Today I’m going to say some unpopular things about the world of Decentralized Finance (DeFi).
- DeFi is filled with gamblers and speculators who are placing increasingly risky bets.
- DeFi is building not the future of finance, but a parallel version of our riskiest financial markets.
- Most people will lose money in DeFi, because of the sky-high gas fees (far more than any bank would charge).
- DeFi is not a technology for the people, but for the whales who already own enormous amounts of crypto wealth.
- Like our current financial system, DeFi is making the rich richer, and the poor poorer.
I saw all this with fresh eyes when preparing our DeFi Hands-On Workshop (access the replay here).
For most people, the best investing strategy is simply to buy a DeFi token, then hold it long term (5+ years) — not using the DeFi websites themselves.
To use an example from the real world: you could either put money in a banking savings account, or you could just buy the bank. With DeFi, for most of us, it makes way more sense to just buy the blockchain.
The crazy thing is, I am a believer in DeFi. It’s a global game-changer. This tech is going to radically disrupt the banking, finance, and insurance industries … and these clowns have no idea what’s coming.
However, in its current state, DeFi is dangerous. It should come with a warning: DEFI MAY BE DANGEROUS TO YOUR WEALTH.
The Dangers of Jenga Towers
Let’s begin with the idea of lending protocols like Aave. First, there’s the confusing and jargon-filled description of what Aave actually is:
Aave is an open source and non-custodial liquidity protocol for earning interest on deposits and borrowing assets.
I could easily picture this as a Dilbert strip:
I’ll translate this for you. Aave lets users borrow and loan crypto … not from banks, but from each other.
That’s a pretty cool vision, until you understand that borrowing crypto has to be overcollateralized (more jargon), which basically means if you want to borrow $10,000 worth of ETH, you actually need to put in $15,000 as a deposit.
Why would anyone do this? In the real world, if you wanted to go buy a $100,000 house, you wouldn’t give the bank $150,000 to take out a loan — you’d just buy the stupid house.
Here’s your answer, taken straight from the Aave documentation:
Why would I borrow instead of selling my assets? Users are mainly borrowing for unexpected expenses, leveraging their holdings or for new investment opportunities.
I’ll translate this for you.
- “Borrowing for unexpected expenses” means you don’t have enough money to pay the rent, or buy groceries. Why are you investing in crypto if you don’t have enough money to live? For God’s sake, sell the crypto and get your finances in order first.
- “Leveraging their holdings” means people are essentially gambling: putting $10,000 worth of ETH on the craps table, so they can roll it into $15,000 of ETH because they’re sure it’s going to the moon. If they’re wrong and ETH crashes, their position is auto-liquidated (more jargon: it means “we’ll sell your crypto”) and they lose it all.
- “New investment opportunities” is similar, except here they’re gambling $10,000 of ETH on $15,000 of BillyBobToken. If BBT doesn’t pan out, they’ve lost BillyBobToken and the ETH.
Worse, some people will then take the $15,000 of BillyBobToken and go put it into another DeFi site where they can borrow $22,500 of PooCoin. They can continue this stacking up of loans upon loans, which leads to the famous Jenga Tower scene from The Big Short:
How the financial crisis happened, in the real world.
This is what’s happening now in DeFi.
There are other use cases for Aave — avoiding taxes, arbitrage, and so on — but these are complex for the average investor. Do you have 40 hours a week to work on crypto? Are you ready to obsessively monitor the price of every crypto asset? Do you hate restful sleep?
Most of us have lives. For most of us, borrowing on DeFi protocols like Aave is time-consuming and dangerous. But what if we work the other side: what if we simply lend?
The Dangers of Fees
The premise of all DeFi platforms is the same, and I will explain it simply:
- Put crypto into our platform and you will earn interest, plus our token. (Put it into Aave and you earn interest, plus AAVE).
- The more crypto flows into our platform, the more our token will go up in price.
- You can cash out any time, taking the interest and the token.
Sounds pretty great! New projects reward early users with 100%, 10,000%, or 100,000% interest rates, which causes some people to go berserk. They are always chasing the latest thing, looking to mine those early tokens that could go 100x, 10,000x, or even 100,000x.
I subscribe to all the DeFi newsletters, and they are constantly hyping these projects and how much money everyone is making. What they leave out is the fees.
Ethereum has the most expensive fees in the world. Way more expensive than any bank. More expensive than some loan sharks.
When you actually deposit money into the Aave platform (different DeFi projects call it “Vaults” or “Lending Pools” or “Liquidity Pools” — more jargon), here’s what you get:
That tiny print at the bottom? That’s your fee. $361.31 on a $1000 deposit. It would be helpful if they, you know, used a dollar sign. Some platforms don’t even list the fee in dollars, but list it in ETH, making it even harder to see how much the Ethereum network is gouging you.
And those unbelievable interest rates? You can believe they’ll fall, as more people put money into whatever “vault” or “LP” or “trading pair” you’re funding. And don’t get me started about impermanent loss: trust me, the loss is permanent.
For most people, the simplest way to invest in DeFi is to just buy the token and hold it for five years or more. Rather than constantly moving your money around, try investing once … and waiting with patience and persistence.
Persistence: The Opposite of Boredom
In a recent column, we talked about the Boredom Syndrome, which is a bad habit of our brains that we always need to be doing something. (Says the guy who puts out a daily newsletter.)
The opposite of boredom is not excitement, but persistence. Letting things play out. Giving it time.
The idea of HODLing is essentially PERSISTENCE. Don’t sell through market panics: hold your investments.
The idea of “Diamond Hands,” popularized on r/wallstreetbets, is essentially PERSISTENCE. Your hand is strong: don’t sell it.
If you’ve been using our Investor Mindset MP3 series (guided meditations for investors), you’ll see how hard it is to persist in just sitting there. Our brains crave activity. You’re trying to sit in silence, and suddenly you realize you’ve been thinking about the grocery store for the last three minutes.
There is a direct correlation between this frenetic mental activity and frenetic investing activity. The two go hand in hand.
The reason you’re persisting in these exercises — and the reason we’re persisting in developing them — is because they’re golden tools to train your brain.
When we train our brains, we become better investors. Better internal persistence builds better external persistence. It’s all connected.
If you’ve persisted with us since Week 1, you’re probably starting to see small changes in your thinking already. You may be calmer, more self-assured. You may be less anxious, less depressed. You’re probably having new insights into investing. Trust them.
I encourage you to keep persisting. Paid subscribers can get the entire series here, including Episode 5:
- Investor Mindset, Episode 1
- Investor Mindset, Episode 2
- Investor Mindset, Episode 3
- Investor Mindset, Episode 4
- Investor Mindset, Episode 5
Remember: I’m a DeFi Believer. I’m invested. But the hardest lesson to learn in this fast-moving space is when to just quietly persist.
Learn to persist. It’s another investing superpower.
John Hargrave is the author of Blockchain for Everyone: How I Learned the Secrets of the New Millionaire Class, the bible of blockchain investing.