As an advocate of open market and capitalism, in the book The Road to Serfdom, P. A. Hayek claimed that the competition in the free market would be much better than centralized and mandatory planning because he believed the open competition was the only way to coordinate social activities and stay away from the autocracy and manipulation.
I agree with Hayek in the aspects of open competition, especially when you observed and participated in the DeFi movement in the market recently, you will understand what the free competition can bring to us. With the backbone of Ethereum and the whole DeFi ecosystem, everyone can turn an idea into a product and quickly pool hundreds of thousands of funds to get started.
And almost simultaneously, innovations, scams, worship, curses, FOMO, FUD… all come out like a drama. Although everyone called it a social experiment, the fake experiments just won’t push society’s advancement, only leaving someone getting rekt.
It’s time to review what lead us here and what’s the way out.
It was said that the phrase “Decentralized Finance” was first shown up at a meetup in San Francisco held by Dharma in May 2018. At that time, the Maker Foundation, Compound Labs, 0x, dYdX, Wyre, Bancor, Augur, Uniswap, and Dharma, which I defined as “Generation Zero”, have started their respective financial experiments for a while. They are all great projects, but just as other blockchain projects, they described a bright future, while their tokens’ liquidity still relied on CEX to provide. In December 2018, research data showed MakerDAO, Compound, and Uniswap as the top three applications, with almost 90% of all the collateral locked on MakerDAO. Combined, they held a mere$317 million.
Then in the early summer of 2020, ignited by the high APY of “Yield Farming” and the burst of DEX, Compound, Synthetix, YFI, Lend, Balancer, Curve, and a lot of DeFi projects have evolved to DeFi 1.0, which is featured by great liquidity, high APY incentives, and DAO governance structure. The total value locked(TVL) has passed $12 billion in October.
However, as Michael J. Casey suggested in his article Money Reimagined: DeFi-ing History, “by some measures, DeFi is nothing new.” DeFi is only an extension of a four-decade cycle of ever-more-sophisticated financial engineering — from junk bond financing to collateralized debt obligations to algorithmic trading.
DeFi will face the same pattern as other “innovation waves”: engineering, hype, speculation, bust, and consolidation. These technological evolution waves have delivered spectacular profits to some, giant losses to others, and lasting change to Wall Street. Yet it, too, will have a lasting impact, in ways we might not imagine at present.
Serve the speculative market, not related to the real-world economy
With high APY to solve the liquidity issue, yield farming stirred the market hot, but it also amplified people’s greed, made people impatient with the project’s fundamentals and development progress. Pumping the price up is the sole aspiration for them.
If you named Wall Street a giant casino, it’s a casino deeply integrated with the real economy. It’s the fundamentals that make finance sustainable. And this principle also works for DeFi, which is still a game of who runs fast and has little to do with the real economy.
Borrowing and lending is a zero-sum game, people will have no loyalty, and they are always looking for better opportunities to move their bags to a new higher APY pool. Actually, yield farming comes with high barriers, limiting the general public’s participation. With no new users flowing in, it is still a game in a small circle.
Ethereum provides the capability for innovation, but the ironic part is the more you hope to use it, the slower it becomes. And the gas cost is so high that only giant whales can afford it. With low scalability, functions and UX are also limited.
DeFi ’s power comes from its decentralized feature, its community. Most DeFi leverages DAO to organize the community to vote for proposals and allocate budget. However, voting only works well in simple collective decision-making, although people find that giant whales or arbitrageurs could easily manipulate the result.
In a DAO, a project has its community members, token incentive mechanism, and the blockchain as the infrastructure, so there should be something magical happening. But most projects only use DAO for voting, which is a kind of waste. From this perspective, there are still a lot to do at the DAO level to fully unleash the community’s power.
It is the mini winter for DeFi now, but I’m afraid I have to disagree that DeFi will end this way. I believe those social experimentalists will find their way out for the DeFi movement’s next generation: DeFi 2.0.
DeFi 2.0 will be built on a much scalable and affordable infrastructure, which is represented by Layer 2 (different rollups)and Ethereum 2.0.
With the supports from Layer 2, more complex logic can be built into the smart contract, and the execution cost will be significantly reduced, so new decentralized finance products like derivatives will be created. And Layer 2 will also ease the derivative traders’ sensitivity to slippage and fees as they are more short term.
DeFi 2.0 will have a much robust governance framework to guide the community’s power.
Due to the limitations on Layer 1 Ethereum, most of the current governance mechanisms are incompetent for DeFi to cope with complex collaborations in their community. Meanwhile, with layer 2 rollups and Ethereum 2 coming, the governance mechanism will also have to evolve to keep pace with the technical progress.
To support the development of DeFi and also other DAO projects, we need:
So, not just use DAO as a voting vehicle, DeFi 2.0 should fully embrace DAO, upgrade the governance mechanism, and truly leverage the community’s decentralized power.
DeFi 2.0 will connect and support real-world economic activities.
As QiaoWang said, there should be more teams building bridges to the real world for DeFi to fully fulfill its potential of becoming a globally distributed casino. The more applications serving non-speculative, real-world economic activities, the more liquid DEXes are, the higher capacity lending platforms are, the more strategies robot-advisors can build, the more products insurance platforms can offer, and the more innovations will emerge.
DeFi is the Lego, will and should be plugged into more projects and real-world business. In the future, DeFi will become a dispensable component in every community-related projects.
