DeFi for Next Generation Blockchains
Part 2: How to Improve Mass Adoption
In part 1 of our DeFi for Next Generation Blockchains series, we took an in-depth look at the strategies to enter the arena. We discussed the ‘Distribution Quadrilemma’ and the steps that are required by new networks to make a place in the emerging DeFi ecosystem. The most crucial step mentioned was to contend with the network effects of the established players with a clear narrative to the user community about the strengths and differentiators of the technology. We also talked about how finding the right use cases to tap is the key to gaining a foothold in the DeFi world. The objective of part 2 is to identify what are some of the other areas to look at for winning the user adoption race.
A good starting point to understand the challenges for user adoption of DeFi platforms is to hear what some of the experts in the Web3.0 space have to say for improving the market traction. Zachary Dash, at Around the Block and Max Yakubowski, Cointelegraph have interviewed many renowned thought leaders, market analysts, and founders in the Web 3.0 space to get condensed answers on what these individuals think is the primary reason causing lack of adoption of DeFi and accordingly what needs to be done.
By consolidating the keywords from the answers by these individuals, we start to notice emerging areas that require the focus of next generation blockchain protocols, platforms, and DApps. Figure 1 is a qualitative representation and is distributed based on the frequency of each area mentioned by these individuals.
To further solidify, we went a step ahead to gather more quantitative data as to what might be stopping the users from joining the DeFi ecosystem. We conducted a poll on our Twitter channel to gain some insight from the community. The results of the poll as shown in Figure 2 gave a very clear picture that the mass audiences want to be better educated on the technology and its implications to start using decentralized applications.
Analyzing the results from the chart and poll, we can categorize these factors into categories based on how they relate to one another. The four broad categories we derive are — applications, ecosystem, regulatory environment and capital flow.
- Applications: Use Cases — Consumer & Business, User Experience, Security & Privacy
- Ecosystem: User Education and Technology Literacy
- Regulatory Environment: Financial Regulations, Fiat Instability
- Capital Flow: Liquidity, On/Off-Ramps
Building with the specific areas of shortcomings mentioned, we start to notice a macro picture emerging based on the interdependence of these categories. It is important to map this out to better visualize their interaction and impact on each other.
Evolution of Financial Landscape with DeFi
Before we get to the current state of DeFi, Figure 3 shows how the financial landscape started shaping with upcoming decentralized applications. The decentralized financial instruments started growing outside of the traditional financial sphere, which is built on an established ecosystem and fairly clear regulatory framework. Bitcoin could be considered one of the first DeFi applications which emerged entirely out of the traditional financial landscape and started gaining traction with the early adopters.
Slowly, the innovators and early adopters started to build the ecosystem to support this new emerging decentralized digital and economic innovations. The capital started to flow from the traditional financial applications to new decentralized tools. The regulators came in slowly, starting to notice the shifting ecosystem trend and capital movement. They started providing more clarity and support on some of the instruments and interactions which have the potential to be compliant with existing systems. Figure 4 demonstrates that shift of ecosystem and regulatory environment.
DeFi applications started interacting with their traditional peers and there emerged some common use cases. These are highlighted by the red triangle in the middle of Figure 5. Even though the early adopters started educating themselves about digital currencies and blockchain technologies, there still happens to be a clear imbalance in the overall structure.
This complex financial structure has a number of moving pieces and to make an impact in the financial world, there are multiple directions to work on to bring DeFi into a highly stable system that will encourage mainstream adoption.
These include: regulations catching up with the innovations, ecosystem and awareness growing for users, builders, and regulators, DeFi applications augmenting more traditional financial user cases, and increasing fiat capital flowing into the DeFi space. Let’s discuss each of these components in more detail in the following sections.
Regulatory environment forms the foundation for many products and services that we interact with on a regular basis, whether in terms of standardizations, certifications, assurances or safety mechanisms. There is no doubt that products that have a nod from the regulatory authorities resonate better with the general population. These masses are usually not the innovators or the early adopters but who form the majority of the users that benefit from new innovative products and services. Regulatory approval also facilitates capital flow from the traditional financial system, especially when it comes to institutional money. Most countries are now progressively discussing frameworks to include decentralized technologies to transform financial systems and the crypto community needs to do their part to create symbiotic relationships.
Another aspect to cover here that peripherally relates to the regulatory environment is Fiat Instability which many experts have mentioned that it could lead to higher adoption of DeFi. Fiat instability in this context refers to the volatility in the value of fiat currencies due to macroeconomic factors. Market forces like financial recessions, wars, pandemics and the inherent shortcomings of the fiat system design. These macro shifts warrant another look into how the current financial system is designed and demands for better mechanisms for safeguarding public interests. It is apparent that the origin of Bitcoin in 2008–09 and the relatability with its decentralized ethos is a result of the global recession and the market sentiment due to the crisis during that time. The technology has evolved a lot since then and new consensus algorithms like Tree-graph Structure will ensure the high-scale solutions required for next generation financial systems.
