What It Will Take To Bring DeFi to the Masses?
Since the inception of cryptocurrencies, there have been dreams and narratives for what they could be used for — a store of value, financial privacy or publicity, monetary sovereignty, freedom, decentralization, etc. While some of these narratives have come true, and others will take years to play out, one of the most recent narratives, Decentralized Finance (DeFi), has gained serious attention from inside and out of crypto.
When Bitcoin reached an all-time high of over $69,000 on November 10th, 2021, the Total Value Locked (TVL) in DeFi protocols across the entire crypto landscape was $179.89b, according to DefiLlama. Although accounting for only 6% of the total crypto market cap, centralized exchanges such as Coinbase realize how big DeFi might become, citing Decentralized Exchanges (DEX) as their biggest competition before going public in Q2 of 2021.
Today, however, the landscape looks a lot different. The current DeFi TVL has more than halved, with TVL sitting at $59.56b at the time of writing. User growth has slowed and stagnated, only growing by 300,000 new users since the start of 2022, less than half the increase during the same period of 2021, according to Statista. What can DeFi do to attract more users and work towards the goal of mass adoption?
A Better User Experience
The current difficulty level to enter the DeFi space is very high. Before considering participating in the DeFi ecosystem, one needs to first understand what a cryptocurrency wallet is and how it works. They must also be responsible for their own seed phrase, know all the steps of token swapping, depositing and withdrawing liquidity, as well as comprehending how the protocol they're interested in interacts. And this list only scratches the surface.
This is an overwhelming task to navigate and unrealistic for non crypto-natives to understand. It can take a long time for users to even feel comfortable moving tokens off centralized exchanges, let alone comfortable using DeFi.
DeFi services need to be available on only one platform for ease of use. As it is now, solutions are separated which makes things unnecessarily difficult for users. To illustrate, if someone wanted to swap USDT for ETH, and then deposit the ETH as margin to get a loan in USDT so that they could trade perps with the new currency, they would have to go through three different protocols. It's tough enough trying to figure out how one works — asking people to deal with three different ones creates way too many barriers.
Finally, the user experience within the protocol’s themselves need a massive overhaul. Most DeFi protocols offer no readily available walkthroughs or tips when first arriving to the application. The protocols almost assume the user knows exactly what they’re doing. Someone who has never used DeFi before would have no idea how to deposit collateral, select a good debt ratio, how to manage their collateral, and where their rewards go. There needs to be an over abundance of guidance and resources to make the user comfortable to use the application.
Oftentimes the best technology is the technology we don’t even realize we’re using, and DeFi needs to adopt this ideology.
So to recap, for DeFi to see mass adoption, there needs to be:
- A better user experience available on one platform
- More guidance and resources available for users
- Ease of use for non crypto-natives
These are only a few examples, but if the DeFi industry can focus on these key areas, it will go a long way in achieving mass adoption.
Improved Security and Insurance
When choosing between centralized finance options and DeFi, security and insurance should be taken into the strongest consideration. Both retail investors and institutions alike prioritize feeling secure when giving their assets to a protocol- knowing that these assets will still be available as needed, but also safe from smart contract hacks, rugpulls, or any other possible bugs. If any incidents like these happen; fortunately, users' assets would be backed up or insured.
Wallet security is also a big concern. Needing a 12 or 24 phrase passcode to be safely written down, stored, or memorized is daunting. Seed phrases regularly scare people away from ever taking custody of their keys, and are a big reason why keys never leave centralized exchanges. Additionally, scammers and hackers are constantly prowling social media and Discord channels trying to steal seed phrases, which has been very successful.
To combat this, DeFi protocols are routinely employing code auditing companies to comb through their smart contracts for vulnerabilities. Bug bounties are also popular, incentivizing users who stumble across bugs to report them for a reward. Code is constantly being improved, but outside of this, not much advancement has been made in DeFi security. If code is going to be law, the code better be bulletproof.
What needs to be done further, however, is developing a seed phrase management solution that is much more secure, user-friendly, and accessible. Also, social media and Discord channels should do a better job at moderating their platforms and weeding out these scammers.
Less Volatility, More Stability
As an asset class, cryptocurrencies are volatile and risky. Even stablecoins that are supposed to be pegged to $1 don’t hold their value and can have catastrophic consequences. While volatility can be great for trading, it can be a huge issue for money markets.
If an asset's value is constantly changing by large margins, the risk increases of that asset being liquidated. protocols such Orca were created to prevent this by monitoring assets and providing a public marketplace for them.
Liquidations are not only devastating to individual users but could also have broader impacts on the crypto ecosystem as a whole. When Ethereum (ETH) crashed under $900, a user with a 152k ETH position, worth almost $140 million, missed liquidation by 20 cents. If their position was liquidated, it could have caused a catastrophic chain reaction as 152k ETH would need to be sold to cover the loan, thus driving the price of ETH down even further.
Stablecoins are also a big contributor to liquidations, despite their “stable” nature. The most famous example is the UST de-peg and collapse of Luna, which evaporated billions of dollars across the entire crypto market in just a few days. Less extreme examples are stablecoins de-pegging under a dollar during times of extreme volatility. This can cause widespread market fear and actors to rush to close their positions, creating even more volatility.
In order for crypto to become a truly mature asset class, the underlying economics needs to be sound and predictable. Improved risk management solutions are desperately needed to help avoid situations like this in the future. A potential solution to this could be the introduction of a decentralized oracle system that would track an asset's price in real time and automatically close positions before they are liquidated.
Clear Regulatory Guidelines
The current state of crypto and DeFi regulation is muddy. Lawmakers and the SEC have been spinning their wheels on major crypto and DeFi laws. The few laws that have been enacted vary wildly from country to country. There is a lack of consistency and precedent that rightfully scares participants.
Stablecoins have been a recent focus of government scrutiny not only because of the UST collapse, but because of Facebook’s Lira project and governments looking into creating their own digital fiat currencies. Attacks on Tether, a stablecoin created by iFinex that is one of the most used stablecoins in DeFi, happen daily from regulators, lawmakers, and institutions.
Considering that partisan bickering and government bureaucracy could easily stall the legislative process for years, it’s important that the crypto community come together and create its own set of best practices and regulations. The goal should be to get ahead of lawmakers and create a well-regulated environment that protects users without stifling innovation.
As the crypto market grows in value, however, regulators will be forced to step-in. On May 3rd, 2022, the SEC “nearly doubled the size” of their crypto and cyber unit with the goal of “protecting investors in crypto markets and from cyber-related threats.” More congressional hearings on crypto than ever are being held, and for the first time, congressional candidates running on a pro-crypto platform are surfacing. It’s only a matter of time before serious regulation starts.
It’s no secret that DeFi has a lot of work to do before going mainstream. The barriers of entry are high, and the legal waters are murky. However, every day DeFi is progressing. Time will only tell if DeFi can overcome these obstacles and reach mass adoption.