There are two ways in which you can view decentralized finance (DeFi) depending (mostly) on your level of cynicism. One is that DeFi is taking the concept of artificial scarcity successfully created by bitcoin to the next level on a mission to recreate human socio-economic structures on blockchain. That is the less cynical point of view. There is a lot to it; we’ll get to that later.
Then there is the other more cynical view, which (based on centuries of historical evidence) knowingly expects the human nature to be naturally drawn to market bubbles, self-delusion and greed, and that over time the only thing that changes is that Ponzi schemes get dressed up in more complicated, opaque forms.
This more cynical You would rejoice at how Sam Bankman-Fried - one of the biggest names in crypto - recently explained yield farming for Bloomberg. (Yield farming simply means putting money into various DeFi products to maximize returns.) You will enjoy reading through the full transcript, I am sure, but a brief version would be: Sam Bankman-Fried painstakingly explained yield farming as a magic box in which you put e.g. ethereum and get a token representing your claim + another token X representing your rights to vote on the future of the magic box. The magic box is supposed to do something great in the future, more or less (if you go through the DeFi projects, the details are never that clear; remember the magic box cannot be owned or controlled by anyone or else SEC). So great, the magic box just created something out of thin air for you. Now, because people (incl. sophisticated investors and institutions) like to get something for nothing, the capital starts flowing in and the market value of the token X grows. Make no mistake, the investors can absolutely sell their token X which they get just for using the magic box and get dollars, but they don’t do it on a mass scale because the yield from the magic box is too attractive. Repeat this several times and the magic box’s value goes to billions.
There is no economic case. The magic box doesn’t “produce” anything; it exists to lock in capital to create abstract returns out of thin air in order to lock in more capital. A textbook Ponzi scheme, but is it also something else?
Ponzi-ing its way to legitimacy.
DeFi is completely detached from the real world and it is not its fault. It does not fit the real world’s frameworks. Put differently, you cannot attach real company’s future cash flows to a token that is transferable, modifiable, transformable, etc. in the DeFi sense. The way that legal titles and the administration of them works today won’t allow you to do that, absolutely not.
DeFi’s whole purpose in its current form is speculative. There is, therefore, a risk that over time and/or in a large enough market downturn (and a subsequent bank run on DeFi), the value of the tokens goes to zero. This would be consistent with a Ponzi scheme imploding.
The other possibility that you can play with is that some DeFi projects will be able to Ponzi their way to legitimacy.
Or, Sam Bankman-Fried:
[..] at some point if the world never decides that we are wrong about this in like a coordinated way, right? Like you're kind of the guy calling and saying, no, this thing's actually worthless, but in what sense are you right?
Out of the thousands, some DeFi projects will survive and they will be able to lock in so much capital that they will become entrenched; no market collapse would wipe them out completely. Over time, those magic boxes that survived become mature, their returns become less magic but they will still offer a better passive rate than a traditional financial system ever could because, you know, it is fully automated and humanless (no middlemen - no payroll). You can see how eventually many more people will start using them to earn day to day passive earning, and more.
Let’s stretch this and say that there is no reason why DeFi could not outgrow its speculative use cases and become a financing tool for real world needs. The law of large number dictates that if DeFi become sufficiently large (let’s go with giant), volatility decreases such that users can take out loans to finance their house or business, I guess?