The ongoing COVID-19 crisis has the potential for a significant impact on global economies and the digital assets market. Blockchain and post-COVID economies is a topic that needs immediate attention knowing that more and more business activities will be going online in the near future. Apart from the financial instability due to reduction in usage of physical cash and de-stabilizing fiat; we will see rapid digitalization of financial infrastructure that comes with many other risks associated with data safety, cybersecurity, stakeholder confidentiality, talent models.
Conflux Network is actively forming partnerships and working on building solutions where blockchain technology could be leveraged for social good in the post-COVID 19 economies. Some of the examples we are looking into are decentralized IDs for immunity passports, DApp for contact tracing — a use case that requires a delicate balance between public safety and public privacy, along with having the right incentives for participation.
In traditional Web 2.0 products like social networking applications, the ecosystem is usually built on top of the platform. However, in the Web 3.0 world, the ecosystem and user community play an important role since day one in the success of the project. They are closely invested in the development of open commerce platforms, with the right economic incentives to participate and govern the ecosystem.
Developing the ecosystem by educating the users about the value propositions of DeFi and the business context of the applications is key to bringing more people to try the solutions. These users include retail consumers, enterprise executives, designers, developers, and most importantly the regulators — on whom we depend to provide the environment for smooth operations.
Before we talk about the use case and applications, we need to understand how all the macro-components of the financial landscape are interlinked, inter-dependent or a consequence of the flow of capital between fiat finance and DeFi. We need to address the challenge of capital flow for better user adoption. The experts in the industry talk about Liquidity and On-ramps as the primary issues.
The steep on-ramps with few windows to enter discourage many investors to try DeFi. Low liquidity in regulated and approved venues deter the rest, especially the institutional investors. For next generation protocols, more liquidity is an outcome resulting from prioritizing the right collateral mechanisms, strategic cross-chain alliances, building decentralized exchanges ecosystem, and having a clever incentive design baked within the protocol to limit capital risks to the participants.
Applications and Use cases
Even though the blockchain industry has moved many steps forward in the mass awareness direction, the path to mass adoption is still a long way to go. To understand mass adoption, it is important to categorise it specific to the use cases. For example, adoption of cryptocurrencies as a store of value is different from adoption as a payment method, or as lending and borrowing instruments, non-fungible asset mechanisms, or other mass users DApps.
The kind of open financial applications that will gain the most traction in the market are either those that are more efficient and cost-effective than their centralized peers, or with better incentive design for customers to use, or those that could not have been possible without the principles of decentralization. DApps build on crypto-economic principles for solutions that result in predictable coordination between individuals towards specific goals or outcomes. smart-contract governed crowdsourcing marketplaces, token-curated registries for fairer curation markets, bonding curves use cases for societal impact, etcetera all present new avenues for future of finance.
In developing countries with limited and siloed banking infrastructure, DeFi will play a major role in financial inclusivity. Use cases with stable-coins for security against inflation, international remittances, peer-to-peer microinsurance would make these closed economies more open and stable, bringing in more users seeking financial security. It will be interesting to see the developments in DeFi in the near future as money is going more digital in the post-COVID world and decentralization brings in more reliance on digital code to trust and manage the money. For next generation blockchains, these are some of the domains to focus more attention on in terms of technology and community growth.
User Experience is another major issue with Web 3.0 apps. Key management, wallet extensions, transaction payments for blockchain interactions, and other in-between layers makes the UX fairly complex for new users. Every application in DeFi needs to be compared from an old state to a new state. In one of our Medium posts recently, we covered in-depth on the UX of blockchains and how Conflux Network is solving some of these challenges with Transaction Sponsorship Mechanism.
In the next article in this series, we will map DeFi applications overlapping with traditional finance and talk about two innovation zones emerging from the interaction. We will also cover more on the security and privacy issues in DeFi.
In an ideal world, the financial system would look more balanced with the convergence of DeFi applications to traditional, having a strong regulatory foundation supporting a major set of new innovations and an ecosystem intellectually keeping up with the pace of new developments.
History has taught us that it would never be the case that all these macro-components are in perfect synchronization. However, as technologists and innovators, the imbalance has never stopped us from striving for a better socio-economic paradigm.
DeFi applications are still limited to a niche audience who are technologically literate with a streak of crypto-anarchism to their digital personalities. There is no denying that to cross the chasm between innovators and early majority into DeFi, the next generation protocols and projects need to have clear use cases with simpler user experience and enhanced security. They have to navigate the regulatory environment effectively with economic designs that are better than the incumbents and an ecosystem that ensures high liquidity and low risks.
Written by Conflux Network’s Strategy Manager, Karan Ambwani