Is DeFi a $10 billion Ponzi scheme?

Full Transcript

Angie Lau: Well, DeFi has been seemingly defying gravity for months; is DeFi a bubble? Should traditional banks be worried about DeFi, or should they embrace it? Welcome to Word on the Block, the series that takes a deeper dive into blockchain and the emerging technologies that shape our world at the intersection of business, politics, and economy — it’s what we cover right here on Forkast.News. I’m Editor-in-Chief Angie Lau.

Well, there ain’t no party like a DeFi party, because apparently a DeFi party don’t stop. This time last year, DeFi was just another potential application of blockchain technology with around half a billion dollars in total value locked. Fast forward to today, it’s now an US$11 billion application. Some say it’s a natural boom, some say it’s out of control, and it’s time to ask the question: is DeFi sustainable?

And should traditional banks be looking into how DeFi can reshape its existing structure? Here to unpack the seemingly complicated world of yield farming and governance tokens and so much more, let’s welcome to the show right now, Marc Fleury. He is the founder and CEO of crypto asset management and fintech firm Two Prime: Marc Fleury, Ph.D. and a brilliant mind in this space. Thank you so much for joining us.

Marc Fleury: Thanks for having me.

Lau: All right. So for all of those catching up to the DeFi space right now, let’s start with the absolute basics. What is DeFi?

Fleury: Well, first of all, it’s a little bit of a buzzword, so the good news is, we get to define what it means. The crypto space is very fond of buzzwords, and DeFi’s definitely it. But if you scratch [its surface], there’s many aspects to it. To me, the most interesting thing besides the buzz is truly the decentralized finance yield farming. You can think of Bitcoin and Ethereum as the equity play of the crypto financial world, meaning like stocks; DeFi is actually dealing with yield, so it’s more like bonds.

So at a very high level, if you think of your investments in the traditional financial world in terms of equity and debt, I think what we’re witnessing on a certain level is the introduction of debt-like instruments in the crypto space after the smashing successes of Bitcoin and Ethereum, where the currencies have values that are more equity-like and very volatile. That’s the first layer of it. That’s a good place to start, actually, just the yield and the bond, just to keep it simple to begin with.

Lau: Yeah, let’s keep it there because that’s absolutely where the interest is right now, and in your op-ed piece for Forkast.News, you note that the excessive money printing that we’ve been seeing, excessive central bank monetary moves and policy — what we’re seeing right now are near zero returns on bonds, and they’re driving investors to really explore alternative assets. That means we’ve seen a lot of influx of interest and money into cryptocurrencies. But DeFi, we’re talking about cryptocurrency derivatives; we’re talking about yields. And what is the challenge to essentially traditional banks also competing for the same investor interest?

Fleury: Let’s back out a little bit. It is true that with Covid-19, the financial system has come under stress. First of all, increased volatility in the broader markets due to uncertainty, and economies on pause, that’s on the real economic side of things. Then central banks have deployed airbags in terms of monetary easing, money printing, to basically provide emergency funds for people struggling, specifically in the United States, in the Western world. And of course, that’s a debasement of the currency that has led to a rapid appreciation of the financial markets, at least in the United States.

Some will argue that you’re not really seeing the financial markets doing well, what you’re seeing is the dollar being actively debased, so that your assets denominated in dollars are going up just because the dollar is going down, relatively speaking to other currencies. And certainly that is a valid analysis. But the result is that yield is, well, several things. Number one, yield is hard to get, or nonexistent in this market. We’re talking about negative yields; we’re talking about zero yields, it’s called zero interest rate policies. These are new times. Even though we tested the waters back in ’08 and ’09, this is now in full view for everybody to see. It’s modern monetary theory, MMT, in action; it’s not a bad thing, but it means new things for investors such as very little yield.

Bitcoin is attractive on both the equity and the debt side, because on the equity side, you have to bear in mind that in times of inflation or economic hardship, certain — what’s called numerus clausus, meaning finite numbers — there’s a finite number of bitcoin, as most investors know, and what that means is just like, really fancy real estate or pieces of art or in fact, gold. Once you have an instrument that cannot be multiplied in number, its price tends to become an inflation hedge. And that’s very attractive in these tough times. And bitcoin has outperformed gold on that front, as a pure inflation hedge on the equity front.

