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The Defence Use Case for DeFi
Thinking through very real hypothetical scenarios and identifying credible use cases for DeFi
Welcome to another edition of the DeFi Mullet newsletter! In this newsletter, I hope to cover the arguably boring world of the most anticipated collab of the decade: Fintech x DeFi (ft. policy, markets, tech, product, etc).
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Hello - I just wanted to express my thanks for your patience between posts. I have taken some time off during the summer; I know, ambitious of me to start a newsletter just before taking some time away. For those in my various inboxes with messages still unread, do not fear, I will be getting back to you shortly. There is still a lot of work to be done and I look forward to continuing writing and/or working with many of you in the near future.
The Defence Use Case for Decentralised Finance
In a world trending towards multipolarity, the importance of anti-fragile financial infrastructure has never been more pressing. Economic coercion takes many forms and can cripple a state’s ability to defend itself at scale. Defence is both labour intensive and expensive: having inefficient or partially functional financial infrastructure can hasten a state’s collapse. In instances of state-sponsored economic warfare or kinetic warfare targeting financial infrastructure, DeFi can be used as an immutable tool to quickly instantiate a decentralised financial infrastructure that provides a readily scalable secondary layer of economic defence. It may seem unintuitive at first but harnessing the intersection of DeFi and Fintech can have a profound impact when managing scenarios of extreme consequence and volatility.
Defining Economic Coercion
With US hegemony being tested and multipolarity being pursued by many of the world’s aspiring superpowers, economic coercion is a tool that is increasingly being adopted as a mechanism for pursuing foreign policy. This may be a new area of inquiry for the many folks operating in Fintech x DeFi; I will define some key ideas to help further illustrate the different scenarios in which this applies.
Targeted currency devaluation → adversary central banks using available liquidity to cause a defending country’s currency to devalue in open markets i.e. continued downward sell pressure.
Supply chain disruption → using sanctions or other means of coercion to disrupt an adversary’s supply chain.
3rd party trade coercion → using diplomatic or economic pressure on 3rd party neutral states to sever or limit important economic relationships.
Asset seizures → seizing state-owned or privately owned assets held by foreign states, banks, firms, or individuals.
Kinetic attacks → targeting physical locations of financial infrastructure i.e. central banks, domestic banks, and stock exchanges.
Cyber attacks → targeting software and systems underpinning core financial infrastructure i.e. central banks, stock exchanges, domestic payment networks, domestic banks, and telecommunications infrastructure.
Economic warfare is a very real pillar in any combatant’s toolkit. It is crucially important that we, as practitioners, understand the role of financial infrastructure in maintaining a state’s ability to function and defend itself. There are a variety of vectors in which economic pressure can be exerted and it is our role to facilitate the mechanisms for ensuring there are readily deployable defences if ever the need arises. It would be naive to think that the financial services industry is immune from contention in periods of conflict between nation-states: we are already very much familiar with the importance of Anti-Money Laundering, OFAC, the Financial Action Task Force, and Countering Terrorist Financing.
Relevant Attributes of DeFi
As DeFi continues to scale, it is increasingly obvious that there are some fundamental attributes that make it the ideal technology for defending against economic coercion at scale. Interestingly, these attributes are also the core features that distinguish DeFi from CeFi.
Decentralisation → By the very nature of being decentralised, DeFi enables access to credibly neutral and censorship-resistant distributed settlement mechanisms that can be utilised by a state under duress. A distributed architecture provides an avenue to deploy and maintain a minimum viable payments network that can continue to operate across a distributed network despite known defensible vectors for attack.
Permissionless → DeFi’s permissionless nature enables distributed teams of engineers to ship services and updates on top of already existing credibly neutral base layer protocols. This permissionlessness is crucial for enabling the swift establishment of a minimum viable payments network, avoiding any unnecessary centralised gatekeeping that could delay implementation in a crisis.
Composable → Composability enables nation states to iterate and scale a minimum viable payments network, utilising existing primitives or developing new primitives in response to novel circumstances. This composability and utilisation of existing primitives enables lean teams to operate at a tremendous scale once services are in production.
Although we may be accustomed to the idea of AWS, Azure, or GCP having a bad day (some of us have eu-west-2 or us-west-1 etched into our brains), it is not often that we take a step back and consider how we would deal with a key piece of financial services infrastructure being taken offline by a hostile state actor. To set the scene, take a couple of minutes when you are next drinking your morning tea or coffee and play through resolving these scenarios:
A hostile state actor conducts a cyber attack taking a European nation’s domestic payments infrastructure offline indefinitely. As the European nation’s government, how do you roll out an alternative payment infrastructure as fast as possible whilst also trying to bring back online your legacy systems?
A hostile state actor annexes a contested region and begins a program of re-denomination (using traditional fiat or CBDCs, worse if CBDCs). It is not clear whether pensioners, now under occupation, will have access to payments that are crucial to maintaining their way of life. As a government, how do you ensure pensioners in the annexed territory are not forced into poverty?
Opportunities for DeFi
Below are several use cases enabled by DeFi that states can leverage in order to defend the economic infrastructure underpinning their economies.
