The Bank of International Settlements released a 19 page report on Decentralized Finance.
Surprisingly, the raw data within the report is quite good. The report is well researched in parts, demonstrating the authors did their homework and have a deep understanding of DeFi. At one point they even cited Convex.
Sadly the delicious meat of the report is sandwiched by stale, unsatisfying bread. The report is bookended with gibberish and FUD against DeFi. You can almost imagine the bosses complaining the report is unpublishable unless it makes DeFi sound scary. Thus they tack on some easily discreditable nonsense. Oh well, they got their headlines, which is all people read in the end.
Naturally, the community howled back.
Let’s pick apart their laughable arguments for the umpteenth time.
Decentralized Illusion
BIS’s core argument is what they call the “decentralized illusion.” They make two key assertions, both valid in and of themselves:
Some degree of governance mechanism will always be necessary for DeFi protocols to deal with unforeseen circumstances
Some protocols pretend to be decentralized while actually being centralized.
Nobody actually takes exception to either of these points. In fact, the crypto community is heavily self-policing, and vocally opposed to projects that are insufficiently centralized. Witness this recent exchange:
Surely, some protocols do lack sufficient centralization. They are easy prey for governments to actually exploit this attack vector. We wish the best of luck to Uniswap. They coveted centralized control, and soon we’ll find out if it proves their undoing.
Yet the fact that some protocols are insufficiently centralized does not imply all suffer this flaw. Herein the authors commit a classic fallacy of defective induction. The few protocols that LARP as decentralized do not negate the protocols who have sufficiently decentralized.
Their attempt to hand-wave this away is laughable.
Discussions about changes to governance protocols, in particular to rein in collusion, have gained momentum in the DeFi community. However, adopting these changes would not alter the basic fact that some centralisation is unavoidable.
Here they commit the fallacy of ambiguity… (ie “No True Scotsman!”) You can never be perfectly decentralized! Well, no protocol need demonstrate “perfect” decentralization, whatever that means. All DeFi really needs to prove “sufficiently” decentralized to protect against governance attack, which they can achieve by passing a simple litmus test I suggest:
No single entity holds a majority of voting power.
The protocol can maintain continuity of operations no matter how many large stakeholders get neutralized.
Maybe readers could propose additional criteria, but the point is that it’s straightforward to achieve a level of decentralization that provides resiliency against governance attacks. Their paper simply never addresses the dozens of protocols that pass this low bar of decentralization, except dismissing that they still have “some level of centralisation.”
Another way to think about this. Assume BIS was opportunistic. Instead of just looking to spread disinformation, suppose they actually believed they found a viable attack vector against DeFi. Instead of warning about a potential attack on DeFi, why not simply wage such an attack? They are well-financed and surely could find allies who would love to kneecap DeFi. The opportunity amounts to billions of dollars. Why not just take the money in a visceral demonstration of just how scary and dangerous DeFi is?
Curve has $20B locked, for example. If DeFi is as vulnerable to a governance attack as the report likes to pretend, why not just execute such an attack and drain that money? You’d be doing the global financial system a favor by eliminating this purported danger. Just vacuum up that $20B for yourself and present it as a cautionary lesson to other aspiring blockchain developers.
For Curve’s sake, how would you commit such a governance attack? You can’t really get a majority share of veCRV, Convex has basically nailed this. So you’d need to attack Convex. Except that’s got too many stakeholders. Good luck landing a fatal blow with a governance attack.
They can’t, because they know it’s not a real attack vector. Vulnerabilities in the blockchain world get exploited almost immediately.
If any attack threat actually existed, it would already have been exploited long ago by the merciless hacker community. The open and permissionless nature of DeFi allows anybody who locates any weakness to become very wealthy, very quickly. This is how you know BIS is bluffing — this attack vector does not actually exist, or it would have already been exploited.
It’s like the old joke: two economists walk down the road. One says, “Look, a hundred dollar bill.” The other says, “Impossible. If it was a real bill, somebody would have picked it up already.”
Really, there’s little difference between “DeFi Governance FUD” and the “51% Attack FUD” Bitcoin had to deal with. For the better part of a decade we’ve had to hear the bad-faith fear merchants crying, “yeah, but what if miners get 51%.”
Systemic Risk
DeFi’s vulnerabilities are severe because of high leverage, liquidity mismatches, built-in interconnectedness and the lack of shock-absorbing capacity.
They don’t spill as much ink elaborating their second complaint about systemic risk, probably because it’s a cliched rehash of boilerplate FUD. For nearly a decade banks have leaned on this type of FUD to do things like “protect” their customers from evil volatility by preventing cryptocurrency purchases. The crypto community responded by rendering banks obsolete. Now banks are seething.
To the first point… yes DeFi is very risky. So what? Other than Mark Cuban, no human being has seen seen double or triple digit yields and assumed it was a safe place to put their money. The communities identifies as degens not because they’re investing grandma’s retirement money, but because they’re degenerate gamblers. Users only play with money they fully expect to lose, hoping for the outside chance it actually works out.
The crux of their argument really boils down to the last part, “the lack of shock-absorbing capacity.”
There are no shock absorbers in DeFi that can cut in during stress periods. By contrast, in traditional finance, banks are elastic nodes that can expand their balance sheets (extending loans or purchasing distressed assets) via the issuance of bank deposits, which are a widely accepted medium of exchange. The ability of banks to do so rests on their access to the central bank balance sheet
The way TradFi works is everything they accuse DeFi of… banks are themselves “centralized”, “highly leveraged” and deeply “interconnected.” They have a nasty habit of stressing the system beyond its breaking point. When it inevitably collapses, the whole thing breaks. Yet they know can rely on the federal governments to just print more money. This effectively clears off the playing field, and everybody starts again from scratch.
Except the poor get screwed every time this happens. The Cantillon effect is real. Every time the “shock-absorbing capacity” is flexed, whoever is closest to the money spigot benefits disproportionately. And you complain about DeFi centralization? Pot… kettle….
Where the paper complains about DeFi lacking this shock-absorbing capacity, one could more easily argue that the very existence of such a centralized money printer represents an existential risk to TradFi. Try rewriting the paper from the reverse point of view….
TradFi is itself a centralized, risky, and deeply flawed system. DeFi is an experiment in building a system without these inequities. When a DeFi protocol goes belly up, the entire community takes a haircut and rebuilds. This happens frequently, and the net effect is that people’s social feeds fill up with memes of people applying for McDonalds jobs.
What BIS presents as a bug, the community views as a feature. DeFi is building a financial system that fully rejects the “shock-absorbing capacity.” We do not want protection, nor do we seek it. We reject it wholeheartedly.
This stance theoretically inures DeFi against the criticism that it could present a risk to the traditional system. If DeFi fails, it fails alone. No taxpayers on the hook.
When we fail, we try harder. Your system is failing. Cry harder.