Will DeFi survive? The 5 keys to rebuild trust

After the crypto crash how will DeFi survive, and what do projects need to do to rebuild trust in the DeFi sector?

There’s no question that the first half of 2022 has been bruising for the crypto world, and in particular the DeFi (Decentralised Finance) space. In a previous article we examined what caused the DeFi space to implode, and concluded by highlighting some of the factors vital to rebuilding trust in the sector.

In this article, we expand on these key ingredients which will help users regain confidence in DeFi projects and protocols.

1. Transparency

In November 2021, right at the height of the last peak in the crypto market, SEC commissioner Caroline Crenshaw identified two specific issues which she believed the DeFi industry needed to address from the perspective of the regulator. These were, unsurprisingly, a lack of transparency and the pseudonymous aspect of most decentralised finance protocols.

Fast forward to Mid 2022 and the calamitous plunge of crypto prices, and once again transparency is chief among the online conversations relating to DeFi protocols, and interestingly open-ness and honesty, particularly around the use of funds and how yields are derived are currently popular talking points amongst crypto enthusiasts right now.

Some of the most notable aspects of how blockchain projects are developed are once again being talked up, including the fact that, if truly decentralised protocols are to thrive, that there is a need to refocus on open, programmable and composable architectures.

However, there exists more than just a need for transparency and accountability around codebases and use-cases. It’s quite clear that many crypto holders simply haven’t realised that risk follows you around like a Poodle in the crypto world.

Many protocols don’t always highlight to their users what these risks may be, and how they may manifest. For example, how many of those who happily stake tokens to earn rewards into any given protocol, are aware of the circumstances upon which their tokens could be liquidated?

In the TradFi world, financial services operators, bound by regulation, generally ensure they go out of their way to make risk statements clear, to make certain they don’t fall foul of the various regulatory requirements in their jurisdiction. The same, however, is not always true in the DeFi space.

Whilst this is most certainly not advocacy of TradFi-like regulation in the DeFi space (in fact, regulators and policy makers are increasingly discovering the difficulty of such a move), it does highlight some of the aspects which protocols should be more open about.

After the cataclysmic scenes witnessed in the DeFi space over the last few months, it’s probably fair to say that individual protocols would be well advised to go back and assess their risk impact statements, and the implications of Black Swan events on the market.

2. Novelty

The emergence of DeFi promised a whole slew of new financial instruments and innovative ways for market participants to engage, and it’s certainly true that there have been some exceptionally interesting products which have grown out of the space.

Of course, a number of TradFi copycats have sprung up, many of which are offering access to the very same kind of services which have been available for decades off-chain.

That’s not to say that these products and services shouldn’t be replicated in decentralised Web3 accessible protocols, they most certainly should, especially where they are offering access to the type of services which were formerly reserved for institutional grade or accredited investors.

But the fact is that novelty is king in the DeFi space, and truly innovative protocols, which can demonstrate clear business and usage-cases not found in the traditional financial services industry, are more likely to win out in the long run. Degens, it appears, are really very keen on novelty.

This novelty isn’t without its inherent risks of course. New products, especially those which are extensible through their open source codebases, are often a target for unscrupulous attackers, especially when the potential gains are so vast.

If you were to throw something new and shiny over the fence into the monkeys enclosure, you’d almost certainly be able to watch them curiously examine it in detail, alternately sniffing/wearing/eating it before one of them finally pulled it apart.

In the open-source software sandbox-cum-zoo, there are many developers and early adopters who are well known to exhibit many of these same primate behaviours in order to try to understand (and often to game) the interesting new toy they’ve just been presented with… and this segues nicely into our next point — Security.

3. Security

There is no doubt that one of the chief reasons for the colossal failure of some protocols has been down to security.

In the two-month run up to the end of June 2022, Harmony, Inverse Finance, Mirror Protocol, Fortress, MM Finance, Saddle and Fei Rari all fell foul to a variety of attacks which collectively drained their coffers of around $290M.

It’s not just that codebases were insecure, there are a number of examples of early warning systems being breached, and even threats being signalled by external sources only to be met with apathy from some projects.

This should underscore the need for caution amongst projects to make sure they undergo potentially multiple levels of audits, as well as engaging in continuous architecture testing, atop financial simulations to reduce the number of various attack vectors.

As it’s fair to assume that users would be somewhat concerned about the safety of their funds, the question of security has to be tantamount, over and above that of the desire to release a protocol early and potentially put insecure treasuries at risk.

