What Happened to DeFi?
Over the last two years, protocol innovation in DeFi has stagnated. This is particularly true of borrow-lend protocols, where the once-novel aspects of MakerDAO and Compound have become the norm. And while many have developed derivatives that tack on additional features, most have made little progress in taking market share away from the core DeFi giants.
MakerDAO started with a simple idea: make a stable currency backed by a volatile asset. Single collateral Dai was an amazing achievement and — after extensive development — became the first tangible example of decentralized finance’s potential. Since its inception, MakerDAO has evolved more than any other project and has consistently led DeFi in almost every respect: token locked value, collateral assets, assets borrowed, governance processes, organizational structure, and engineering development.
Shortly after MakerDAO’s Dai, Compound launched their v1: the DeFi money market. At Compound, users could supply multiple collateral assets and borrow multiple assets. Interest rates increased or decreased as demand increased or decreased. Much like MakerDAO, the platform was the first of its kind and overcame numerous development hurdles before it became the v2 that everyone knows today. They developed the most popular governance contracts used in crypto — Governor Alpha and Bravo — and some even regard Compound distributing governance tokens to users as the catalyst of DeFi summer. Today, Compound is synonymous with safety and innovation.
Aave entered the scene a couple of years after Compound with a focus on technological innovation. They introduced a “stable rate” option and changed the cToken exchange rate system into the aToken rebasing system. Today, Aave is known for its success in going multi-chain.
MakerDAO, Compound, and Aave have all innovated around substantial obstacles to become the successes they are. Compound had the opportunity to learn from MakerDAO, Aave had the opportunity to learn from Compound, and countless other DeFi protocols have learned from all three.
While there has been relatively little technical innovation in the last two years, DeFi has seen rapid organizational innovation within DAOs, and the broader DeFi ecosystem has grown astronomically. As DeFi becomes more and more mainstream, this growth will only increase.
We have seen extraordinary innovation in protocol development and organization, but each has happened in isolation; a truly successful combination has yet to be seen.
Being the best platform requires a great protocol and a great organization. It isn’t enough to build a great protocol and expect the technology to carry you to market dominance. It isn’t enough to have great minds and brands to run a protocol. While these may have been sufficient in the past, money markets and borrow-lend platforms require thoughtful and consistent management to be maximally successful. Their business, after all, is risk management. Whichever protocol can best manage risk can offer the most efficient market and thus command the largest market share.
A protocol needs the proper foundation and tools to empower governance with the ability to fine-tune the platform. Since markets and capital are fluid, the community needs to continuously reevaluate its standing and innovate. Complacency creates opportunities for new competitors. For the entrant, it is one thing to take the lead and an entirely different effort to hold the lead.
The entrant protocol needs to be simple, safe, and adaptable. Simple protocols are safe protocols. More features can offer more tools to manage risk, but there is a delicate balance between simplicity and safety. Protocols that are simple and adaptable can be understood by a greater populous and incite innovation and usage. To be adaptable means to evolve as the general market evolves. While protocols should not evolve so quickly as to erode their safety, they should leave a path for future innovation.
The community of governance token holders is responsible for maintaining the protocol while preventing information asymmetry and centralization of power. A protocol cannot be safe for use without a strong foundation, and the bedrock of that foundation is the community. Fair and transparent governance distributes control of the protocol but ensures community control is still possible when it counts.
The community must also maintain the protocol. Typically, that means adjusting LTVs, interest rate curves, and other parameters. To make informed decisions, the community will need to attract those with a strong understanding of both the platform and its competitors.
Finally, the community should think about the future of the platform. DeFi exists in an ever-evolving landscape; good governance will guide the protocol through changing circumstances, allowing the protocol to remain competitive and further grow the platform’s market share.
While this post is a critique of the state of DeFi, it comes from a place of respect and admiration. Over the last few years, immense work has gone into building DeFi up from nothing. But those efforts represent a down payment, with follow-on efforts required. Existing protocols need to evolve and innovate, and new protocols need to think more carefully about their goals. If we want to turn DeFi into Fi, projects need to focus on building better protocols and more robust governance.
