The Decentralizer’s Dilemma
Everyone: we did it. DeFi hit $10B TVL. We’re in Bloomberg, WSJ, FT. Everyone’s pivoting to DeFi. We nailed it, right?
Maybe the sarcasm is a bit much, but I think it’s clear to most people that DeFi is still in the early stages. Whether looking at user numbers, or comparing DEX volumes to CEXs, or looking for real flows and non-speculative use cases, DeFi is here, but it still needs to grow up. Let’s ignore for a minute the numerous technical and product barriers that are preventing DeFi from reaching a mainstream audience. Let’s instead pretend we can wave a magic wand and get to the promised land of cheap, fast transactions and a slew of products that garner mainstream demand. What might a mature DeFi ecosystem look like in practice?
In one potential vision of the future, DeFi… just remains a niche ecosystem! A small group of enthusiasts who are aligned with the vision of decentralized finance continue to trade, lend, and borrow using this web of protocols. But it remains just that: a small group of enthusiasts. We’ve seen many privacy-preserving and decentralized technologies go down this route before, as they’ve never been able to solve many of the usability and product issues that these solutions usually have.
Consider something like ham radio: a decentralized communication method used by self-sovereignty fiends and tinkerers with a whopping… 2 million users worldwide. Technically, it does what it says on the box, but I think general consensus is that ham radio does not exactly have the same influence on the world that we hope DeFi will, largely in part because it does not have reach. In one future of DeFi, Uniswap LPs and Compound lenders go to small meetups and chat with each other on online forums until their spouses ask why they’re wasting so much time and money on this crap.
Another potential vision of the future of DeFi is what one might call the “decentralization maximalist’s dream”. People around the world, by the millions and billions, realize that they’ve been entrusting their financial well-being to unaccountable centralized entities for far too long, and move their financial lives “on-chain” in hordes. Distant cousins reach out asking how to install Metamask. Infura becomes the world’s most valuable company overnight. Everyone, finally, becomes their own bank and traditional financial institutions crumble. If one squints, one can see that this is a similar vision to the first, but in this one, consumer taste and preferences change, giving way to a wave of DeFi adoption that was not there in the first scenario.
Unfortunately, I feel this is also unlikely. Time and time again, we’ve seen that consumer tastes are extremely slow to change, and consumer tastes reject many of the intricacies of DeFi. Consumers value ease of use and convenience over privacy or self-sovereignty. This has been one of the many themes of the Internet: open, accessible protocols and tools that most people access through managed services. Think running your own email server vs. using Gmail, or running an IRC server vs. using Slack. This is a well-established pattern that I expect to play out again in Web 3 and DeFi.
Thus, assuming users will prefer to use some kind of managed or semi-managed solution, the question becomes: which one?
Any time there’s a generational change in technology, there’s a tension between two sets of players: the incumbents, who must decide to innovate and disrupt themselves by adopting this new technology, and new players, who must grow fast enough to not be crowded out by the titans. And unfortunately for these young upstarts, enough CEOs have read The Innovator’s Dilemma at this point that there is not a single clear path that this transition takes. Sometimes, incumbents do disrupt themselves, but usually, they don’t.
In a world where incumbents fail to innovate and adapt to these new DeFi challengers, we might see a service like DeBank or Instadapp rise and become more palatable to mainstream consumers over time by offering some kind of semi-custodied solution where a central party retains a Gnosis Safe-type backup key. While true DeFi heads might not want to trust a third-party, the masses simply prefer convenience and don’t feel comfortable managing private keys, and it may end up falling on these products to develop new semi-custodied solutions, such as MPC or SGX-based solutions like Enigma or Bitski to welcome these new users. These products must also grind to acquire the same thousands of users that centralized exchanges have (and manyfold new ones as well), while simultaneously building out these products to onboard them.
