Analysis

The New Supreme Court

When markets crash, code becomes law.
David Hoffman David Hoffman Jul 18, 20224 min read
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The New Supreme Court

Dear Bankless Nation,

The 2022 crypto crash has a lot of parallels to the 2008 housing market crash.

Unsecured credit, irresponsible leverage, and retail investors taking the majority of the fallout.

We’ve been here before. We know how this ends. Creditors line up at the courts. Lawyers are hired to advocate for their clients to be repaid first.

Litigation, arbitration, and a lot of fees and time.

Meanwhile, retail investors — individually too small to participate in this process — sit on the sidelines and receives the crumbs of capital that’s left on the table.

This is the world we wanted to leave behind. Unfortunately, centralized lending institutions have brought the errs of human folly into our brand new, rebuilt financial system.

Does this mean crypto has failed? Are we just recreating the old financial system on a new platform?

Is anything different this time?

In the wake of the ‘08 financial crisis, Bitcoin was created with the explicit intention to create a new financial system—one that doesn’t break down from human folly and irresponsible money management.

The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.

- Bitcoin Gensesis block

Bitcoin was created to produce a system of money that couldn’t be inflated or centrally operated. However, it wasn’t the breakdown of the financial system that Bitcoin was meant to prevent; it was the bailout of the irresponsible banks that created the conditions in the first place.

The banks broke the system, and then the government printed a bunch of money to bail them out. Privatized gains, but socialized losses.

Ultimately, it was the taxpayer that footed the bill for the irresponsibility of the banks. With Bitcoin, a money system outside the control of any government, no one could ever be bailed out as no one has the powers to mint new BTC.

The bailouts of 2008 solved the short-term problem of illiquidity and likely saved the economy in the short term. Ben Bernanke famously said, “If we don't do this tomorrow, we won't have an economy on Monday.”

It was probably the right choice.

But 14 years later, we are now facing the consequences of that choice. What turned out to be a 2008 banking debt crisis was ‘kicked upstairs’ to become a sovereign debt crisis in 2022.

Luke Gromen discusses in this week’s podcast:

DeFi Fixes This

If we had a 2008-like financial crisis under a Bitcoin standard, Bitcoin would prevent the bailout of the banks by the federal reserve. There would be no minting of new BTC to recapitalize a distressed financial system, and the problem wouldn’t be kicked upstream to be turned into a much larger problem to be dealt with by a future generation.

But in order to solve the problem at the source, we need DeFi. And now, with the crypto crash of 2022, we have the data to prove it.

DeFi Loans Paid in Full

Celsius, Three Arrows Capital, and all the other irresponsible financial crypto institutions have all repaid their DeFi loans, in full.

Celsius Network, the embattled crypto lender that is facing liquidity troubles, fully paid off its remaining debt to the decentralized finance (DeFi) lending protocol Compound, freeing up nearly $200 million of pledged collateral.

Krisztian Sandor, Coindesk

The New Supreme Court

In the world of TradFi, there’s the concept of junior and senior debt.

If a company files for bankruptcy, senior debt claims are paid first. All other debt is subordinated (junior). Collateral from asset-backed debts may be sold to pay off senior secured debt.

The table stakes for DeFi applications is that they are the most senior lender. They have the most superior claims upon a borrower’s assets.

DeFi apps never needed to take 3AC or Celsius to court to receive their capital back. They have first dibs on the collateral, and they also have custody of that collateral. The agreement is bound by smart contracts.

It doesn’t matter what happens. If the price goes down to the liquidation price, the position is liquidated. No phone calls, no lawyers, no nothing.

The code is the law. And we can see this happening right now in real-time.

Currently, the creditors for Celsius and 3AC are lining up at the courts to get whatever money is left, but only after the DeFi apps are repaid in full.

The legal courts overseeing the Celsius and 3AC cases are subordinate to the court of the EVM; the code that enforces the smart contracts that power the DeFi lending applications.

The EVM is the most superior court in the world. The legal contract system of nation-state courts is junior to Ethereum and the EVM.

When markets break down, they revert back to a system of lawyers and courts, and we are currently witnessing that in the cases of 3AC and Celcius. Long-drawn-out court proceedings are beginning; meanwhile, DeFi is still chugging away and onto the next thing.

And no DeFi lenders lost a dime.

Preventing Financial Crises

Under a Bitcoin standard, no banks would have been bailed out in 2008. We wouldn’t have kicked the problem down the road to be dealt with in 2022.

But we also wouldn’t have been able to prevent the financial crisis in the first place.

The fallout from 2008 would have been far worse.

Under a DeFi-based financial system, we actually might have been able to prevent the crises from happening in the first place.

All 2022 DeFi liquidations were efficient and orderly.

If DeFi apps were the foundation of the global financial system, we may just be able to prevent incidents like this.

By prioritizing lenders with the assurances of the most supreme court in the world, DeFi apps can attract more capital and more liquidity than any other financial institution in existence.

Lenders of all sizes could sleep soundly at night, knowing that whatever happens tomorrow, they can withdraw all of their money.

That’s the future of finance.

- David


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