How DeFi Can Avoid the Irrelevance of P2P Lending and Crowdfunding

How DeFi Can Avoid the Irrelevance of P2P Lending and Crowdfunding


How many Libertarians do you think there are in the United States?

Everyone, right? Everybody wants personal freedom and a limited government. Just listen to Twitter bots and the talking heads on the propaganda channels. Everybody votes their principles and is internally consistent in their logic. Long live Ayn Rand!

The answer is … about 3% of the voting population.

About 3% of the population actually cares enough about their personal philosophy to lodge a particular vote in the direction of the Libertarian Party. We could have picked on the Green Party instead, or any other policy-oriented group, and gotten the same result. The reality is that everyone else votes Democrat or Republican because those are the teams that matter.

Everyone complains about Amazon but we all shop online. We mourn the loss of the neighborhood coffee shop but we buy Starbucks for the loyalty points. Thus the hypocrisy of human nature.

And here’s the meat: We want peer-to-peer (p2p) economies, grounded in our neighborhoods and tribes. We think Wells Fargo and Bank of America and the Federal Reserve and the rest of “them,” whoever “they” are, are centralized monoliths running on papyrus and holding back innovation.

Right. Where do *you* bank exactly?

Do we really want peer-to-peer economies, though? Or are we lost in the poetry of utopia?

Remember Napster, Kazaa and BitTorrent, with their brick-through-the-window of the media industry? Initially, the naive reaction of the labels was to build digital rights management into music players, song files and any teenager onto whom they could tattoo the letter of the law. DRM didn’t work, right?

Certainly one way to look at the explosion of file sharing is to focus on the absolute figures of people consuming media for free. The core question there is to ask whether those people would be paying consumers in the market in the first place, or whether radio and mixtapes have been replaced by the digital substitutes of “piracy,” YouTube copyright infringement, and other modern artifacts.

We don’t know the answer. We suspect, however, that if you had the patience to suffer through a DJ’s advertisements or had the time to rip tapes, you might be the kind of person who has the capacity to deal with managing the mechanics of using torrents for file sharing. The clearest formulation on this topic comes in the article “” from Bill Rosenblatt.

The media industry has been able to deploy a business model that uses the internet to deliver a better user experience when bundled with the law. It is a worse user experience to avoid it. DRM-free downloads have collapsed as a commercial model.

Put another way, a digital music company is as much a monopoly as its predecessor the record-label. Likely an even better one, given digital returns to scale. It is so good, that the peer-to-peer alternative loses as a value proposition.

In the same vein, it’s hard to find good data on YouTube as a facilitator of copyright breach. But we know that a lot of websites and videos contain media content a record label would otherwise try to monetize. If that media is not on Spotify, it is very likely on YouTube, A proxy for this content are the take-down requests under the DMCA now numbering in the hundreds of millions.

Is that piracy? Maybe. It is certainly “file sharing.” Is it peer-to-peer? Absolutely not.

Just because content is user-generated, that does not mean it is peer-to-peer. Google is the platform that mediates access and takes rent through advertising. Google is the platform worth over $1 trillion today. And this realization takes us to Lending Club.

Lending Club represents an era of fintech credit. The core premise at its founding was to recreate the dynamics of the sharing and social media revolutions. Instead of mediating everything through the centralizing machine of a bank – and by the way banking licenses were sort of hard to find in 2006 – why not create a connective platform like Kazaa (a long defunct file-sharing service)? A bunch of people who need to borrow can show up with various credit risks. And a bunch of people who would like better investment returns can show up to assess those risks. And you, as the platform, take a cut.

Sound familiar? This section is a warning shot to Compound, Aave and the rest of the DeFi protocols that think that redefining technology redefines market structure, human nature and micro-economic behavior.

The first problem is getting good risks. If you are a venue for emerging credit, the risks that come to your platform are subject to adverse selection and the . So you need sufficient aggregation, correlated with heavy customer acquisition and branding costs, to create the asset class of reasonable credit exposure. This is also why digital asset fundraising platforms are having a hard time. Most good startups still want to raise money from Goldman Sachs, Google Ventures, and Andreessen Horowitz. Not Globacap, the investment software platform, despite such a site being a strong technical and market innovation.

The second problem is getting enough investors. Remember we started talking about Libertarians that actually vote their politics? The same dynamics are there for financial behavior. Nobody actually wants to do the homework of selecting Lending Club notes, which requires learning about credit risks and understanding complex financial geek jargon to pick an investment. And the investors you get, especially if they are retail, are lumpy and finicky. Your liabilities do not match the time horizon of thousands of people, flickering about with their needs.

By the way, this is a problem solved 40 years ago. Instead of selling its mutual funds to retail – and dealing with constant redemptions and purchases – it targeted only institutional distributors (RIAs). This strategy meant the financial product had less turnover and generated better returns. It all worked, until the ETF [exchange-traded fund] product packaging came along, which did not even require fund redemptions and purchases to take place, instead letting retail investors trade the abstraction of an index as a share.

So you soldier on and bring in hard-nosed hedge fund capital. A private equity firm here and there, to package up all those Lending Club notes and smooth out the risks. Maybe sell them downstream into fixed income funds. Of course the cost of this funding from alternative financiers is really high, because their job is to take the entire economic return and you have no pricing power. .

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