Alternatively, in a world where incumbents innovate and adapt to these new DeFi challengers, it’s becoming increasingly clear what this would look like: look no further than large centralized exchanges across Asia doing this today. Centralized exchanges can take their existing huge user bases and infrastructure, and integrate DeFi protocols under the hood as new features. In a world where consumer attention is being increasingly bid up, this gives them a huge leg-up over their DeFi neobank and interface upstarts, who must grind to acquire new users from scratch.
As one example, OKEx, one of the top exchanges by volume, has already integrated MakerDAO and now Compound as lending and borrowing options alongside their own centralized options! OKEx users don’t have to pull their funds out, setup Metamask, worry about gas congestion, or any of the other hassles that DeFi native users encounter — they simply get access to the sweet sweet fruits that live on-chain. This has already proven successful in the short time since launching, with an estimated 50MM in Compound deposits originating from OKEx across 2,000 accounts.
Or take Matrixport, one of the largest asset management mobile platforms founded by Bitmain founders, Jihan Wu and Yuesheng Ge. Matrixport has historically been a centralized crypto finance app, offering lending, borrowing, and structured products to cryptocurrency holders, but they too have recently dipped their toes in the DeFi waters by offering an integration with Curve liquidity mining as an asset management product. Users are able to get CRV mining with a few simple taps on their mobile phone without leaving the centralized experience of Matrixport’s main app. More recently, they launched a product called ‘DeFi Smart Pool,’ which allows users to earn yield on non-ETH assets such as BTC by using them as collateral to get stablecoins for mining, which Matrixport will automatically rotate to the best-performing opportunities inside of DeFi. While users relinquish control to Matrixport’s centralized custody and execution, for most, this tradeoff is worth it for the convenience.
One doesn’t need to squint too hard to see how this practice might play out with other DeFi protocols as well. Centralized exchanges are already tripping over themselves in a race to list the hottest new DeFi tokens, which of course requires sourcing sufficient liquidity, onboarding market makers, etc. For many exchanges, especially second-tier ones, it might be preferable to simply integrate with a DEX aggregator like 1inch, which can give their users access to any token as soon as it becomes available, and can often provide better prices than they could get on CEXs alone, as we’ve seen with stablecoin swaps on Curve. This playbook could repeat with even more products and more protocols, from futures to options to synthetics. These CEXs could slowly add on more and more DeFi protocols until they begin to resemble existing DeFi UIs or wallets that are trying to replace them. What’s more, these centralized players can even roll in their own homegrown competitors under the hood, as we’re already seeing with DeFi world with 1inch’s Mooniswap and in the CeFi world with Binance Liquid Swap, their own centralized AMM.
Is this likely? Hard to say. Is this possible? Yes, definitely. If history is any guide, crypto companies in China seem best poised to cross this chasm into DeFi.
China is the home to superplatforms. During the Internet era, super platforms like WeChat and Meituan emerged initially as simple products. In the case of WeChat, it started off as a chat app that eventually expanded into payments, taxi hailing, hotel booking, and eventually a whole platform of mini-programs, lightweight apps embedded on top of the WeChat ecosystem. Meituan started off as the Groupon of China, but has similarly slowly expanded its feature set to branch into more markets. While in the West, people might use Yelp for reviews, DoorDash for delivery, and OpenTable for reservations, Meituan has absorbed all of these features and is now the one-stop-shop.
We can see a similar path for centralized exchange platforms evolving into superplatforms, starting first with trading, to now expanding into lending and other bank-like services. It doesn’t take much of a stretch of the imagination to see them integrating DeFi products under the hood as part of this “superplatformization”.
Ultimately, this comes down to a simple question: can CeFi become DeFi before DeFi eats CeFi? While we’re still early in this race, if initial traction is any judge and history can provide any lessons, the latter scenario here is more likely than it might seem.
By Tom Schmidt and Mia 格格 Deng. Thanks to Haseeb Qureshi for editing and Feng Liu from Chainnews for translating and publishing in Chinese.
