The Next Upgrade of Money: Programmable Money

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Going off the gold standard was the best thing that could happen to money. We should all be sincerely grateful to Richard Nixon for ending the Bretton Woods system in 1971. "Tricky Dick" (Nixon's nickname) ushered in a new era. Until that moment in human history, money has been associated with tangible assets. First shells, then gold, then paper money backed by gold. With one stroke of his pen, Nixon created fiat money without any backing.

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I know that praising the demise of the gold standard might upset Bitcoin maximalists, but think about it: we wouldn't have Bitcoin without fiat money. With fiat currency, currency as an abstract technology can emerge as the times require. Once it becomes an abstraction, money becomes programmable. Cryptocurrencies are a natural implementation of programmable money.

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Electronic money is not programmable money

But the problem is that electronic money is not programmable money. Currently, money exists as an entry in a private ledger we call the "banking system". The banking system is rife with unnecessary redundancies and corresponding inefficiencies. While this traditional system is electronic, it simply digitizes a process designed in a time when money was explicitly pegged to physical gold: banks store gold in their own vaults and do not use hard currency to physically settle transactions. Instead of a single transaction, transactions are recorded on the ledger to offset the inflow and outflow of funds.

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Our current e-money system is designed according to the old model - no programmability!

And if we had taken an Internet-first approach in the first place, money would be completely different from the current banking system. Currency, both fiat and hard, will exist on a public blockchain, be accessible to anyone with an internet connection and be inherently programmable. 👇

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The Next Upgrade of Currency: Programmable Currency

I keep using the word "programmable" without defining it: money is programmable if it can be invoked as a simple software primitive integrated into a smart contract.

You might think that programmable money is just about faster settlement times, or payments without borders, but in reality, programmable money can go much farther. Ultimately, this is a story about financial complexity. With programmable money, financial instruments can achieve a higher level of sophistication.

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To really understand the implications of this, it is necessary to consider monetary upgrades that have occurred in the past and how they have changed society.

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The end of Bretton Woods marked the culmination of a monetary process that began during the Tang Dynasty in eighth-century China, when it was realized that paper money could be used as a symbolic representation of gold stored in vaults. The benefits of paper money over physical gold are obvious. Bill paper is lighter, easier to carry, and easier to count. These properties greatly reduce the cost of financial complexity. Assets can be transferred by manipulating the ink on the parchment (i.e. printing notes of different denominations).

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Printing plates and banknotes of the Yuan Dynasty were one of the earliest monetary upgrades

Paper money started several financial innovations, but I want to focus on two of the most important: bonds and stocks. The earliest bonds originated in Italy during the Renaissance in the 13th century. Investors buy paper bonds that promise to pay a certain amount in the future. As it turns out, this is a great way for a society to pool capital and direct it to productive use.

All of these innovations required exchanging one form of paper (banknotes) for another (financial instruments). None of this would be possible if paper money had no value. Moreover, since bonds and stocks exist in paper form, they can be traded in secondary markets, opening up a whole new path to financialization. Investors no longer need to establish a direct personal relationship with each other, they can directly buy stocks or bonds second-hand.

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When the cost of financial complexity falls, we create new forms of business that fundamentally change society. Stocks and bonds effectively provided the economic guarantee for the Industrial Revolution. Such great works as railways, factories, and steam engines would not have been possible if society had not managed to transfer excess resources from one domain to another, from one interval of time to another. Without paper money, we would still have to rely on subsistence farming.

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Programmable Currency Upgrades

We're going through another inflection point in history, only we're moving much faster, so buckle up. To understand how programmable money is raising the level of financial complexity, one only has to look to the DeFi movement.

A new revolution in financial complexity is happening before our eyes. We have lending pools like Compound [1] and Aave [2]. These protocols allow people to pool their tokens together and lend them out to earn interest. This interest is earned through another token that can be traded secondhand ("cToken" and "aTokens" respectively). Essentially, these lending pools are like traditional money markets, except they’re distilled into programmable currency LEGOs that can be combined with other DeFi protocols.

For example, Staked[3] has a protocol that dynamically deposits tokens into and out of a lending pool for the highest yield. The protocol, called "Robo Advisor for Yield" or RAY, is a protocol built on top of programmable money.

• Another promising area of ​​rapid innovation is liquidity pools driven by "automated market makers" (AMMs). A typical example is Uniswap v1[4]. Uniswap completely abandons the concept of limit order books, and instead uses a model of liquidity pools and automated market makers to make markets and determine prices for asset transactions:

• Liquidity providers pool two tokens (ETH and another ERC20 token) into one smart contract (i.e. create a liquidity pool) and earn transaction fees;

The liquidity pool automatically determines the transaction price of assets through established algorithms, replacing manual quotations, thereby realizing the automation of market makers.

