Smart Contracts, Composability, and a Dash of DeFi

One of the tricky things about web3 is that the subcomponents are vast and overlapping. By overlapping I mean the concepts meld into one another and build off of each other. With that in mind, lets dive into some more concepts I’ve found really interesting as an operator.

Smart Contracts- Smart contracts are “self-executing contracts with terms written as code and then deployed on blockchain networks like Ethereum”. Smart contracts will have a wide range of applications. Market making, a time-honored tradition that has required rich men and women in suits, is today being done in decentralized exchanges via automated market making (AMM). I have many friends that were, and are, traders. Call me cold-blooded but I am excited about seeing the job fade out of existence — at least in web3 — and watch them put their talents to more productive use. 

The most frequently cited examples of smart contracts, and easiest to understand, are related to content creation, particularly for artists. Several weeks ago my wife and I went to The Art of Banksy exhibit in San Francisco. I was familiar with some of his work, including “Love is in the Bin”, which self-destructed after selling for $1.4m in 2018 at a Sotheby’s auction. I didn’t know, however, that in October 2021 it resold for $25m. Smart contracts that could automatically provide the original artist (or their estate) with a royalty for all future sales would be a game-changer in the creative world and bolster creativity by making the process more economically attractive for artists. Connecting with the concept of composability, smart contracts can also build on top of each other. 

Composability- One of the components that I am most excited about receives (relative to the value) the least attention: composability. With the composability of web3, products and companies can more easily build on top of each other, like Lego blocks. Smart contracts can be programmed to interact with each other, as Linda Xie explains: “Just like a software library, smart contracts for different protocols and applications can easily plug into each other.” For those that haven’t rolled up their sleeves and tried to build in web2, it is hard to understand how exciting this is. 

In web2, tools like GitHub and GitLab have allowed engineers who don’t know each other to more easily leverage code from previous projects and speed up effective development time. They facilitate building on top of what others have built. As a technology company founder and CEO, the challenges for building are immense. It is a constant race against time to find product market fit before you run out of money or your competitors find it first.

Composability has astounding implications for the rate of innovation and will hopefully lower the cost to develop (though we’ve said that before…). I suspect it will also facilitate more meaningful innovation as developers and builders can iterate more quickly and learn from the improved feedback loop. To be clear, sometimes composability is as simple as another meaningless fork that adds no value. But I’m a believer in compound interest and I agree with Chris Dixon that composability is to software as compounding interest is to finance. Having built in web2, I’m incredibly hungry to build with the composability in web3. 

 Something I’m wondering: what are the second and third-order implications of composability in web3? If the barriers to entry are lower, does it mean founders with perhaps a more narrow skillset will get things off the ground? If yes, what does that mean for their ability to scale or the resources and teams they will require to grow with the product or company? To be clear, overall I think reducing friction for companies getting off the ground is a great thing. But there are additional implications that are interesting to think through in terms of the potential tools and resources that could support scaling founders. 

DeFi- I started a venture-backed web2 fintech company and was its CEO for over nine years. Prior to that, I was a growth investor. DeFi is exciting to me. And I have lots of thoughts and questions on DeFi and will go into more detail in future posts.

DeFi allows anyone to borrow, save, invest, trade and more. As this Ethereum post explains: “DeFi products open up financial services to anyone with an internet connection and they’re largely owned and maintained by their users.” By eliminating human interactions, some transactions should be quicker. Trustless. Open. The un- and underbanked now have options in a DeFi world that few in Silicon Valley can totally appreciate. Each of us no longer needs permission from a centralized authority to get a loan, to invest, to participate in the financial markets that have made the wealthy wealthier. I recently asked an engineer I think highly of why she was so excited about web3 — her first answer related to sending money back to her home country in Central America. It is easy to see why there is passion around DeFi.

Composability (mentioned above) is an incredibly important reason why DeFi is both possible and has the potential to revolutionize finance. The opposite, a lack of interoperability, has limited both traditional finance and many web2 fintech initiatives. Let’s be clear, we are still *very* early in the days of DeFi. It’s easy to criticize existing DeFi offerings without imagining how they could unfold over time, just as it’s easy for me to look at my 4-year-old’s Legos and not see the Spiderman tower he is envisioning that uses no Marvel toys. But that’s the beauty of interoperability: people building today can’t predict the amazing things that will be created with their blocks tomorrow. Yet centralization has some benefits too. As a smart ex-Bridgewater investor turned VC recently pointed out to me: “A historian of markets knows that there is a general trend towards centralization for capital markets. That has been true for payments, debt, etc etc. Moxie thinks we want centralization from a technology standpoint. I think we want it from a capital markets standpoint.” Why? All architecture has advantages and disadvantages. Trade-offs. Decentralized products give up scalability and usability in order to forgo the requirement to trust a centralized group. Most applications being built on web3 could more easily be built by a centralized group, but it would require trust from the users. But do the vast majority of users care that the product is decentralized? Only if there is value to those users.

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