Programable money: the foundation of decentralized finance

Crypto 1.0: a store of value

Comprising more than 50% of the entire crypto marketcap, Bitcoin is of course, the dominant crypto player and arguably the most important innovation in the blockchain world. The prevailing narrative of recent years states that Bitcoin’s utility is primarily as a long-term store of value; the argument being that Bitcoin represents, for the first time since the creation of money itself, an improvement upon gold.

The other advantages of Bitcoin over gold which contribute to its utility as a store of value are that it’s easily transferrable (moves at the speed of the internet), impossible to fake, and censorship resistant.

The above characteristics of Bitcoin are incredibly powerful. Combined with its first-mover advantage, it’s entirely possible that Bitcoin continues growing until it replaces gold’s role as store of value. Bitcoin maximalists will argue that, in a world of currency by fiat – where government issued currencies have an average lifespan of just 27 years – Bitcoin has the potential to replace the USD as the world’s reserve currency.

But there’s another powerful characteristic of Bitcoin that is often overlooked – and it’s a characteristic shared by all the top cryptocurrencies.

Crypto 2.0: programmable money

The property of cryptocurrencies known as programmable money is a property that enables cryptos – from ETH to EOS – to serve as the foundational open-source layer needed for the decentralization of economic activity. This has the potential to reshape global finance, enfranchising billions into what remains an industry used mostly by the world’s elite.

To give an example of the power of programmable money, let us examine the fascinating use-case that has been developed by silicon-valley based remittance company cum crypto wallet, Abra: synthetic assets.

Synthetic assets

Abra’s synthetic assets – which as of the end of May 2019, include dozens of currencies, the top 100 NASDAQ stocks, and a range of popular ETFs – enable virtually anyone in the world (even if they don’t have a bank account) to get exposure to financial assets that, until now, have only been available in extremely limited regions.

The app currently has 500,000 downloads, and according to Abra CEO Bill Barhydt in an April presentation at MIT, the company has processed almost a billion dollars in synthetic asset transactions “over the last 14 or so months.”

Automated risk hedging

To understand how synthetic assets work, it’s useful to examine their origin in Abra’s context. Abra started as a remittance business – primarily between the USA and Philippines – that used Bitcoin as the settlement layer. People sending USD from the US to Philippines via Abra were offered significantly lower rates than the average 7% fee incurred when using traditional remittance services like Western Union. Abra could offer the lower rates by onboarding traditional banking partners in the US and Philippines to accept and dish out cash, while employing Bitcoin in the background to move money across borders. This process required Abra to hedge risk while holding Bitcoin which, as we all know, is still a much more volatile asset than most fiat currencies. Through this experience, Abra learned to automate its risk-hedging by employing the programmable money functionality of crypto.

Abra realized it could vastly reduce counter-party risk by running the entire remittance transaction process on-chain. The moment customers sent USD to Abra’s accounts in the US, Abra converted it to BTC and created a multi-signature wallet with the customer and Abra co-signing. In the app, a customer would appear to have USD, but in fact they would be holding BTC. To use the Abra app, customers must therefore confirm that they’ve written down their 12-word seed phrase, with the usual custodial rules applying: lose the phrase, lose the ability to back-up the wallet, and consequently lose the BTC.

On its end, Abra would set up a short-long position on USD vs BTC such that no matter which way BTC moved, the net result for both parties would be zero sum (with Abra’s business model sustained by extracting a small profit on the exchange rate). Incredibly, Abra’s system of hedging seems to have stood the test of time. During 2018’s 85% draw-down in the price of Bitcoin, and with many of Abra’s customers holding synthetic dollars, Abra didn’t lose a penny while all its customers were made whole.

Non-custodial on-chain investment contracts

With this system, the real innovation is that Abra is technically not holding customers’ money. Instead, Abra is entering into contracts with customers, and settling them when customers choose to send, trade, or withdraw their money. The non-custodial nature of the contract is enabled by the programmability of Bitcoin (and cryptos like it), and it means that Abra’s liability is vastly reduced. Since the arrangement is decentralized, it also means Abra can enter into contracts that would otherwise be illegal, with practically anyone in the world. In Abra’s case this now includes as mentioned, more than 50 fiat currencies, a synthetic version of the NASDAQ, and more.

The implications

The implications of the innovation that is programmable money are huge. Consider that while access to financial instruments is a key factor for accumulating wealth, approximately 1.7 billion people today still do not even have a bank account or access to traditional banking services. Meanwhile, for those that do have access, Financial Services is one the least trusted sectors, that according to the Edelman Trust Barometer. The build-up of systemic risk caused by the centralization of financial services and its accompanying concentration of wealth is widely considered to be major cause of the last financial crisis (1% now own almost 50% of household wealth).

If others can emulate the model currently employed by services like Abra, and as the crypto ecosystem grows, features of programmable money such as the crypto-collateralized synthetic asset model could finally provide the foundation for a viable alternative to the traditional banking system: a decentralized crypto bank that would be open to all. Such an alternative could signal the start of a new era of financial inclusion, one that – to everyone’s advantage – would spread economic growth and lessen the concentration of wealth.

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