Not long ago, I was at a lunch where nearly everyone present was new to each other. The central figure in the party introduced me as, “this is John, he’s part of a really cool crypto VC firm.” Of course I politely corrected him, letting everyone know that while my firm was in fact really cool, we were actually a crypto based hedge fund, not a crypto centric venture capital firm. I don’t think anyone really cared about the distinction, and as long as they think of me as “that crypto guy,” I’m happy.
While my lunch partners might not have really cared about the legal structure of Vellum Capital, or the mandates under which we operate, the event did highlight for me how terms can get confused within the financial space. As crypto comes into the mainstream, some of these terms are being borrowed from the legacy financial system, and that has the potential to cause a lot of harm. The recent Terra LUNA debacle is a case in point, but I already sense that with the most recent inflation number coming in at 9.1%, many crypto enthusiasts are hoping to simply move on without having to really address some core concerns.
While the details of the Terra Luna collapse are not the focus of this article, the idea of “yield” within the Terra ecosystem was certainly at the heart of the matter. Specifically, a protocol / token known as Anchor was a place where you could park your UST stablecoins and earn “yield.” Not just any yield mind you, but 20%. Of course this sounded great to a great many people, but the problem was, Anchor didn’t really do anything to earn that yield. In other words, it was passing on “yield” to its subscribers, when all it was doing was passing along a subsidy that was bound to run out eventually.
The world in which Anchor operates is known as “DeFi” or Decentralized Finance. To the true believers in crypto, DeFi represents the unseating of legacy financial systems that receive exalted status and are sometimes viewed as “too big to fail.” DeFi represents getting a loan based solely on the collateral you have and not on the subjective determination of a random loan officer. To the DeFi defender, bringing banking services to the “unbanked” is a true mission, a mission devoted to lower fees, lower barriers to entry, and high inclusion.
While the acronym is not altogether misleading, it is perhaps a bit too optimistic at this point, and when combined with things like “yield,” you begin to see that the idea of risk is being seriously obfuscated. A better acronym for this area of crypto is probably “UnFi” or Unregulated Finance. While many DeFi protocols hope to one day truly be decentralized, nearly all of them have front men, boards, VC backing: the very opposite of a decentralized structure.
While “DeFi” certainly sounds better than “UnFi,” that “finance” part of the acronym needs some evaluation as well. The word “finance” is quite broad and vague, and much of what is actually done in DeFi falls into the category of unregulated venture backing. For example, when one goes onto a staking protocol where one stakes their alt coin for yield, you are really lending your token to a new project that is promising high yields while they try to build out the ecosystem. What this really amounts to is unregulated venture capital, or perhaps “UnVe.” No, that’s not particularly catchy, and when one looks at the space in this light, it looks much riskier, and a lot less inviting.
What is unfortunate about some of these nomenclature issues, is that so much of the technology within the crypto space holds great promise. Decentralized file storage and computing power is something that freedom lovers should be embracing. Decentralized music platforms that allow artists to take control of their work without the monolithic music label taking a huge cut is something laudable. Some of these platforms will eventually be quite mainstream, but in the meantime, those in the space need to realize that borrowing terms straight out of the legacy financial lexicon is probably not doing anyone any favors. This reality got glossed over in the bull market, not so much now that the bear has arrived.