Crypto and DeFi are changing the financial system, but it's a very complicated system, so it's hard to predict how this change will happen. Like anything in this field, it helps to go right back to the beginning. The first thing is this:
Nobody knows what they are doing
Nobody knows anything, and everyone is winging it. This is one of the universal truths that - unless you read the right material - nobody tells you. You realise it one day when someone drops their guard. There are some people who manage to give every impression of having it all figured out, but nobody really has.
Nobody really can. The systems we have created are so complex that the best approach to achieving something is an adherence to a general direction, a comfort with ambiguity, and an adaptability to change. If you can figure out that direction, get used to the uncertainty, and be resilient to the slings and arrows then you will do well. But don't ever pretend you are always on top of it. The best business people I know are a paradoxical mixture of humility and self belief; recognising that they don't know it all, while backing themselves to deal with whatever comes next. When you see behind the curtain, you realise that imposter syndrome is just self awareness for modest people.
It wasn't meant to be this way
Taking a wider view than the individual leads to a mistake that accompanies the assumption that everyone knows what they are doing. This is the misconception that there is a good reason things are like this. "Like this" might be the way an organisation works, the way an industry works, the way a relationship works; how any system works at the moment. We are inclined to assume that somebody very clever designed things like they are now, and there are good, logical reasons for the current state of affairs.
There may be good and logical reasons, but they are almost always related to how things have evolved, not how they were designed. How they evolved is a function of a system. As soon as it gets complex - which tends to happen very quickly in the field of human endeavour - a system starts to show emergent properties. "Emergent" is a systems term that covers all the unexpected stuff. Systems tend to become complex quickly, and their behaviour is subject to so many variables that it becomes hard to predict.
Gall's law, named after author John Gall, says that "a complex system that works is invariably found to have evolved from a simple system that worked". It's more of a rule of thumb than a law, but it is one of those wonderful ideas that almost immediately seems so obvious that you think you'd always known it.
It is very, very difficult to design a complex system from scratch. The interactions between the various parts and players are so hard to predict that the emergent properties will kill you, however smart you are. Far better to start with the simple pieces and then see what happens. When you observe the behaviour of the simpler system you start with, your ideas about how the whole thing might work will probably change anyway.
One corollary of Gall's law is that trying to change a system is also prone to disaster, and unintended consequences - the Cobra Effect. Trying to make a complex system do something different is just a form of trying to design it. It is also tricky to do effectively, or predictably.
Remember the general direction, comfort with uncertainty, and resilience, from above? That's the personal level. Letting systemic behaviour emerge and then adapting to it is the system level.
It's a moving target
The third thing to recognise is that everything is changing. Once it is pointed out to you, you realise that Douglas Adams' assertion that "anything that exists before you were born ... is a natural part of the way the world works" is very true. CS Lewis coined the term "the snobbery of chronology" for a similar idea: that the way things are now is the final version, and everything in the past was designed to get us to this point. The way of things now is not permanent, was not carefully thought through, and will change. Thank goodness.
The current state of anything - society, finance, football, government, music - is the result of an evolutionary process of change made up of simple beginnings, well meaning intervention, unintended consequence, randomness, and opportunistic self interest. You apply a shifting set of incentives and patterns of behaviour, and then you look back and explain how we got here. Life only makes sense backwards.
But then everything is still changing. "Geological time is now" is a phrase I remember from "Between a Rock and a Hard Place" - the book by Aron Ralston that became the movie "127 Hours". The meaning is that although things change slowly, and we might not be able to see them moving, they are changing. In Ralston's case it was the boulder that shifted and pinned his hand - inextricably - to the canyon wall. There was a long period of time when the rock was in one position, and after that there will be another few hundred or thousand years with it in the new position. He was just unlucky enough to be there and cause it to move.
Evolution is live and current, and if it looks like nothing is changing, then there are two possible reasons for that. One is that whatever you are looking at is in a phase of relative equilibrium, when change is slow and incremental. So things are changing, just very gently. The second possibility is that you are looking at things on too narrow a timeframe. These two are really the same thing: if you take a broad enough perspective, then everything is temporary. The wheel's still in spin.
It's about the money
The above three things are true in any field, but I am interested in the financial system. With the advent of fintech, things have changed a lot from the perspective of the customer. New apps, new banks and better connectivity have changed the way that we interact with the system. But in the back end, the system itself hasn't changed much at all. Central banks set interest rates, issue currency, and implement fiscal and monetary policy. Commercial banks take deposits, make loans, sell foreign exchange, issue credit cards. These things, and the infrastructure behind them, have all been pretty stable for about 50 years.
