In traditional finance, most contracts or agreements require central intermediaries tasked with guaranteeing fairness. Sometimes the trust placed in those organizations is broken, as malpractice comes to light or policies seem to favor those already in power. DeFi offers a more trustworthy alternative financial system, built on open-source code that’s fully auditable and transparent, allowing equal access for both creators and consumers of services.
Truly decentralized finance, all the way down to the settlement layer allows societies to grow and scale without requiring trust in institutions – ultimately solving many of the deep-rooted problems that exist in our financial system today.
But we’re a long way off from DeFi actually replacing traditional finance, and much of that has to do with gatekeepers weakening decentralization and exploiting flawed security. Many of the new entrants in the space fail to satisfy the degree of decentralization and robust security required to make DeFi work as envisioned.
Gatekeepers on the prowl
The institutions and organizations that deal in “trust” earn a hefty premium for their services, both in monetary terms as well as soft power. DeFi would unseat incumbents as the need for centralized power is greatly reduced by automated pieces of code, which is open-source and auditable by anyone. This naturally leads to resistance and direct attacks – you’re going to get bitten if you get between a dog and his lunch.
Some of the attacks on DeFi and the wider crypto industry we’ve seen come in one of three forms. The first is using blunt tools like a blanket ban, designed to discourage and block people from accessing crypto in any form. The second way disrupts trust by spreading false and negative narratives, orchestrating meaningful hacks, and price manipulation to further erode confidence in the operation of markets for digital assets.
The third tactic involves co-opting a system targeting weak decentralization and hollowing it out from the inside. This is perhaps the most dangerous one, as it pretends to be progress but actually changes nothing. Central Bank Digital Currencies come to mind – they do nothing to further the value system of DeFi and only give centralized authorities more control and reach. Its bleat will soon turn to a howl.
Not all blockchains are equally decentralized
What all these different tactics have in common, is weak decentralization and security. As you might notice, scalability, the third element in the Holy Trinity of Blockchainism, is not targeted. That’s because decentralization and security are essential at the fundamental level and scalability less so, the same way you can trade-off strength for beauty at the roof of a building but not at the foundation.
Yet, many of the DeFi players both old and new seem to focus more on scalability to reel in the retail convenience crowd, and less on widening a decentralized network and strengthening security. These networks, like Binance Smart Chain, sacrifice security and decentralization in the name of programmability and transaction speed. This gives us many new projects, tokens, and protocols – and it hides lack of strength.
Even Ethereum, the primary engine of DeFi today suffers from a monetary policy that is unpredictable and openly targets minimum issuance to secure the network, an unclear roadmap for upgrades leading to frequent and lengthy delays, and insufficient decentralization as setting up and syncing full nodes is of prohibitive difficulty. This makes Ethereum an easy target for co-opting attacks as well as direct hacks like exploiting vulnerabilities in the code base, as the tale of DAO hack goes.
Strangely enough, we already have a protocol that does meet the decentralization and security needs of a robust DeFi ecosystem, but it seems to get overlooked for the role. It could even hold up against the full weight of the organizations that currently hold power. Maybe it’s because the majority of Crypto Twitter & Co. are mostly interested in the latest turbo-farmed yield wielding meme token, but the old trusty Bitcoin can do a lot better than most people seem to realize.
Bitcoin as the foundation for a robust DeFi ecosystem
Bitcoin beats all other blockchains on security and decentralization. Bitcoin nodes are cheap and easy to run, leading to a large set of validators across the world. A predictable proof-of-work consensus mechanism has led investors to pour billions in purpose-built bitcoin mining machines, which are plugged in at every corner of the globe. The Bitcoin chain has never suffered a serious reorganization or successful attack on its foundational ruleset, despite the many malicious attempts.
While complex financial contracts are difficult to execute on Bitcoin’s blockchain right now, that will soon change with the oncoming Taproot and BIP 300 upgrades scheduled for activation on block 709,632 (mid-November 2021). It is the first upgrade in four years, making it a momentous achievement for Bitcoin, enabling many new things for Bitcoin and everything built on top of it.
Some of the main benefits include increased privacy by making complex transactions indistinguishable from simple transactions in terms of on-chain footprint, lower fees as the data size of complex transactions is reduced, more flexibility with a new type if signature that will enhance smart contract functionality, and a boost for the Lightning Network – a layer 2 solution that enables faster and more scalable payments.
But it’s not only the features of the upgrade that further the case for Bitcoin as the primary infrastructure for a truly decentralized financial system. It’s also the process around it, and what the changes imply.
Taproot is the most significant upgrade to the Bitcoin network since the block size increase of 2017, which highlights one of its main features: it is robust.
Bitcoin upgrades are relatively infrequent because making changes is hard. There is no one in charge who can decide what changes get pushed through. And achieving consensus among such a diverse and dispersed group of participants is a challenge. It took years to refine Taproot features and agreeing on the best way to bring it online before we got even close to agreeing on actually enforcing the upgrade.
If anything, Taproot also serves as a reminder to everyone obsessed with the price of BTC this minute and the next: Bitcoin is a technology, and technologies evolve. Nobody wonders how their gold will evolve in the vault, but who knows what the evolution of Bitcoin has in store for us. Yes, Bitcoin can be a store of value, hedge against inflation and return to sound money principles. But it also very early in its development and it can do a lot more for the way our future financial system works that just sitting there as another uncorrelated asset.