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This is:A whirlwind tour of Ethereum finance,...
Welcome to The Nonlinear Library, where we use Text-to-Speech software to convert the best writing from the Rationalist and EA communities into audio.
This is:A whirlwind tour of Ethereum finance, published by cata on the LessWrong.
As a hacker and cryptocurrency liker, I have been hearing for a while about "DeFi" stuff going on in Ethereum without really knowing what it was. I own a bunch of ETH, so I finally decided that enough was enough and spent a few evenings figuring out what was going on. To my pleasant surprise, a lot of it was fascinating, and I thought I would share it with LW in the hopes that other people will be interested too and share their thoughts.
Throughout this post I will assume that the reader has a basic mental model of how Ethereum works. If you don't, you might find this intro & reference useful.
Why should I care about this?
For one thing, it's the coolest, most cypherpunk thing going. Remember how back in 2012, everyone knew that Bitcoin existed, but it was a pain in the ass to use and it kind of felt weird and risky? It feels exactly like that using all this stuff. It's loads of fun.
For another thing, the economic mechanism design stuff is really fun to think about, and in many cases nobody knows the right answer yet. It's a chance for random bystanders to hang out with problems on the edge of human understanding, because nobody cared about these problems before there was so much money floating around in them.
For a third thing, you can maybe make some money. Specifically, if you have spare time, a fair bit of cash, appetite for risk, conscientiousness, some programming and finance knowledge, and you are capable of and interested in understanding how these systems work, I think it's safe to say that you have a huge edge, and you should be able to find places to extract value.
General overview
In broad strokes, people are trying to reinvent all of the stuff from typical regulated finance in trustless, decentralized ways (thus "DeFi".) That includes:
Making anything that has value into a transferable asset, typically on Ethereum, and typically an ERC-20 token. A token is an interoperable currency that keeps track of people's balances and lets people transfer it.
Making liquid exchanges where you can swap all of those tokens at market prices.
Making schemes for moving those tokens over time, like borrowing, futures, etc.
Making elaborate scams and arbitrages to obtain other people's tokens.
It's not completely clear to me what the main value proposition of all of this is. It's easy to generate things about it that seem somewhat valuable, but hard to say how each stacks up. Some possible value includes:
Evading regulation, like securities laws, money laundering laws, sanctions, capital controls, laws against online gambling, etc. etc.
Allocation of capital among projects that can raise money using cryptocurrency tokens (because somehow they have a scheme to tie the success of their project to the value of the token, making it a kind of virtual equity.)
Having less middlemen than existing financial systems, making it more trustworthy and cheaper. (It is not currently more trustworthy or cheaper than mainstream American institutions, but it plausibly could be in a few years.)
Tokenization
The first step is to make everything into an ERC-20 token. This will let all the other products work with everything, because they will interoperate with ERC-20 tokens.
Stablecoins and pegs
It's common for someone to want to own an Ethereum version of some other asset that is not Ethereum, so that they can use it on Ethereum. The most typical example of this is US dollars. A token whose price is designed to be pegged to an external thing like this is called a stablecoin.
There are a few techniques people use to accomplish this. The most popular one is to have a giant pile of US dollars somewhere under someone's control, and have that person act as a counterparty for anyone who wants to buy or sell 1 US dollar for 1 ...
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