4. Interoperability

The ability for cross-chain operability has been widely touted as one of the great advantages of many DeFi protocols.

The ability of different blockchains to be able to communicate in a secure, productive and efficient manner will further encourage innovation and a wider range of novel use-cases.

During the previous crypto-winter, developers spent the time building and deploying interesting new blockchain solutions, and there may well be some upside to a protracted bear cycle, as, if past history is anything to go by, there will likely be a period of further innovation throughout the next few months to improve inter-chain communication.

Furthermore, as wrapped tokens become more and more commonplace, the ability for users to access and redeploy locked tokens enables new opportunities in the crypto space.

There is no doubt that synthetic digital assets, exchangeable at 1:1 rates with their underlying asset, and free to be transferred to provide some useful function on another network, are changing the game for many protocols which can benefit from both the network effect as well as being able to offer asset tokens which can be freely used elsewhere.

Interoperability therefore remains the holy-grail for many projects, and as cross-chain technology continues to mature, there will be no shortage of new opportunities and possibilities in the DeFi space.

5. Governance

In the case of many of the projects which have been most severely affected by the widespread contagion, one of the most notable aspects has been the suspension of activity, such as trading and withdrawals from the affected protocol.

Whilst in itself this is not necessarily evidence of any form of foul play, it does rather demonstrate that some of these services still retained significant levels of centralisation.

There are, of course, sometimes very good reasons for a DeFi project to have a degree of centralisation in them. For example, it’s fair game to assume that new protocols which have recently launched are likely to have a level of centralised control from the start, and to cede power over time to the DAO.

But what we have seen lately has been the blurring of what DeFi means, where although it claims to be ‘Decentralised Finance’, some protocols are clearly 100% controlled entirely by the projects team, or in some cases by a third party custodian. In this respect, there are many protocols which clearly should not be labelled DeFi, when they are clearly CeFi.

Secondly, DAO structures have a tendency to apportion vote weighting purely on the number of tokens an individual wallet holds. The downside here, of course, is that a whale, or at the very least, a group of whales is able to reject a proposal, and if their percentage of the circulating supply is quite sizable, then these individuals have a very good chance of being able to pass or reject a proposal, even if the opposing view is highly popular among smaller holders.

Governance participation in a protocol increases where the governance token is baked into utility. This is particularly important when it comes to calibration of a protocol, as ensuring the community has a say in important aspects which may affect yield, elements of risk, or other token-economic factors is not only important to the user base, but may have implications for regulation in the future too.

How Bumper’s price protection protocol is focused on best practice.

Transparency: Bumper is committed to transparency, and this is one of the reasons our founders have chosen not to remain anonymous, but rather to put themselves out there, with regular livestreams, AMA’s and sitreps.

Novelty: Bumper is the epitome of novel, both in the way the protocol is designed (for example using a quadrature of four pools instead of the normal two pools for each asset and liquidity pair) and the way in which Bumper’s game theory is structured.

Bumper’s purpose is to develop a mutual price risk facility that minimises individual loss, as opposed to a more traditional venue that optimises for maximum individual profit. To find out more about this, we strongly recommend reading the Bumper Litepaper.

Security: Bumper’s team takes security very seriously. We have held off on releasing the protocol until we are absolutely certain that the system is secure and functions as intended in any situation. This is especially important for a protocol with a high degree of complexity built into the codebase, and we have undergone multiple audits to date to ensure the Bumper protocol above all protects users’ funds.

Interoperability: Bumper’s roadmap includes both integration with and across multiple networks, and for Bumpered Assets (which are held by open position) to be fungible, allowing them to be used in other DeFi applications (for example as collateral for crypto loans, with the added benefit of having the downside volatility removed).

Governance: Bumper’s plan is that the DAO structure will be deployed slowly over time after the AURYN release, giving token holders the right to raise and vote on Bumper Improvement Proposals. Furthermore, we are solving the problem of Whale centralisation by implementing a vote weighting system based not purely on token holdings, but how long a user has held their token for, which directly benefits those token holders who were either early adopters and/or have held for the longest time.

Conclusion

DeFi may be on a trajectory to a great resurgence, and certainly, this latest wretched period has exposed how protocols focused purely on profit maximisation above all else have the propensity to simply collapse.

As for us here at Bumper, we have always been fastidious about security and functionality over and above all, and we hope that this sentiment is shared by other DeFi protocols which are sure to emerge over the coming months and years.

Have questions? come and join our Discord and ask away…

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