On the debt front, the DeFi movement — ourselves included in Two Prime, but we’re not the only ones — we’re capable of offering fixed income products to the fiat people. We are not talking to the crypto crowd now; we’re really talking to traditional investors, saying, ‘look, we have a treasury in crypto. The fact that it’s crypto is almost irrelevant to you unless you really want to know the details of what goes into the recipe.’ But we’re capable of extracting a fixed income revenue. This is what I do as a private investor, this is how I started, by investing on my own and realizing that I could derive significant fixed income out of these volatile exchanges.

So the first part of your question is indeed the attractiveness of crypto instruments in response to the crisis. The second part of your question about challenges to the traditional bank maybe deserves another question and a full on answer. But I’ll just say that in general, both at the central bank layer — as you know, China is introducing their CBDC, their central bank digital currency, the digital yuan, the United States has openly talked about the digital dollar during the Covid crisis as a way to deploy funds directly from the federal authorities to the end users, completely bypassing the banking system as a normal distribution channel for the newly minted moneys.

So if you come to the market with what crypto is doing, which can be between 6% yield to 15% yield, which is what we’re offering at Two Prime, you’re going to catch a lot of people’s attention. As you know, a lot of scams, unfortunately, out of China, the latest one was PlusToken, it was on the promise that they would give 6% yield, things like that. So yield is extremely attractive even to retail, and that will be impacted in the near future. I think that’s long enough of an answer, and I’m happy to get into any aspect.

Lau: Well, look, you make a great comparison that Bitcoin and Ethereum share some characteristics that are perceived as equity in the market, DeFi is the bond fixed income ability, the yields. You know, we hear terms like yield farming being bandied about, but it’s also now being compared to the ICO craze of 2017.

We’ve heard terms like Ponzi scheme, the impending rug pull, yield jumping, and in fact, Messari founder Ryan Selkis recently stated that DeFi is a bubble waiting to burst. How are your institutional investors and your high net worth clients viewing this concern? What’s your view, especially as you really try to derive value to a more traditional audience?

Fleury: It’s a fair question and crypto has a hard-earned, difficult reputation in general, specifically in the United States, even though this is changing and a lot of institutional investors are taking interest in the numerus clausus bitcoin and crypto in general. But to answer your question, I started with DeFi as first and foremost a buzzword. Let’s not forget that this is an industry where linguistics play a very important and predominant role.

We have decided to call a currency essentially something that is not at all a currency. And yet, I mean, on purely technical grounds, it is not a unit of account. It is not a medium of exchange, and it is a very volatile store of value, all of which makes it a very good and interesting, in fact, outperforming investment vehicles on technical grounds, but certainly not a currency. Yet because we call it cryptocurrency, people treat it as such. I say all of this to insist on the fact that this is still an industry where buzzwords can carry the day. And fortunately or unfortunately, what your previous comments are referring to is, in fact a truism.

A lot of people are doing scams because a lot of people are interested in DeFi, so if you slap the word DeFi on anything, you will get a lot of money coming your way. And a lot of the industry is still focused on brand awareness, popularity contests, because they are Ponzis. If, in fact, you do not have any value behind you in a creative, real asset backing, then your liquidity only comes about if you have somebody new coming in. And this is the very technical definition of a Ponzi scheme. Now it makes it an illegal Ponzi only if [what’s] underlying disappears.

But a pyramid scheme where people come in [with] liquidity is how every financial instrument on the planet works, so this is not necessarily a bad thing. So I’m trying to give you a balanced answer. The fact that it’s a buzzword to me is a negative, but in general it’s not because it attracts a lot of people. The question is, what do we do with that newly found fame? Do we decide to do the ICO all over again, where the monies were thrown at technology no one asked for and no one needed and blockchain and blah, blah, blah, and saving the world with blockchain? Or are we going to do something that works?

Well, I’ll give you the answer right now as Two Prime and as a private investor. It was always my thesis that blockchain was never about blockchain, even though that was the buzzword of 2017, and the technical applications, and we would see blockchain everywhere. This has not come to pass for very simple reasons: no one wants to share a database that they don’t control specifically in IT, and I come from that IT background. So to me, blockchain tech was not that real. However, the financial applications of blockchain technology are plain for all to see. There are Bitcoin, and Ethereum and now the derivatives and now the yield.

