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DeFi is the Ultimate Defense Against Political/Financial Disasters

Juan M. Villaverde
Last updated: | 7 min read

Juan Villaverde is an econometrician and mathematician devoted to the analysis of cryptocurrencies since 2012. He leads the Weiss Ratings team of analysts and computer programmers who created Weiss cryptocurrency ratings.

Source: iStock/Oleg Chumakov

Fact is stranger than fiction. But before we talk about the latest facts, imagine this fictional scenario …

The Dow Jones Industrial Average plunges 10,448 points … in a single session. The U.S. dollar loses one-third of its value against the euro, the yen, gold and virtually every other asset class … in just 24 hours. The expected probability that Washington will default on its debts, as reflected in credit default swaps, doubles … overnight.

Unbelievable? In the United States, yes.

But in Argentina, Latin America’s third-largest economy, this is exactly what happened just a few days ago. And it has a direct impact on virtually everything we’ve ever written about the ultimate use-case of cryptocurrencies as a safe haven.

Here’s the actual sequence of events …

  1. Primary election: The anti-austerity opposition scores a major victory. It threatens to overturn economic achievements of the current regime. And it sets off a chain reaction of market disasters …
  2. Weakening currency: The Argentine peso falls by one-third against the dollar, euro, gold and other assets.
  3. Market uncertainty: Argentina’s Merval stock index plunges 40% in one trading session, its worst decline in history and the second-biggest crash for any stock market since 1950.
  4. Ultimate disaster?: The premiums on credit default swaps, indicating the expected likelihood of a sovereign debt default by Argentina, almost double.

To call this a panic would be an understatement. If it really happened in the U.S., investors would think the world as we know it is coming to an end. And indeed, if you’re a citizen or resident of Argentina, that’s exactly what you’re thinking right now.

What caused all this panic?

It was the fear that the former government of Cristina Fernandez de Kirchner is making a comeback. Her administration was known for four things:

First, money-printing: They ran the money-printing presses practically 24/7, creating unstoppable inflation.

Second, debt defaults: To score points with its base, the Kirchner regime defaulted on outstanding dollar-denominated debts. It was their way of “sticking it to the evil capitalists.” But in reality, the default primarily hurt retirees.

Third, currency controls: In the wake of these politically motivated defaults, the government was cut off from global capital markets. So, the only remaining source of funding was the local industry and average citizens. They suffered a series of disguised confiscations and currency debasements.

In some other countries, if citizens suffered massive currency collapse, they’d rush to buy dollars or euros. But if you were a citizen of Argentina in the Kirchner era, the simple act of owning a foreign currency could be considered a crime.

Sure, you could legally transfer foreign currency from abroad via the banking system. But you could never touch it. Even before it hit your bank account, the government converted your foreign money into Argentine pesos at an arbitrary discount of 40% and 60% from the true, free-market rate.

You suffered an instant loss of about half your money.

Let me repeat that: You were not allowed to own foreign currency. If you tried, you would lose about half and the rest would be converted into pesos anyway.

This meant that, unless you kept your assets abroad illicitly, there was virtually no way for you to escape the government’s debasement of your money.

Fourth, propaganda and lies: The government told the population that there was no such thing as inflation in the country. Runaway inflation was spun as “a lie told by disgruntled political opponents.”

I was there

I know something about that period because I used to live there. Never before have I seen economic mismanagement on such a grand scale. But even more shocking was the propaganda that gullible citizens were willing to believe.

The same thing could happen almost anywhere.

It could happen in the wake of radical political change or international conflict. It could be caused by a government’s overzealous reaction to an extreme boom-and-bust cycle. Or things could simply deteriorate steadily over time.

And if the government’s hell-bent on siphoning off your money, it’s very tough to escape their dragnet — let alone change their course. They make the laws and have the guns. You don’t.

