A framework for understanding value
If you’d prefer to listen rather than read, I made a video for you!
I recently had a chat with one of my colleagues who works as a marketing product analyst at an investment firm near where I live. He has never dabbled into crypto currency, and has 10+ years of knowledge of mutual funds, stocks/equities, bonds, essentially the entire financial system.
But when I brought up the topic of crypto currency there was a smirk and small chuckle at the fact I was even discussing such a matter. I asked him if he has ever heard about Decentralized Finance within his work circles, either being work mates or upper management, and he has not. Not even once has the term Decentralized Finance pass by his ear.
“Hah! What is that? Crypto stuff?”
I started talking to him about it for a little bit and I noticed after speaking to him that my perception of value since I have entered the DeFi realm (back in September 2020) has changed and was different than his. I think it’s because he’s missing some fundamental understandings on the topics of Tokenomics. Which I think is native to crypto. I don’t think the world outside of crypto has new currencies being created as frequently, with such intricacy in the development process of the smart contracts backing it, and with such amazing use cases. As such, I say Tokenomics is native to crypto and it makes sense my colleague was lacking such. So, I want to talk about some deeper concepts that exist within DeFi that have altered my perception of what value is; at least to what I think is a more true understanding of value.
A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained therein exist across a distributed, decentralized blockchain network. The code controls the execution, and transactions are trackable and irreversible.
A smart contract is some code
Smart contracts are automated enforceable agreements that don’t need intermediaries like a bank or lawyer for ensuring legitimacy of financial operations and use online blockchain technology instead. These smart contracts can also be audited by a variety of different auditing teams to ensure legitimacy of their proposed use case. (NOTE: these are the smart contracts you should probably only interact with!)
What can these smart contracts do?
Tons of different things. Smart contracts, when deployed on a blockchain, seem to have this emergent property about them. Meaning you can know what a smart contract is in itself, but once it is deployed on the blockchain, you can’t be 100% sure how the users will interact with it. A specific example here could be referring to the birth of DEX’s which emerged from a collection of different smart contracts (in this case these smart contracts would be acting as liquidity pools for the use of swapping tokens from one to another).
Summed up, smart contracts can provide value to the user, depending upon what the smart contract is designed for.
Different smart contract designs
A couple main uses for smart contracts are…
- Transfer tokens from one account to another
- Transfer tokens to the smart contract itself. Thus placing your value into some pool of value.
The concept of #2 is what makes DeFi possible. Once you have a large amount of value placed into a variety of different smart contracts, different products and services can emerge. The most common emergent services are Decentralized Exchanges, Lending/borrowing protocols, and insurance providing.
All of those services provide value for the user in some way. Such as providing a way to swap tokens without having to use an intermediary to facilitate token swaps, or gaining a credit that is a % of your deposit (while your initial deposit is earning a yield). The user that is utilizing these smart contracts pays a small fee to those who are providing value/liquidity to the smart contract in question.
Tokenomic concepts that contribute to a new perception of value
There are some currencies with a capped supply of tokens available. The FIAT money supply, at least where I live, is controlled by a central location and can create or destroy their tokens at will.
(The following is an example. Not real numbers. Used to explain the effect on your initial value based on fluctuations of the total money supply)
You have $100,000USD.
The total money supply of USD in circulation = $10,000,000,000
Your amount of the pile
= 100,000 / 10,000,000,000
if there is an increase in total money supply then the avg price of assets increases. therefor if your percent of the total money supply decreases to 0.000001% of the pie (one extra 0), because of money printing, after a certain time, your buying power essentially gets divided by 10. So the value you initially had, has depreciated 90% due to the total money supply inflating.
Your initial position would not depreciate in value if you were compensated an equal % of the total money supply increase. (ex. total money supply increases by 50%, you get compensated 50% of your value. Therefor you still hold the same buying power when taking inflation of assets into account.) But this does not happen
How do you combat this?
Place your value into a non-inflationary protocol. (or even a deflationary protocol!) I’ve contemplated this topic for quite some time.
I initially thought stocks/equities were a non-inflationary protocol, but I was wrong. Well, they are non-inflationary until they aren’t. The reason is because the stock in question has the right/ability to issue new shares or perform share buybacks. This is similar to increasing the supply of the token (the share), and decreasing the supply of the token. This decision is still controlled by a central entity, being the company itself.
But what about cryptocurrencies?
“BTC is amazing as a store of value!”
This meme has confused me. Ok, BTC has a max supply of 21m… Therefor amazing store of value. My thought here is that there are tons of tokens with a fixed supply. If anything there are some tokens that already have their entire total supply minted and circulating, unlike BTC (BTC is inflationary until year 2140). There are even some tokens that have a deflationary structure to them. (ETH will soon have this functionality implemented)Meaning your % of the total supply increases as time goes on. Thus increasing buying power with respect to asset prices.
There are also some tokens that provide a use to the user, thus generating a fee, and then using that fee to buy back their own native token. Which creates a forever positive buying pressure, as long as the use case for the tokens stays strong. This creates a quasi-deflationary Tokenomic model.
Value is weird. You have some, it is held within a certain Tokenomic structure(FIAT, stocks/equities, real estate, crypto, etc.). Depending upon your position of value; the total supply of tokens can fluctuate, your % of tokens in regards to the total tokens could fluctuate. Your buying power can fluctuate. A static or deflationary token model paired with a positive buying pressure by the native token providing some use to its user base over the long term seems like the safest place to put value. But whos to know. This is just one type of logic.
After writing this, I actually still don’t think my colleague would be interested in entering the crypto world, let alone using and interacting with these Decentralized Finance smart contracts. It’s too new and too risky. There are bugs and hacks that have happened, but I feel like in 5–10 years DeFi smart contracts will be refined and worked into our current financial systems and eliminating a lot of un-needed middlemen as a side product, as such giving the yield directly to the provider of liquidity, rather than the middlemen/facilitators.
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