So even though the buzz around DeFi, to your point, is full of scams, because this is an industry that is very good at multilayer marketing and in bringing new people and in fact scamming them, that popularity can be turned into real gold with the yield. And because this is real, in fact, at Two Prime, we don’t even target the crypto guys. We don’t want to talk to them. You have your bitcoin, that’s great.

We’re talking to fiat people, meaning people who are sitting on their dollars or the euros that are desperately looking for a fixed income, don’t know how to get it, and getting into crypto is complicated – who do you trust? Which exchange is going to scam you? Where’s the real liquidity? That takes time and savvy and knowing the people and spending time.

So guiding these people… but the product is fiat on fiat, meaning you give me fiat, and I return to you fiat. What goes on behind the scenes is almost irrelevant to you unless you really want to take a deep dive, and most high net worth individuals do some due diligence as to where the money goes, who’s the custodian, what are the security procedures, in broad terms, what’s the proprietary strategy, etc.

But just to wrap this up, yes, it’s a huge buzzword, yes, it’s a bubble, but can you turn the positive of this froth into a real product? I think so. It makes for actors like ourselves, but we’re not the only ones; this is an industry that has matured a lot since I discovered it in 2011, and it was only used for drug trading at the time. You know, this is a very different industry today, with institutional players, a lot of VC money in the U.S., in Asia, in Europe, a lot of very valued exchanges all over the world, a lot of advanced products such as options and the futures…

This is a different industry, and it’s so financial. And so let the buzzwords be buzzwords, we’re going to do what we’re going to do, and they’re going to do what they’re going to do. Scammers are going to scam, pump and dumpers are going to pump and dump. But there’s a real opportunity here to say something very relevant to the financial world at large.

Lau: On one hand you have some real value that you can derive from fiat on fiat, you know, Bitcoin, Ethereum, and then on the other hand, you have new DeFi tokens purporting to be something raising tens of millions of dollars, and suddenly the floor drops out because the liquidity is sucked out, because the founder has taken that money off the table, etc. And that’s the kind of volatility that is kind of noise in the space.

So let’s say you really want to understand DeFi right now. Yield farming, of course, is one of the main driving factors to this explosion of interest. Where did yield farming come from? How does it work? What are the pros and cons of it? And how would you explain yield farming to your institutional and traditional finance clients?

Fleury: Fixed income is the oldest financial category in the world. Even the Bible talks about a jubilee on the debt every 50 years just because compounding interest is an exponential curve, specifically, mathematically speaking, and that cannot grow forever. In the context of crypto, crypto needs to be held. Specifically, crypto without any endogenous cash flows only gains value in an exchange that only deals with supply and demand if, in fact, the supply is artificially controlled. And that’s what in crypto we call the HODL. We just hold, we never sell. When you do that, you limit the supply.

And so to incentivize, historically it started in 2017 after the ICO bubble. Historically — I like to say historically when it’s 3 years old, but for crypto it is history — three years ago yield farming was really… you are going to get paid in the crypto you were holding. So if your numerare is bitcoin, you get paid in bitcoin. If your numerare is Yield Coin, you get paid in Yield Coin. Now, of course, getting paid in Yield Coin when it’s not liquid is not really interesting for investors, so what you’re yielding is important here.

DeFi does not depend on tokens. What depends on tokens is the pump and dump mechanisms. And yes, those tokens are raising millions of dollars; most of the stuff they pitch have no idea what they’re talking about. It’s the ICO boom all over again. That’s the pump and dump side of the crypto house. That’s the casino side of the crypto house. It’s going to happen, there’s nothing you can do about it except not participate. But it’s going to happen, it’s going to draw attention. Again, the important thing is that we don’t mess up the rest.