How Bitcoin changes this scenario

With Bitcoin, you don’t need a bank account. You don’t even need a phone number or a street address. All you need is an internet connection and a secret key.

With Bitcoin, you can safely exit the system, and — with few exceptions — there’s nothing any government can do to stop you.

When the latest crisis hit Argentina a few days ago, the U.S. dollar and other fiat currencies weren’t the only assets that shot up when measured against the falling peso.

Bitcoin also surged vs. the peso.

But that’s not all. In one context, Bitcoin rose vs. the U.S. dollar as well. In fact, it traded at a 10% premium or higher in over-the-counter (OTC) markets.

Why? Because OTC markets are the go-to place for investors seeking a safe haven from their government. To execute a trade, OTC markets require no exchanges, no bank accounts, no identification.

All this raises an important question: Given the scope of central bank excesses and potential global turmoil, why is Bitcoin not traded more actively?

One reason is that Bitcoin is only one of many crypto solutions.

However, the primary argument against crypto as a safe haven is its price volatility. If you live in Argentina or Venezuela, and your local currency is collapsing, you may be willing to risk the dramatic price gyrations of Bitcoin.

Not so if you live in a country where the money is relatively stable. In that context, you’re probably reluctant to move more than a small percentage of your assets to crypto. You fear the cure might be worse than the disease.

Why decentralized finance could be a game changer

All this helps explain why Decentralized Finance (DeFi) solutions, built on Ethereum, are starting to emerge in a big way. I covered DeFi a couple weeks ago. If you haven’t seen it yet, I encourage you to check it out now.

In a nutshell: DeFi has the potential to evolve into a full-scale financial system, built with smart contracts on public open distributed ledgers like Ethereum.

A defining characteristic is that there are no custodians. There’s no company or overly intrusive government that can target you in order to seize your assets.

If you live in a still-viable financial system and under a trusted government, DeFi may have little appeal to you. But for everyday citizens of Argentina, Venezuela and a growing list of other countries, the non-custodial nature of DeFi could be a game-changer.

Here’s a practical example …

Suppose you like the idea of keeping your money safely stored in a crypto asset. Trouble is, you’ve seen Bitcoin rise and fall over the years. So, you’re not yet convinced it can continue its parabolic ascent. Even if it does, you feel you can’t risk it.

One solution is provided by Ethereum’s DAI stablecoin. (I explained stablecoins earlier this year.) DAI is what I call an “algorithmically driven stablecoin.” It’s designed so that the value of each token hovers around one USD.

It does this by creating an incentive for traders to make a profit whenever it diverges: If it’s trading above USD, they can make a virtually guaranteed profit by selling DAI against the dollar. If it’s trading below USD, they can make the profit by buying DAI against the dollar.

But unlike other stablecoins, DAI needs no custodians to “guarantee” its value. Its stability is based on the dynamics of supply and demand in the marketplace.

To trust custodians, you need due diligence. And even if the custodians are trustworthy, what about trusted governments that fail to keep them in line? Or worse, non-trusted governments that have the power to seize control?

Despite some volatility, DAI can help you sidestep those dangers, an advantage that cannot be underestimated.

The DAI stablecoin is at the heart of DeFi. It allows other crypto projects, such as Compound Finance and many others, to set up non-custodial credit markets where buyers and sellers meet directly and without intermediaries.

Three steps to consider

If you’re stuck with custodians you’re unsure about, or …

If you live under a government you feel you cannot trust, and …

If you’d like to avoid crypto market volatility …

Consider this 3-step experiment:
Step 1. Use a non-custodial OTC (over-the-counter) market like AirSwap.
Step 2. Put a small portion of your keep-safe funds in DAI tokens.
Step 3. Then lend them out at Compound, currently yielding about 10% per year.

Not only is the yield better than virtually any bank in the world, it comes with the security of the Ethereum blockchain and without the potential risk of custodians and middlemen.

Read more: Bitcoin As a Safe Haven Case Still Lacks Proof