Students taking economics courses are expected to learn about traditional finance and intermediaries that impact the economy, like supply and demand, trade, stock markets and hedge funds. These are critical topics that help them to understand individual markets, the impact of government policies and the overall economy.
But what, if anything, should students learn about decentralized finance, like cryptocurrency? Why is or isn’t it important to learn about these peer-to-peer transactions and their impact on the economy? We asked the popular economist and co-
What is decentralized finance?
Traditional finance involves many financial intermediaries like stock markets, hedge funds and banks. Banks, for example, stand in between savers and borrowers and, as we explain in Modern Principles, they perform useful services like evaluating borrowers and creating easy means of payments like credit cards and checks. Naturally, financial intermediaries also take a cut of the proceeds, about 8% of GDP!
Decentralized finance replaces some of these intermediaries with code, smart contracts, that allows buyers and sellers, borrowers and lenders and others to interact more directly and we hope at lower cost and with greater innovation.
Loosely speaking, decentralized finance is to finance what Facebook and Twitter are to newspapers and magazines; namely, replacing a centralized authority with a more decentralized peer-to-peer interaction, for better or worse!
How do cryptocurrencies fit into decentralized finance?
Right now, "DEFI" is mostly used to borrow, lend and trade cryptocurrencies. And frankly it's very risky, hard to do, and pretty weird.
What we are seeing, however, is a very rapid evolution in the DEFI sector and this may turn out to be a fantastic example of Clayton Christiansen's disruptive innovation; namely, an innovation with a smaller company at the bottom of the market that traditional players ignore and discount until it moves up market and disrupts established competitors before they even know what is happening. Frankly, every stock exchange in the world ought to be very fearful of DEXs, i.e. decentralized exchanges.
You’re covering cryptocurrencies and decentralized finance in an online chapter in the next Edition of Modern Principles of Economics. Why did you choose to include it?
Students ask us about crypto all the time! I don't expect there's a lot of time to teach this material, but a teacher should always know a little bit more than their students! So we thought teachers might be interested in this material to help them answer questions and they can always include some of this material when talking about money or financial intermediaries.
Right now BitCoin remains the most accepted and widely known form of crypto. Do you think that is the case going forward, and what other coins do you think may become more prevalent and accepted?
Bitcoin has proven to be a good store of value, somewhat equivalent to gold as a store of value. It's not a good medium of exchange, however, and I don't think it ever will be. There are lots of other coins, including stable coins that are very useful in transacting online and a lot of coins tied to various products and projects. Most of these coins will fail and people will lose money. Still, the new tools that are being developed today at a rapid pace suggest the future of finance is going to be quite different than the past.
To learn more about decentralized markets and how to teach students about it, sign up for the free professional development webinar hosted by Tabarrok on Feb. 23 here.
Alex Tabarrok is Bartley J. Madden Chair in Economics at the Mercatus Center at George Mason University. Tabarrok is co-author with Tyler Cowen of the popular economics blog, Marginal Revolution. His recent research looks at bounty hunters, judicial incentives and elections, crime control, patent reform, methods to increase the supply of human organs for transplant, and the regulation of pharmaceuticals. His popular articles have appeared in The New York Times, The Wall Street Journal, and many other magazines and newspapers.