Now, yield farming to us at Two Prime — again, we’re all defining DeFi, no pun intended — but to us, yield farming is really fiat on fiat. If you give me fiat, I’m going to go and extract a yield, which is going to be 15% , and we’re going to pay you monthly on this 15% as income. We’re not talking equity, we’re not talking a token that’s not liquid that you get paid in. You’re not crypto-rich, you are fiat-rich. We’re paying you in the currency you’re based in. Now, that is very relevant. There is nothing like that on the market today.

Since 2008, since the Feds and the central bank decided to print and flatten the yield curves, finding passive income has been extremely difficult for a lot of high-net-worth individuals, and so income is the new black. If you have income, people are listening to you. And crypto can do that, so let’s go do that. We don’t need to talk. In fact, we don’t market at all. We don’t want to market a token for the debt instrument. It makes no sense. It might make sense in a secondary debt market, just like you have secondary markets for debt all over the world, but the primary market is what’s interesting right now. Let’s make sure the primary markets are solid. Then we can look at real secondary debt markets.

Right now, the crypto token markets are just the same thing as ICO. It’s exactly the same thing. We just put a different word on it. But intrinsically the value is nil and the same, meaning nothing, it’s just the word. But there is real value. There is real accretion, there are real cash flows, there is real yield that one can have in fiat, not in Yield Coin. And that, I think, will actually be an even bigger wave for crypto than the ICO boom ever was, because we’re dealing with debt. And, as you know, debt markets are trillions, across the world.

Lau: And to your point in the Forkast op-ed that you shared with us, this challenge and obviously could be a legitimate alternative specifically of providing yield to people desperately seeking yield. So can DeFi challenge the traditional financial structure? Should banks be worried? And what should traditional banks be thinking about? Can they even participate in the DeFi space?

Fleury: Well, there’s several layers to the banking system, as you know, and we touched briefly upon the central banks doing their thing, won’t talk about the commercial banks right now, but retail banking certainly is going to feel the impact on the DeFi front, specifically if yield comes to fruition. Banks and bank deposits today cannot offer yield. The federal windows are so low, and for the foreseeable future so low. The discount windows are at zero or negative, that a retail offering above 1 or 2% is… who can get 3% in this environment? No one can.

And so if crypto gets its act together and offers some true yield, this is going to catch on like wildfire, because no one is doing that. No one. And crypto has the opportunity to not mess it up. Now, retail offers of this require several layers. Right now, at Two Prime, we’re purely targeting accredited investors. We don’t want to hear about retail at this moment, even though it would be the most impressive product for a retail holder. We’re focusing on high-net-worth individuals; it’s easier on the sell standpoint. It’s just guys like me that go, “you want income? Here it is. This is how I do it.” And I’m opening this book for others to do the same or place with us.

Now, doing that for retail is a very different proposition. Is this product competitive? It’s more than competitive, it’s unique. And by that I mean not just Two Prime’s, but the yield in general. You pick your poison, it’s between 6 or 8%, 11%, up to 15%. And that’s unique. So, yes, a lot of people are paying attention. It struck me in 2016, when my teenage boys were out of their miner phase and the whole mining thing was out, I was looking at them and they were banking on Binance.

Let me explain that: they had their accounts in Binance, and I would give them their allowance and they would put it on Binance and invest, and keep their balance in USDT. And it struck me for the first time, “oh, my goodness, the convenience of the USDT, the Tether, or whatever stablecoin we call them now, that’s phenomenal.” They would keep their balance there, they would invest right there, and the difficulty was actually moving the money to PayPal so they could spend it on whatever they spend as teenage boys in the United States. But it was obvious to me that, at some point, this was the real bank.

In fact, many say Tether was born as BitMax’s bank, if you remember the history of that. And so you can make the case that in the near future, the new banks are the exchanges. Now, when we talk retail, what grandma wants to look at a trading desk to manage her assets or even her expenses? No one wants to look at a trading view. This is for experts, gamblers, traders, market-makers, professionals. Even as an individual, I don’t want to deal with a Binance trading interface to manage my bank account.

So, yes, figuring out the user interface — you know, what’s my balance? Am I insured? Who’s the custodian? Where are my keys? These are issues you and I don’t think about. We don’t think about losing our credit card — it’s not a big deal if we do. If you lose your keys, it’s a huge deal. It’s gone. So there’s a lot of things for us to figure out as an industry before we really have impact on the retail space. But I look with a lot of interest.

