Finance, close to the metal
The following article introduces the concept of a new type of finance – Open Finance or Decentralised Finance – living natively in the digital world for the first time and made possible through blockchain technology. Free from legacy finance’s high costs, inflexible terms, and opaque structures, parties are today transacting peer-to-peer using smart contracts that deal natively with digital assets on a common platform. An explosion of new financial products, services, and solutions that the world has never before imagined is on the horizon. We are excited about this development and hope you will be too!
Software is eating the world because our world is becoming ever more digital. Software gives us superpowers when we need to work within the digital world.
If you open a computer, you can see a vast array of transistors, resistors, capacitors, slots – like landmarks and buildings in a miniature city. Heat sinks tower above like shining skyscrapers; printed circuits – perfectly rendered streets – connect everything. Somewhere in the middle of this green expanse, like a monolith in the city centre, is the CPU. This is where the work gets done. Programmes are executed here in their ultimate binary reduction: 0s and 1s. This, as programmers would say, is as “close to the metal” as it gets.
Programmes always end up close to the metal, regardless of how their journey began. After all, binary is the computer’s native language.
Until now, modern finance has used software and computers as tools to support the management of assets, which are still very much real-world, analogue things with ownership and rights defined by real-world legal frameworks. Digital assets have existed, but they are mere proxies of the still very analogue assets which ultimately remain beholden to anachronistic laws and institutions that interpret them. There is a wide chasm distancing the digital asset and the judge’s solemn gavel, with many people, parties, procedures, and motives in-between.
But something magical happened when the idea of a proof-of-work data structure called a blockchain arrived on the scene to little fanfare. It promised self-sovereign, secure, digital scarcity. Boom. A new kind of money was born. Value that is natively digital, and that, is the game changer.
Until then, the concept and implementation of money had barely changed in hundreds of years. The idea of digital scarcity was genuinely radical, but bitcoin, of unknown origin, actually pulled it off. A few years later, Ethereum smart contracts added granularity and the freedom to define how value is transferred, bringing programmatic sophistication to the simple arithmetic transfer of value between accounts that bitcoin perfected.
The unbelievable success of these platforms is, in hindsight, just the inevitability of the amazing ideas they engendered. The general purpose flexibility to freely design instructions that define the behaviour of an open, secure, global value platform resistant to corruption and influence is enormously powerful.
People are just beginning to intuitively understand what this means and what they can do with it. Already, you can hear the nascent rumblings, the sound of thousands of uncoordinated programmers and enthusiasts creating financial building blocks under no one’s direction, inventing new financial constructs, solving obscure problems, or simply fiddling because they think it’s cool that they can. Some call it “Decentralised Finance” or “DeFi”, others say “Open Finance”. Regardless of the name, it’s the most thrilling thing to happen to finance since the internet, and the momentum is just getting started.
The innocence of the word “open” in Open Finance is deceptive and belies the movement’s power. Open can mean a number of things in this context. Transparency is paramount, as it begets trust by allowing verification. Open can mean the ability to copy or change code, providing a permissionless nature. Another interpretation is the neutral interaction within a network, as no authority
can prefer, influence, or hinder a transaction.
But the most important take on “open” in Open Finance is the idea of composability.
Let me take a quick segue to the world of the command line interface, so zealously celebrated by techies. Why is this so? After all, modern operating systems are astonishing in how they abstract away the functional complexities and give an intuitive experience at the human level. This slick shell is only fooling us however – it’s still 0s and 1s in the end.
Linux and Unix operating systems, which seriously do most of the heavy lifting in the digital world, have a near-religious philosophy at their heart: write programmes that do one thing and do it well. This allows a second mantra: write programmes to work together with well-defined inputs and outputs.
Now we can begin to see that techies love the command line because of boundless flexibility and freedom to quickly link together many small programmes that do one thing well, resulting in a powerful tool and solution for a perhaps very specific task.
This captures the spirit of Open Finance’s financial primitives very well as embodied smart contracts working natively with digital assets on a common platform. Contrast this with traditional finance’s high costs, rigid usage, and strict terms, forcing a product or service to be used as the issuer or regulator intended. This is the clear analogue to proprietary software, where creativity
is stifled and innovative ideas die on the vine.
So what are these “financial primitives”? What are the things we need to be able to do with money? At the most basic level in blockchain open finance, we need the ability to securely store value in accounts and the ability to reliably transfer value, effectively changing its ownership and control. Bitcoin, Ethereum, and others have this covered.
To move beyond this base financial functionality, we needed the complexity that a full programmability enables. It’s the programmability that replaces financial institutions’ functions.
Ethereum brought the idea of a token that anyone could create, define internal behaviour, and launch globally without the need for a whole new blockchain network (hardware, miners, full nodes, and nodes). It was a major milestone. Very soon, a standard for tokens emerged (ERC20), so contracts, wallets, and even other tokens could predictably and reliably interact.
As new tokens were being created, the next natural thing happened: trade. Trading is of course enabled by the ability to transfer. More sophisticated trading venues came with decentralised exchanges. Now things started to get rolling with the smart contract implementation of ideas like lending and borrowing, collateral, escrow, interest, and saving.
Momentum gathered as the ideas became more ambitious: insurance, investing, asset management, and stablecoins – synthetic assets able to track a real-world asset’s market value. Just as with the legacy financial system’s stack, Open Finance can follow up with margin, leverage, and a whole universe of derivatives that can be tailored to fill any niche risk exposure agreed between
An asset’s price has many components and is impacted by a litany of risks. The openness of these financial primitives may even provide more pure pricing mechanics, as specific risks become more transparent or are eliminated altogether through the trustless nature of a smart contract.
Following the script
Good tech is built on layers. With financial primitive smart contracts that do one thing and do it well, we can layer individual financial concepts. This also helps us abstract more complex pieces and better reason about their interaction. Of course, as these financial primitives are themselves programmes, they can be strung together by other “meta-programmes”, or scripts that can arbitrarily choreograph the interactions or just make a cumbersome set of tasks a one-click affair with higher quality and repeatability as added benefits.
An explosion of new financial products, services, and solutions that we’ve never imagined is on the horizon. We’ve never imagined them because we lacked tools and stepping-stone examples to imagine them. Free, open, and accessible tools are the fertile ground that real financial innovation needs; just add curious, unencumbered minds who want to create their own visions and value.
In the literature around the study of disruptive technologies, it is often said that these innovations at first only look like toys. It is then fitting that a powerful metaphor for open finance is the simple Lego block. From childhood, the toys that received the most attention were the ones that let us express creativity in an unconstrained way. Each time we opened the box, we saw something
new. Toys that didn’t force us to build someone else’s idea. Toys that we could tear apart, rebuild, and reuse as new ideas came to mind; as we discovered what worked and what didn’t. We were not forced to build the thing depicted on the box.
Recently, financial innovation has progressed at glacial speed. What has really changed, for example, in asset management over the past 30 years? Embedding assets natively in the software tools, websites, and apps that we use today will help to achieve entirely novel, beneficial use cases and unlock previously hidden value. The open finance community should be bold and heretical, pushing the envelope, challenging the status quo, and providing direct comparison.
In nature, diverse ecosystems thrive because they have the freedom to evolve and interact, bearing unanticipated synergies. My guess is that the financial innovation enabled by open finance and these financial primitives will cultivate a similarly robust and diverse ecosystem, inherently more able to deal with the systemic challenges and requirements of the ever-more digital world.