DeFi protocols are becoming more and more complex, which creates the need for "decentralized portfolio management". For example, PieDAO[5] is a governance layer where users can come together to participate in collective investment strategies, which may not be much different from ETFs (Exchange Traded Funds) and mutual funds in traditional markets. Instead of managing a complex portfolio yourself, you can buy a PieDAO portfolio.

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Programmable money — simple primitives for building complex financial instruments

Let’s give an example of how these three currency LEGOs (i.e. liquidity pool, lending pool, and governance layer) can be synthesized into a more complex financial instrument.

Let's start with a liquidity pool consisting of Token A and Token B. Instead of simply storing Token A and Token B, why not deposit the idle tokens in the liquidity pool contract into a lending pool to earn interest? When the liquidity pool needs to be traded, we can temporarily withdraw tokens from the lending pool and re-deposit them into the liquidity pool. In this way, the liquidity pool can still facilitate transactions, and at the same time deposit idle funds in the lending pool to earn interest.

In my opinion, this is just the tip of the iceberg. You know, at the end of 2018, lending pools and liquidity pools were largely hypothetical, with only a few examples. Imagine what will happen in five years? The technology, which is still in beta, already has behavioral capabilities and sophistication not found in traditional systems.

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Interactive protocols create emergent financial superstructures like Conway's Game of Life

These examples from DeFi show us that programmable money enables new complex financial instruments. The tools themselves are also programmable and can be combined to create increasingly complex tools. Most importantly, the inherent openness of public blockchains means anyone can access this new ecosystem.

Benefits of programmable money?

Why would the average person want or be able to benefit from this financial complexity? It's a bit like asking why anyone would want or be able to benefit from having a supercomputer in their pocket. Today's iPhone is many times more powerful than the current NASA (National Aeronautics and Space Administration) computer used to land on the moon. The financial tools available to ordinary people will be many times more complex than those on Wall Street today.

For example, a friend of mine owns a mango farm in Ghana. One of her biggest pain points is the volatility of mango prices in the global market. In the future, the application to be able to hedge mango prices through futures and options will become so simple that even small businesses can do it. This might sound like speculation, but we are already down this path: protocols such as Opyn[6] and Futureswap[7] allow users to buy and trade these derivatives on a decentralized marketplace. It’s only a matter of time before these protocols are integrated into the new “currency Lego” that will eventually power user-facing applications.

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"But these things are still too complicated"

I'm not going to try to predict how society will change - there are too many second order effects at play. However, it seems clear that if anyone in the world had direct access to far more sophisticated financial instruments than traditional financiers use today...then the world would be fundamentally, fundamentally different.

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potential bottleneck

At this point, trying to imagine the future of human commerce is a bit like a Renaissance Florentine businessman trying to imagine Standard Oil. However, I can try to anticipate potential bottlenecks.

One of the bottlenecks is that if the blockchain does not scale first, the programmable money revolution will stall. I'm not an expert on blockchain base layer protocols, but it seems that Eth2.0[8] is making progress, and if so with alternatives such as Cosmos[9] and Harmony[10].

Another bottleneck may be regulation. Regulation has always been a difficult problem for the crypto industry. While unfavorable regulation will certainly hurt short-term development, bureaucrats cannot stop this revolution. True, traditional interest groups were quite powerful, but so were the original European monarchs and the Church. Change is inevitable. Regiments that failed to adopt the new institutions were as sure to decline as those that refused to industrialize.

However, there is another bottleneck that people don't really discuss. Stablecoins are the backbone of DeFi. A crypto ecosystem cannot function without a stable asset that acts as a store of value, medium of exchange, and unit of account.

In DeFi, only a few stablecoins are widely used: Dai, USDC, and Tether. Ironically, the U.S. banking system is more diverse than DeFi. If the resilience of DeFi is what we care about, then we shouldn't have any too-big-to-fail stablecoins. But simply adding more stablecoins won’t solve the problem: Even with only a few stablecoins in circulation, the market remains highly fragmented, diluting the liquidity of each stablecoin.

What we need is a stablecoin interoperability protocol that unifies stablecoins into a coherent monetary system. Not only should the protocol bring liquidity between stablecoins, it should also incentivize the creation and adoption of new stablecoins. The financial sector is like a rainforest, where biodiversity allows the entire ecosystem to thrive. (My project Shell Protocol [11] is trying to solve this problem. Our goal is to create a stable and liquid medium of exchange that anyone can use on the Internet.)

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