Just to wrap up this question, you know, I look with a lot of interest at what China is doing in Africa, for example, and their central bank. And just as disclosure, I had dinner with the lead architect of the central bank of China in Beijing, and he told me, Dr. Fleury, I want you to know that we use your software as the infrastructure for the core banking system.

Lau:  I can’t confirm or verify that, but that’s — 

Fleury: I’d be happy to put you in contact with them. They use JBoss as their infrastructure. I didn’t know because it’s the nature of open source that they use the software I developed 20 years ago without owing me anything. But I say all of this to say, here’s a very aggressive, forward-looking and politically motivated country, because the African Silk Road is a reality today. It may be predatory like the IMF was — let’s not get into those details.

Long story short, they are about to say something very profound to the banking infrastructure of Africa, where you do have relations. You can’t trust your local banks, you can’t trust the local authorities, you can’t trust the local warlord with his printing machine — they could really, really say something very profound and relevant on the retail banking front. And I’m a very interested spectator. I think they very, very soon will.

Lau: I have no doubt that there’s definitely a lot of expansionary thinking on the digital RMB — we’ve been reporting it’s already in the test phase, the pilot phase, and people are using it on a retail level and what it means for trade relationships for China across Africa and around the world, potentially, especially in light of the U.S.-China trade tensions. It sounds like another tangent, but it very much ties into all of this.

If when we talk about decentralized finance, everyone can be participatory, there’s a lot of liquidity in this space. If you think about it, this year has been enormously unpredictable. It’s been Covid-19, there’s an intensification of U.S.-China trade tensions… We still have a couple of months left here. DeFi has grown enormously despite this very volatile environment. What’s your prediction for DeFi in the coming months and into 2020?

Fleury: Well, I think the movement is real. I think it’s so real that we shouldn’t mind the buzz nature of it, and we should embrace it. In fact, because of the nature of the crypto industry and the way a lot of the token exchanges are set up, you’re going to see a lot of people chasing the buzz.

My prediction is that, given the professionalization of the space, both the investors that are in on the tech from the financial front, the participants that have stepped in for the past five years, I’m an active participant as the company and a private investor on these exchanges… we’re a far cry from the fake volumes that were being reported in the past. This is real liquidity. So my bet is that both the equity side of bitcoin, meaning the price of bitcoin, is going to go up just on technical grounds — finite number of bitcoin supply, infinite fiat supply — so the demand is going to increase in dollar a base and the supply is finite, so the equity is bullish.

But the most important thing, the most interesting and perhaps the most impactful, is going to be this yield, because it’s speaking to the debt structure, it’s speaking to a lot of people, speaking to millions of investors that are looking for fixed income today. And that will, if we don’t mess it up and I want to use the F-word as a Frenchman, but if we don’t mess it up, what we’re looking at is truly something that will establish crypto as a very viable and relevant instrument.

And mark my words, just like my open source software was plumbing of the Internet infrastructure, and nobody knows, even if you use the RMB, you don’t know you’re using JBoss. And I don’t mind. I think DeFi and crypto are heading the same way, meaning we can talk for hours about DeFi, the liquidity, the options, how mature the debt pools, the spreads, etc… but if we offer 8%, 15% yield — “Oh, really? When? Now.” You know, everything else is almost noise at this point, and that’s a very positive thing, because it’s simple: nobody’s doing it; crypto can do it.

Well, that’s it. I think that’s the opportunity, and that’s going to take 2 or 3 years, and in 2 or 3 years, if DeFi, the real yield — fiat yield farming, not any coin farming — comes to pass, I think that’s something I and many others would like to see come to fruition.

Lau: Well, Marc, I’m going to use another French phrase, “c’est incroyable” is what we’re seeing right now in the DeFi space. But I really want to thank you for your time and your insights so that we can do at least our intellectual due diligence, understand these concepts a little bit better and what the true interest and ultimately the true potential is. Marc Fleury, thank you so much for joining us on this Word on the Block.

Fleury: Thank you. 

Lau: And thank you, everyone, for joining U.S. on this latest episode, I’m Forkast.News Editor-in-Chief Angie Lau. Until the next time.