How Public Blockchains and Decentralized Finance Can Help Texas’s Underbanked
The Texas Blockchain Council welcomes Patrick Nash as a guest writer. Patrick Nash is a co-founder of DeFi Rico, a microlending start-up leveraging decentralized finance, protocols, and stablecoins. Patrick is passionate about decentralized public blockchains, energy markets, and financial independence.
Below, Patrick shares his thoughts on how public blockchains and decentralized finance can help the underbanked in Texas.
Literature from the dawn of the cryptocurrency industry over a decade ago frequently emphasized the technology’s potential to help “bank the unbanked”. Bitcoin was supposed to allow anyone to be their own bank. Presently, that narrative is difficult to find. However, the recent rise of decentralized finance (defi), or financial markets driven by open-source, autonomous smart contracts running on internet-native public blockchains, may revive this narrative.
At DeFi Rico, we believe that fair access to credit is not only a pillar of a thriving economy, but also a basic human right. This is why we are utilizing defi infrastructure to provide savings for individuals who currently rely on costly alternative financial services, like payday loans. We provide inclusive and equal opportunity access to affordable credit, regardless of race, gender, or socioeconomic status. This amounts to fair access to capital for everyone—even the underbanked. Of all the technologies being built on public blockchains, defi markets have the greatest potential to serve the underbanked due to their democratic nature, permissionless access, and exponential network growth effects. These factors combine to create a flywheel for innovation.
Greater access to capital doesn’t just benefit individuals, however; it is a precondition for economic growth. Capital markets play a key role in a robust economy. Capital efficiency and the availability of credit to entrepreneurs is highly correlated to the accumulation of wealth amongst economic participants. The most sophisticated economies in the world often have the most sophisticated financial systems, and the most efficient deployment of capital. However, even in the US, some segments of the population are consistently barred from fair access. Our capital markets contain numerous prerequisites to participate, including credit history, net worth, and public status, to name a few. In addition, our traditional financial system is run by humans, who are ultimately imperfect creatures and subject to bias. Such barriers exclude huge swaths of the general public from participation in capital markets. This doesn’t just harm the economic prospects of excluded people, but stymies the growth of the entire US economy.
Decentralized finance protocols constructed on public blockchain infrastructure like Bitcoin or Ethereum provide a solution because they democratize capital markets. Public blockchains do not require credentials or proven track records to participate. The only real requirements to access services delivered by public blockchains are a computer or cell phone and internet access. Moreover, decentralized finance on public blockchain networks is run by autonomous machines, and machines do not discriminate in the same ways human agents do. Defi is built on public blockchains therefore lowers the barrier to entry for entrepreneurs and innovators who otherwise would have been cut off from traditional capital markets.
Metcalfe’s law, which states the value of a network grows exponentially with its number of users, has been applied to help determine the value of companies like Facebook. Social networks are simply structures of actors with direct and indirect ties to one another, interacting socially. For the very first social network user, the platform is virtually worthless, since there is no one to interact with. As soon as one other user joins the network, the number of interactions goes from zero to one, and the value of the network increases. As the number of users grows, the network’s value for each individual user grows at an exponential scale.
This law is also applicable to decentralized finance protocols built on public blockchain networks. Defi on public blockchains is not only a network of nodes, but a social monetary network as well. Money, much like finance, is a social construct. Defi runs on public blockchain networks, and its users interact using peer-to-peer cryptographic tokens. As the total number of defi users grow, the network’s utility for each individual user also grows at an exponential rate.
There is another aspect to decentralized finance that, when combined with Metcalfe’s law becomes especially intriguing. Unlike the traditional business environment, business moats do not exist for defi protocols on public blockchains. The code powering these automated machines is all open source. This means the code is visible to everyone, and anyone is welcome to copy it, modify it, or build on top of it. Developers compose new updates to protocols, consistently building upon the open designs of other machines. Innovators build entirely new machines that use the code of other systems as both inputs and outputs. These autonomous software machines can also be built to interoperate with each other. This unique competitive ecosystem creates a petri dish of incredibly fast-paced technological development. It is reminiscent of the TCP/IP revolution that ushered in the open internet—and created a new, web-based economy that is still growing today at an exponential rate.
When this unique competitive ecosystem is operated in tandem with democratic and permissionless public blockchains, and amplified by the network effects of Metcalfe’s law, the result is a flywheel of evolutionary innovation. We are already seeing decentralized peer-to-protocol exchanges like Uniswap, driven by automated market makers, and decentralized applications like Aave, which provides permissionless global savings accounts earning between 6- 11% annual interest.
Traditional business entities can leverage decentralized finance as well. At Defi Rico, we aim to provide online micro-loans to the underbanked in Texas, leveraging defi rails, public blockchains, and stablecoins. Decentralized finance on public blockchains makes microcredit applications scalable for everyone.
No doubt there are issues yet to be ironed out. Anti-money-laundering and know-your-customer policies do not exist on some platforms; user interfaces need to improve; and smart contracts may contain bugs. Network fees on Bitcoin and Ethereum are currently high as well, although Layer-2 technologies such as Lighting for Bitcoin and the Eth 2.0 upgrade for Ethereum provide plausible solutions. Despite these challenges, Texans stand to benefit greatly from decentralized finance, especially in a state that leads the nation in unbanked and underbanked households. According to the 2017 FDIC’s National Survey of Unbanked and Underbanked Households, 9.5% of Texas households have no bank account, and 24.2% of households use alternative financial services. Many of these households have been hit hardest by the COVID-19 pandemic and subsequent economic downturn. Decentralized finance could release this untapped economic potential to create wealth for millions of Texans and drastically improve lives. That is why Texas citizens and residents need clear and sensible legislation that does not inhibit development, but rather supports a sandbox of innovation in financial services. The future of our economy depends on it.