Crossing the Bank

Imagine a river with two banks. On each side, there are different goods and different people. These people want to trade with each other in order to have more of what they want (and less of what they don't). Trade, in aggregate, makes everyone better off.

But it's impossible to cross the river. More accurately, crossing the river is dangerous and time-consuming. As a result, the costs of trade usually exceed the benefits of trade. And so, trade activity is low, and everyone remains poor.  

Until someone comes up with an idea. Instead of letting each person cross the river on their own, why don't we build a bridge? This way, everyone will be able to cross the river quickly and safely.

And so, a bridge is built. Trade activity increases and everyone is better off in aggregate. The bridge is not a perfect solution. At times, it gets clogged and takes a while to cross. Every now and then, a different band of bandits takes over and charges everyone who crosses it a toll. Depending on their religious or cultural beliefs, the bandits also ban different people from crossing the bridge. And some people simply live too far from the bridge and can't access it at all.

Money is that bridge. In the past, people used to barter directly. A person with a carrot who wanted an apple had to find a person with an apple who wanted a carrot. Alternatively, he could exchange his carrot for something else the apple-owner would want. This was a cumbersome process, and it limited people's ability to trade. Everyone who wanted to "cross the river," had to figure out their own path.

This was an information problem. A person with an apple who wanted a banana would not take a carrot as payment  — because he didn't know whether anyone else would be willing to take the carrot and give him a banana. He also didn't know how many carrots he should charge for his apple.

Money emerged to solve this problem. It was a medium of exchange that enabled everyone to transact directly. Over time, the most popular forms of money became formalized and came under the control of national governments. This helped increase trade and, in most cases, make whole countries better off.

But it came at a cost. It gave rise to powerful middlemen who processed transactions and charged high fees. These middlemen could also bar certain people or whole industries from doing business. And when the middlemen mismanaged their own business, the public had to bail them out because they were too important and too big to fail. Controlling the supply of money also enabled the government to create more of it out of thin air every time it wanted to pay for an unpopular initiative — like a war or a program that only benefitted a powerful lobby or union. As a result, everyone paid for these programs even if they never agreed to.

Bitcoin and other cryptocurrencies emerged to offer an alternative to this system. They offer a new "bridge" through which goods and services can be exchanged. That bridge that is not controlled by government, operates transparently, is easier to access, and (in some cases) is cheaper and faster to use. Such currencies rely on decentralized information networks to keep track of all transactions, all the time. But that's not what this article is about.

The evolution of Decentralized Finance points to an even more interesting alternative to traditional money. In a world of abundant information, there might be no need for a "bridge" at all — at least in some cases.

Consdier the man with the apple who wanted a banana. He would be willing to take carrot as payment if he knew that someone else was available to immediately exchange his carrot for a banana (and if he knew that the average global sales price for an apple was 2.5 carrots or 1.5 bananas). In such a situation, direct barter would be attractive. Why pay for the "bridge" when you can simply trade anything for anything else, directly?

Of course, this will not always work. But it will work for popular goods that have a liquid market (such as bananas, apples, carrots, and other popular items). An abstract version of this already exists in the world of Decentralized Finance. Exchanges such as PancakeSwap or Uniswap enable people to exchange about 10,000 pairs of different tokens directly. In essence, they provide liquidity for a long list of potential trades between individual people ("liquidity" means someone will always be available to buy whatever it is you're trying to sell and vice versa).

This shows us that an abundance of information can make money itself redundant. Does this mean all currencies are doomed? No. But it means that the optimal number of currencies within a given economy is probably much higher than one. A truly decentralized economy will not run on a single, decentralized token (such as Bitcoin). Instead, it will run on multiple (hundreds, thousands, maybe more) different tokens that are liquid enough to enable sufficient trade and to avoid the downsides of single-currency economics.

The ultimate promise of Decentralized Finance is not to replace the money we have. It's to make it redundant.

Have a great weekend. 🙏 If you enjoyed this piece, subscribe to my newsletter. If you'd like to dive deeper into the promise and limitations of blockchain technology, check out my Hype-Free Crypto course.