But then step out to a wider timeframe. 51 years ago, we still had the gold standard. 51 years before that, and South Africa's central bank didn't exist, and nor did many others. On that timeframe there was still a lot of debate about how central banks should work. Back then, the IMF didn't exist, nor did the UN or the WTO. All of these institutions only came about at the end of World War Two.
It's a system
The financial system is enormously complex, and prone to unintended consequences and reacting in unpredictable ways to intervention. A history of government initiatives, financial crises and company failures has shown us that. The results of apparently logical changes can run out of control as the chaos from complexity kicks in.
In DeFi (decentralised finance), we see an attempt to do something new. Although large in absolute terms (total value locked in DeFi is $200 billion as of 15th Feb 2022), DeFi is still small relative to the traditional financial system. The global market cap of banks was about $8.5 trillion in 2021, for comparison. It would be easy as a banker to write off DeFi and crypto as a passing distraction.
But that would be to ignore history, and not even ancient history. Chris Dixon famously said that the next big thing looks like a toy. Clayton Christensen advised us to look at the people doing seemingly small things at the fringes of our industry. Crypto might be an almost impenetrable mess of in jokes and technology, but it is also the start of something. The PC, the internet, and any number of other technology driven changes also looked like playthings not so long ago.
Working back: everything is changing
Nobody knows anything, this isn't the end, and everything is changing. If we work back, then it might help. The financial system is continually changing, particularly where technology is involved. It is hard to predict whether DeFi is a replacement for parts of this system, or a lever that changes the system. We have changes being made by regulators, incumbents and a range of innovators from Apple to ZCash. The old road is rapidly ageing, but the drivers of the current system are not going to change without a fight; witness the IMF's increasingly aggressive responses to El Salvador's adoption of Bitcoin.
You no longer need to study history to see that things are changing. It might be instructive to read about how central banking came to be what it is, but to understand the potential of change you only have to have been alive for 20 or 30 years. The iPhone is still a teenager, Google is 23. The thing to note is not what the technology can do, it is how it has already changed our behaviour in a million ways large and small, and the new business models it has enabled.
Gall's Law
"A complex system that works is invariably found to have evolved from a simple system that worked."
Looking at DeFi, we have some simple systems that work. You can lend and borrow, dealing with decentralised smart contracts, and it works. It's not simple in terms of the user interfaces - there is a lot of work needed there - but the concepts are simple. They are also composable. This is critical: each piece is public and is connectable to other projects. The components of DeFi are not designed with a complex goal in mind; they are designed for one task, and to work together. There is a deliberate process of putting the simple pieces in place and letting it evolve. Gall's law is in motion.
As projects build on other projects, we can do more complicated things. New properties of the system have begun to emerge, and DeFi is developing very quickly. It won't happen in isolation, though, just as fintechs have not built a separate financial system. There are far too many customers, too much capital, and too much expertise in the incumbent financial institutions that they will sit and watch the new system grow. Or indeed that DeFi will ignore them.
Some aspects of DeFi will develop in parallel to the existing financial system until a significant portion of certain types of activity are happening in DeFi. At the same time, the current system in the shape of banks, insurers, payment companies and others will embrace aspects of DeFi. These parts will grow fast due to the scale that the incumbents will bring. If you have a million dollars under your mattress, then putting $1 in a savings account isn't going to change your outcome. A meaningful sum for a large bank is a big deal in DeFi.
These two aspects of DeFi's growth will feed off each other. DeFi projects that work with the banks will take their intellectual and financial capital and use it in the "new system" version of DeFi. At the same time, innovations from the 'parallel' system will find their way into the halls of TradFi. So we see that everything is changing fast in this complex system, and that change starts with simple beginnings, but don't forget the last piece.
Nobody knows anything
I've been working in financial services for well over 20 years, and increasingly in blockchain and crypto for about 5 or 6 years. You can't recruit someone with 10 years experience in DeFi. Be wary of anyone who advertises themself as an expert. The only thing to do is learn - keep reading, talk to people, and experiment with it. I know nobody really smart who has invested time in understanding this stuff properly and who still thinks it's a scam / ponzi / bubble / fad - insert your own dinner party verdict. Don't criticise what you can't understand.
The financial system is changing, that change is significant, and it is happening so quickly that you can see it moving. If you are involved in financial services, it's not too late to get onboard, and the upside is huge, but the chance won't come again. What a time to be alive.
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