Enabling immediate access to stablecoins pegged to assets with deep market liquidity → Stablecoins pegged to alternative fiat currencies enable protection against sustained periods of targeted currency devaluation. It is crucial that actors within supply chains do not suffer significant depression in their purchasing power, especially for states heavily dependent on cross-border trade. Utilising stablecoins as an early hedge against devaluation, whilst also protecting manufacturers’ terms of trade, can be crucial in avoiding further supply chain disruption.
Alternative domestic payment networks → In the scenario where a domestic payment network and/or settlement network is taken offline, DeFi could be utilised as a swiftly implemented minimum viable payment network. The purpose of this DeFi-enabled payment network would be to limit the scale of first and second-order economic harm caused by core financial infrastructure being taken offline. States need to think about what is required of their citizens to enable such a switch: internet access, computers/mobile phones, onboarding, private key management, etc.
Establishing shadow economies in occupied territory → Utilising an alternative minimum viable payment network, dissenters in occupied territory can establish shadow economies that are hidden from their occupiers. This can be particularly useful in instances where occupiers are seeking to re-denominate the occupied territory with either fiat or CBDCs or inflict punitive taxes on residents.
Continuity of government services → There are a number of government services that are crucial to the financial well-being of vulnerable citizens. These services can range from pensions, disability assistance, veteran/widow support, jobseeker allowances, carer support, and maternity support. It is crucial that these citizens are not deprived of government support, especially in times of conflict. Once a minimum viable payment network has been established, governments can use this DeFi-enabled solution as a mechanism to ensure the continuity of crucial government services to these citizens. It is important to note that this is particularly relevant for vulnerable citizens residing in occupied territory who may not be eligible to receive similar entitlements under the occupying state.
Alternative methods of sourcing and distributing working capital → Where domestic equity and debt capital markets have dried up or access has been restricted, DeFi can act as a mechanism to facilitate the sourcing and distribution of working capital to businesses crucial to a nation’s economy and/or defence effort. Starving an adversary of access to credit can cause tremendous detriment to the efficient operation of their supply chains, especially when an industry relies on cross-border or just-in-time manufacturing practices.
Identity management and authentication → Where key government services may be taken offline, alternative methods for managing identity and authentication for access remain a key concern. If needed, governments can explore using decentralised identity management and authentication as a means of ensuring continuity of service.
This is happening IRL
Iranian Government settling $10m of imports using cryptocurrency
Ukrainian Government accepting donations in cryptocurrency
Rise of Argentinian cryptocurrency led shadow economy
Sanctions on Russia in response to Ukraine
Chinese pressure on Lithuania in response to Taiwanese presence in Vilnius
Guidance to Nation States
Below is a checklist for nation states when evaluating their readiness to address systematic economic coercion applied to their financial services infrastructure:
Define the requirements of a domestic minimum viable payments network
Who are the core participants?
What level of public awareness and education is needed to ensure seamless onboarding?
How will this interface with foreign financial markets?
Which government departments need to continue issuing payments to vulnerable citizens?
What asset types need to be covered?
Identify resources required to deliver a minimum viable payments network
How many builders are required and what is the needed skill set composition?
What internal and external partners are required for execution?
What are the infrastructure constraints and how do they impact delivery?
Actively participate in simulated catastrophes to identify and remediate potential weaknesses
Simulate a variety of different scenarios with different pieces of financial services infrastructure collapsing.
Conduct ongoing user research and user awareness with respect to onboarding and transacting on DeFi-enabled financial services.
Understand the interconnectedness, both on-shore and off-shore, of core supply chains serving industries relevant to defence or national security more broadly.
Horizon plan with scenarios of differing lengths of time i.e. how do we ensure adequate resourcing and technical capability in the event a minimum viable payments network needs to scale.
Nation states must recognise that their payment infrastructure is the plumbing that maintains the continuous movement of value in their economies. As we continue to see, economic coercion is a vector increasingly used as an alternative or in parallel to kinetic assault. Nation states, of all shapes and sizes, would be well advised to evaluate how DeFi can be rapidly utilised in the event centralised financial services infrastructure is taken offline.
Guidance to Builders
Holistically and at a higher level of abstraction, DeFi enables anyone anywhere in the world to deploy the architecture of a mini-state at any time. At a protocol level, builders can embed all branches of government into their projects utilising a variety of primitives that continue to be iterated upon in the broader web3 ecosystem: governance mechanisms, identity management, liquidity provisioning, throughput scaling, and much more. It goes without saying that there is undoubtedly an opportunity for builders to develop out-of-the-box rapidly deployable minimum viable payments networks for states to utilise in moments of unprecedented crisis. Builders should collaborate with governments to understand the unique requirements that exist in their respective jurisdiction so that generalisable and adaptable solutions can be appropriately developed.
It is important to remember the true power of DeFi: an ability to efficiently create and deploy permissionless, decentralised, and composable financial markets at a scale once previously unfathomable to humankind. When we take a step back and acknowledge the level of abstraction we are operating at day-to-day, the truly significant and life-changing use cases will continue to reveal themselves. Continue to ask questions, work through scenarios, and challenge assumptions, especially those held as axiomatic.
If you are looking to build or are investing in what’s next, would love to chat - please reach out via DM on Twitter or reply via email 🙏
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