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Plenty of asset classes exist with fundamental risks. The risk of investing in stocks is always that the underlying companies could have their business ruined

Plenty of asset classes exist with fundamental risks. The risk of investing in stocks is always that the underlying companies could have their business ruined overnight for any reason. The risk of swaps is always that the counterparty could go bust and be unable to pay you even if your bet pays off (see Lehman Brothers). The risk of leveraged futures positions is you can get liquidated on fat finger trades or flash crashes. The risk of structured credit products like CLOs or mortgage backed securities is that the pool is fraudulent. The risk of many quant strategies is that the correlations go to one and your capital gets wiped out as your hedges fail to protect you. Do any of these risks mean those asset classes are doomed? No, all of the above asset classes are bigger than ever. Markets can and do live with disastrous risk looming over their heads all the time. Unless your name is Nassim Taleb, the reality is that you mitigate the risks you can, model out the risks that you cannot, then price the asset accordingly. The foundation of modern finance is “we don’t have to live in mortal fear of risk if we’re smart about it” If inherent risk was an insurmountable barrier to the existence of a financial product, then I guarantee you the financial system would just be the old-timely community bankers like in It’s a Wonderful Life.

jstx1 5y ago
No banking system has the type of risks DeFi has. Saying that they have some other risks is just a long way to change the topic and it doesn't answer any of the questions around DeFi.
- dcolkitt 5y ago
  Many quant funds have similar “gap to zero” risks like DeFi. Many swaps desks at bulge bracket banks have “gap to zero” risk. Many derivatives strategies actually have “gap beyond zero” risk, as in you can lose more than 100% of your investment. All of these systems are complex black boxes, for which the full risk profile can never be fully known let alone eliminated. Yet all of these asset classes continue to reach record size. For the foreseeable future, risk is not a meaningful constraint on financial activity or the growth of any otherwise profitable sector. Global capital is insanely hungry for yield. It’s willing to accept very large, outsized risks as long as returns are attractive. DeFi continues to grow because it offers significantly higher top-line returns than traditional products. As long as that continues to be true, investors will stomach, and in many cases outright ignore, the risks.

jstx1 5y ago

No banking system has the type of risks DeFi has. Saying that they have some other risks is just a long way to change the topic and it doesn't answer any of the questions around DeFi.

dcolkitt 5y ago
Many quant funds have similar “gap to zero” risks like DeFi. Many swaps desks at bulge bracket banks have “gap to zero” risk. Many derivatives strategies actually have “gap beyond zero” risk, as in you can lose more than 100% of your investment. All of these systems are complex black boxes, for which the full risk profile can never be fully known let alone eliminated. Yet all of these asset classes continue to reach record size. For the foreseeable future, risk is not a meaningful constraint on financial activity or the growth of any otherwise profitable sector. Global capital is insanely hungry for yield. It’s willing to accept very large, outsized risks as long as returns are attractive. DeFi continues to grow because it offers significantly higher top-line returns than traditional products. As long as that continues to be true, investors will stomach, and in many cases outright ignore, the risks.