DeFi Will Never Become A Real Ecosystem Until Utility Is Rewarded, Not Punished

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As much as we like to joke that the world is getting crazier by the day, you can find countless examples where groups of people will generally act in a rational, predictable manner. We as humans do have some biases that don’t make sense, like the phenomenon where losing a certain amount of money causes greater pain than gaining that same amount of money causes happiness. As individuals, we do dumb things all the time. But if you set up a system for people to use, the majority of people will act in a rational way that benefits them most.

With monetary systems, the rules are set and various levers can be adjusted to drive certain behaviors from people as a whole. There is still freedom to act how you want, but the rules will help to incentivize or penalize certain actions. Since people will generally act in a way that benefits them, a monetary system can be managed to handle many different economic situations.

Let’s talk about monetary systems and their various levers, and how it relates to the newly emerging crypto financial system. We will see that there are actually some missing pieces in the current crypto model, and that this will be a limiting factor until crypto is managed similar to a traditional monetary system. Finally, we will look briefly at a platform called Fluidity that claims to have the missing piece needed to unlock the larger crypto ecosystem.

Monetary Systems and Policies

Governments work hard to create a balance in the economy, with the goal of keeping inflation reasonable, prices stable, people employed, and keeping things predictable. In order to accomplish this, some of the key tools used are controlling the money supply and setting the interest rate.

For the money supply, the strategy is fairly straightforward. More money can be printed if needed, but there is a cost to this in the form of diluting the current value of the currency. The interest rate is the more complex and more powerful lever. If an economy is in a recession and the government wants to kick start it back to life, it will lower the interest rate so that banks can lend money cheaply to customers. When borrowing is cheap, more customers will want to borrow and spend money, which helps get the economy moving again. Conversely, if inflation is starting to creep up, setting the interest rate high makes borrowing more expensive and slows down the economy enough to stabilize inflation. Balancing inflation, economic activity (and as a side effect, unemployment levels), and the value of the currency allow a country to keep a healthy economy.

Crypto’s Gap

So how does the world of crypto compare to traditional monetary policy? Actually, crypto shares many of the similarities of how best to create a stable economy. The biggest difference is that unlike entire countries dictating the policy, crypto uses centralized and even decentralized guidance from individual platforms. There are many of these platforms, each working to balance their own mini economy, which is then unofficially combined to represent the larger crypto economy.

Crypto platforms, especially those that are financially focused, will have two key monetary tools: total supply, and interest rates. For the total supply, many platforms have a predetermined supply of tokens they will release, along with a distribution plan. This helps tokens retain value as holders know that they cannot be diluted by future minting. For the interest rate, crypto platforms have an entire collection of levers. They can dictate the interest rate for locking assets, lending, pooling, and more. They can offer additional incentives for providing liquidity to the platform. And they can give additional rewards for users who lock down and do not remove their tokens from the platform. And this is where the big gap lies in crypto: All of these actions promote the behaviors that platforms want, but they are only incentivizing saving and locking down assets. While this can help grow a platform’s value, it does not promote a true economy where people both save and spend. In the case of crypto, users are incentivized heavily to save, but are by definition punished by spending their assets, as they lose out on the interest rates and rewards they could have received by saving. This has put a major damper on the greater crypto ecosystem, and this must be removed before crypto can evolve and compete with traditional finance. As mentioned above, Fluidity is a platform that has made headway on this issue, creating a system that rewards spending as well, which takes away the opportunity cost from saving and allows both spending and saving to be incentivized. With their recent go-live on Ethereum, it will be a good opportunity for other platforms to see the results and consider adjusting their own policies to strike a more healthy economic balance.

In terms of incentives, the mechanisms used by Fluidity are fairly simple, but are expected to be very effective. For example, users can use fluid assets that are 1 to1 wrapped tokens, and when they are spent it exposes the user to a randomly paid large dividend prize, with chances increasing each time a user completes a transaction. These dividends are generated using the cumulative yield the platform earns through principal token deposits and lending. This ensures that as users are rewarded for staking and lending, they are also rewarded for spending and borrowing. This creates that much-needed balance necessary for a healthy economy. Imagine earning interest on your savings, but feeling good about using your fluid assets to buy groceries, clothes, gasoline, or even an NFT. This type of balanced gamification could be what crypto needs to become a mature, balanced, and expanding economy. Is this the only way to promote spending as well as saving? Certainly not, and hopefully other protocols will see this gap and use their ingenuity to find various solutions that create balance. But it will be interesting to see Fluidity’s approach and the resulting balance they might be able to achieve.

Final Thoughts

Crypto has grown and matured an incredible amount in a few short years, accomplishing with small teams and global communities what could only be done by entire governments. The coming year should be another period of growth and improvement, and if more platforms can follow Fluidity’s lead, crypto can truly unleash its potential of a global, healthy economy.