Business Models in Decentralized Finance
Centralized business models atop decentralized financial infrastructure
Core to the decentralized finance (“DeFi”) movement is open-source code in which the execution of contributed code is handled by Ethereum and its decentralized network.
Ethereum is a global, decentralized settlement layer for value on the internet.
- Value can be transferred without centralized intermediaries. (Miners)
- Value can be subject to code without centralized intermediaries. (EVM)
Today, code is live on Ethereum for various “money legos” for borrowing, lending, investing, saving, trading… the DeFi stack is forming, but users are few.
The development to date has been propped up by a variety of investments, including:
…but with limited runway, new business models are needed for continued development, testing, and user acquisition.
While DeFi’s ethos is characterized by the removal of intermediaries, I don’t think it gains traction without them.
DeFi as an industry will likely be similar to the internet, that is, economic moats will form around quality, reasonably priced centralized services. A proven formula: centralized companies atop decentralized infrastructure.
Centralized companies should be transparent around:
1) any added fees (over gas fees)
2) any added trust (over smart contract risk)
…in coupling the above with a valuable service, a fee seems warranted.
There are at least four, distinct layers to Maker’s DAI:
- Layer 1: smart contracts
- Layer 2: incentives
- Layer 3: integration
- Layer 4: user aggregation
Let’s imagine Maker’s Layer 1 is done tomorrow (the black lego in the picture). That is, no more changes are necessary to the smart contract infrastructure. Now,
- Layer 1 developer efforts can move up the stack to contribute to Layer 3 or Layer 4 solutions.
- Network effects will begin to compound at layers above.
Layer 2 is the incentive layer of Maker’s system (yellow legos in the picture) and various stakeholders form here: MKR holders, DAI holders, keepers/arbitragers, researchers, modelers, and so on. Work for the system is rewarded here through cryptoeconomic incentives (e.g. DSR, DSF, MKR) and market-based incentives (e.g. DAI arbitrage).
Layer 3 is the “plug in” layer where DAI is integrated into other DeFi protocols for exchange (e.g. Uniswap), lending (e.g. Compound), and various other purposes.
Layer 4 is the user aggregation layer of Maker’s system (InstaDapp’s white lego in the picture). Layer 4 is the landing page for new users. Aggregation tools should be non-custodial and address various user demands that are not met at the protocol level. Again, fees should be anticipated here for quality services.
Viable business models can form at the outer layers of DeFi infrastructure:
Liquidity & market making
Example 1: Be a liquidity provider on Uniswap (incentive type: Cryptoeconomic)
Uniswap is a trust minimizing solution to value exchange, but it doesn’t work without liquidity, so designed into the protocol is a cryptoeconomic incentive for individuals or institutions to post liquidity as liquidity providers.
Example 2: Be a liquidity provider on Compound (incentive type: Cryptoeconomic)
Compound is a trust minimizing solution to lending, and just like Uniswap, it doesn’t work without liquidity. Liquidity providers supply assets to Compound’s protocol and receive cTokens in return, which in turn accrue interest over time.
Example 3: Help keep DAI stable (incentive type: market-based)
Maker’s system has parameters that can be adjusted to help keep DAI stable, and a global settlement protocol, but perhaps the strongest stability mechanism is the market’s belief that 1 DAI equals its target price, currently pegged to 1 USD. So far DAI has remained stable to 1 USD… with some allowance for minor volatility. Any fluctuation from 1 dollar present a market-based incentive to arbitrage DAI, a role Maker calls Keepers.
Financial literacy & user education
Example 1: MyCrypto’s click throughs on its landing page (business model: free plus ads)
MyCrypto creates open source tools for interacting with Ethereum blockchain. MyCrypto does a good job educating users about risks and varying levels of security for various crypto custody options.
Example 2: Messari/OnChainFX’s screening tool (business model: free plus premium offerings)
Messari/OnChainFX brings new metrics and data points to help users better evaluate things like token suppy, volume, and market cap.
Abstraction & and intuitive tools
Example 1: InstaDapp’s non-custodial dashboard and protocol bridge (business model: pending)
InstaDapp is one of the first DeFi aggregators. Its dashboard is non-custodial and is sync’d up with lending and exchange DeFi protocols. InstaDapp also created an intuitive solution (protocol bridge) for users who want to move debt between Maker and Compound to capture lower rates, collateral options, or liquidation parameters.
Others to note:
With only thousands of users today, it is clear that deploying the smart contracts alone won’t reach a broad audience. There needs to be robust tools and resources surrounding the smart contracts to make DeFi protocols accessible, intuitive, and useful.
We’re not there yet, but momentum is building… and sustained, centralized support is needed.
Would love to hear any responses to the above. DM with questions, comments, corrections, etc. Thanks!
