions” kept chugging along as expected, programmatically liquidating collateral and balancing their markets as designed. Three Arrows Capital, Nuri, Celsius, BlockFi, and FTX were all centralized firms and all imploded. MakerDAO, Aave, Balancer, and Uniswap - all decentralized - remained very much functional, transparently, without any indication of fraud.

Decentralized markets are largely disconnected from the economic activities that really matter. This is the result of a set of related challenges:

Blockchains can only enforce agreements concerning purely digital assets. If a borrower offers bitcoin as collateral for a loan, a smart contract can easily liquidate that bitcoin when the borrower defaults. Loans against real estate, commodities, commercial revenue and other economically fundamental assets, by contrast, require physical contract enforcement. A building used as collateral cannot be programmatically liquidated; liquidation is a bureaucratic process, ultimately ensured by use of physical force. This is by design, given the potential harms of real-world enforcement. It should therefore be the domain of (ideally democratic) states.

We therefore depend on traditional entities, grounded in traditional law, to bring real assets into digital space, in short: to tokenize. Banks turn homes into mortgages, real estate funds turn properties into investment offerings, corporations turn future profits into shares, artists turn imagination into intellectual property, and yet…

We haven’t focused on creating value for these asset originators. Broadly speaking, they want more access to capital, but usually the need is more nuanced. For example, the majority of tokenization projects emphasize high liquidity as part of their value proposition, but small to medium-sized real estate syndicators, which generate $50 billion in assets per year in the US alone, don’t usually want their offerings to be highly liquid. They want their investors staying put. Their investors, meanwhile, would love more liquidity. DeFi could square this circle, but it hasn’t paid enough attention to it (spoiler: Cooperativ Labs has). Fundamental to the success of DeFi is an intense focus on often subtle and highly varied needs of asset originators.