I’m going to start with the assumption that anybody reading this both understands the function and value of Bitcoin, and the basic mechanics of Ethereum, Smart Contracts, and Defi in general. If you don’t understand these things there are lots of specific resources on this sub and many others, don’t be afraid to ask questions.
At the bottom I will share some links to resources I’m pulling ideas and opinions from. I am not an expert. I encourage all discussion and feedback.
Lets move on to identifying one of the most significant problems that occurs throughout legacy finance on every level. The problem is that all contracts (until now) must ultimately be fulfilled by human operators, this creates a system where it is easy and common for the operators of these contracts to be in a situation of both asymmetrical power and incentive over other participating parties.
Some examples of this include:
Banks wrapping up piles of sub prime housing bonds into garbage CDO’s which they send to their friends at the ratings agency the day after their golf trip. The rating agency’s fudge the numbers for years in order to maintain a profitable relationship with their golf buddies and significantly overrate these CDO’s. These CDO’s get passed around all the major banks and become significantly overleveraged. All of a sudden it’s 2008 and it all comes crashing down into a global recession.
Global insurance companies monopolize developed markets and end up with a risk tolerance that prevents them from insuring developing markets. This means that farmers in developing Africa are unable to get rainfall insurance, and when a once in a decade dry season occurs the farm goes bankrupt, not allowing the farmers to fulfill their economic destiny and keeping them stuck in a perpetual low investment equilibrium.
All right, we’ve identified the problem. So how does Defi solve this?
It removes the human operator. It creates a system where from end to end the contract is (when implemented properly) tamper proof. This is all very easy and transparent for something like Bitcoin, where the present data is all static, but growing. There is no need for any external data that’s not already on the blockchain, the system is inherently closed.
But what about when we need the system to be open to external data? For example, real time price feeds for a contract that performs arbitrage between Dex’s, or real time weather data for an insurance contract.
All of a sudden our neat closed system has a big gaping hole. It becomes a variable in the contract that can be manipulated by human parties. So what do these contracts do? They use an Oracle.
An Oracle is a piece of technology that connects blockchains to external real time performance data. They use similar cryptographic techniques and an array of decentralized notes to provide highly reliable and highly encrypted real time data to smart contracts.
I can’t overestimate how important this feels to me. I’m pretty sure this is the technological lynch pin that will ultimately allow crypto to become the predominate form of global finance. It enables economic models that nobody has even imagined yet. It fixes the single largest economic conundrum in human history.
I’ll be honest that these ideas are larger than I’m confident in articulating, I’m hoping that a few people might find my thought interesting and go diving for the many more intelligent people out there discussing these concepts.
This post is intended to be about the implications of the technology. I’m not going to tell you what coins to buy, I have no price predictions. I will, however, be transparent that my largest position is in Chainlink. Always Dyodd. Not financial advice.
Some links to people who’s thought’s and ideas I’ve stolen:
“The evolution of Smart Contracts” by Chainlink founder Serjey Nazarov: [https://www.youtube.com/watch?v=ufVyX7JDCgg&t=540s](https://www.youtube.com/watch?v=ufVyX7JDCgg&t=540s)
“The God Protocols” By nick Szabo, 1993: [https://nakamotoinstitute.org/the-god-protocols/](https://nakamotoinstitute.org/the-god-protocols/)
THE IMPACT OF COMMERCIAL RAINFALL INDEX INSURANCE: EXPERIMENTAL EVIDENCE FROM ETHIOPIA :[https://www.povertyactionlab.org/sites/default/files/research-paper/The-impact-of-Commercial-Rainfall-Index_EPIICA-paper_Ahmed-Mcintosh-Sarris_February2019.pdf](https://www.povertyactionlab.org/sites/default/files/research-paper/The-impact-of-Commercial-Rainfall-Index_EPIICA-paper_Ahmed-Mcintosh-Sarris_February2019.pdf)