Reverse Engineering Crypto's Pain Points

Level 2 - Value Investor

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As we enter the third year of DeFi Education, we thought it would be helpful for both you and us if we put pencil to paper on where we think crypto’s pain points lie, potential solutions that currently exist, and both short-term and longer term prospects for the industry.

If you are interested in building in crypto, we hope this post can serve as inspiration for finding problem areas that you can attack yourself or join a team to solve. Feel free to reference this as you think about business and employment opportunities in the space. We’ll take a top down approach that starts off with looking at the broader vision and then highlights some smaller pain points.

The Big Problem: Not Enough Users

The periods of Q4 2020 and Q1 2021 were the fastest period of growth crypto had ever experienced, with interest in the sector booming at a rapid pace buoyed by broader speculative activity in financial markets and the belief that digital assets were the next “gold rush.” Crypto made headlines worldwide as basketball fans were onboarded to through collectible highlight reels, art collectors were onboarded through high-end NFTs, gamers were onboarded in the Phillipines through Axie Infinity, and those interested in finance discovered DeFi.

This period brought with it a host of challenges, with a massive spike in gas fees making Ethereum unaffordable for most people. As newer participants were largely flushed out by handing over much of their capital to sophisticated participants, this bubble fizzled out as BTC crashed in May 2021. The intense high of speculative activity was met with the deep lows from overleveraged degens being wiped out and spot holders hopes of $100K BTC crushed.

Unsurprisingly, broader interest in crypto spikes with increases in Bitcoin prices. As the price of Bitcoin soared from $10K to $60K, crypto made headlines around the world and drove millions of people to try and figure out what this whole crypto thing is all about. Both retail and institutional interest exploded. When Bitcoin rallied again a few months later, many speculated this was driven by overleveraged crypto native funds like FTX/Alameda and 3AC making big bets they could not afford. This still brought some interest back to crypto which faded over time as the price of BTC bled out over the months that followed.

If we use interest in crypto as one barometer for users, there is still significantly more interest in crypto than there was prior to the 2020-2021 bullrun. We believe that this is a function of the substantial capital and mindshare that made its way into the space over the prior years.

Still, day to day usage of crypto in the Western world is quite rare. The highest utility comes from the very thing crypto was meant to disrupt - USD stablecoins.

One of the reasons for the lack of users is how complex it is to use crypto securely. When we started DeFi Education, we made it a mission to ensure that we helped people avoid rugs. At the time, there were no frameworks with which to assess crypto applications and protocols beyond who “shilled” a coin. We developed a fundamental approach to crypto which put software and security as a key success metric. There’s still a long way to go. The average user can’t be expected to read an audit report, let alone code.

Here’s the typical onboarding flow for a user to get on-chain and use crypto:

• Expend a bunch of time and energy on educating yourself (hours)

• Search the internet to setup a wallet (someone could already be on a path to getting rugged by this point)

• Write down your seed phrase on a piece of paper

• Setup an exchange account

• Purchase crypto on the exchange

• Send crypto from exchange to wallet

• Interact with crypto applications

Here’s the good news: a lot of the complexity is likely to be resolved in the next 12-24 months via account abstraction.

Account abstraction

Currently, if you lose your keys, they can't be recovered, and stolen keys give thieves instant access to all the funds in an account. Smart contract wallets solve these problems, but today they are difficult to program because in the end any logic they implement has to be translated into a set of EOA transactions before they can be processed by Ethereum. Account abstraction enables smart contracts to initiate transactions themselves, so that any logic that the user wishes to implement can be coded into the smart contract wallet itself and executed on Ethereum.

In simpler terms, account abstraction is like upgrading from a basic, old-fashioned lock and key to a modern, digital security system. Instead of just having one key that can open or close the lock (like the private key in an EOA), you can have a system that allows for multiple keys, temporary access codes, time-based access restrictions, and more. This gives you more flexibility and security in how you manage access to your Ethereum account.

At the time of writing, there is a lot of hype around the prospects of a BTC ETF approval in the U.S. While this may introduce longer term capital to the market in the form of institutional investors, these are still not exactly users. For your NFT applications and DeFi protocols to have value, there needs to be on-chain activity. For there to be on-chain activity, there need to be people whose problems are solved on-chain.

The Next Big Problem: Not Enough to do On-Chain

If you build it they will come! And yet, they haven’t.

“Solution looking for a problem” is a common critique of many crypto applications. As you know, DeFi Education is constantly screening new projects that come across our table and are requested in our Q&As from paid subscribers.

And? We agree with this critique in most cases.

However, we sympathize with the builders in crypto. When building in crypto you inevitably arrive at a crossroads.

Do you:

1. Build for current crypto users (“crypto natives”) who are largely short-term traders looking to turn profits on valueless products (tokens)? Or

2. Build for future crypto users who do not currently user crypto in a meaningful way (and may never use it at all)? What you are building may be their first touchpoint to the industry, requiring a long educational process that may never bear fruit.

Going down road #1 means that you will likely have some users and earn some cash flow, but you may be dedicating years of your life to a project that has no real long-term viability and, if rejected by the crypto community, may end up going nowhere.

Going down road #2 has far more ambiguity (exactly what founders need more of!), as you are building something that has likely never been done before. It’s an uphill battle because users are going to be uninformed not only about your product/service, but also about the industry, its risks/benefits, and the regulatory backdrop. Your solution has to be so good that users will overlook the painful onboarding and education process because 1) you solve a problem traditional solutions can’t solve or 2) it’s cheaper/faster/more convenient to use your crypto solution than the existing traditional solution.

One subsector of crypto that can exist at the intersection of #1 and #2 is infrastructure. Take cross-chain bridges for example - they are required by both crypto native users who want to trade on different chains and future crypto users who could may wish to interact with applications that work across multiple chains. These projects can “keep the lights on” by serving the existing user base while having utility to future crypto users as they are onboarded to the ecosystem. Can you think of any others that exist at the intersection?

Big Problem #3: Scalability

Let’s say we are able to onboard millions of new users to crypto and keep them through high value on-chain services. The next big problem we run into is network congestion. Here is where people’s vision of the future can differ vastly.

Some people believe in a truly multi-chain future, whereas others believe in an Ethereum-centric future. Some others believe that we are currently in the “AOL era” of blockchains, and it will be some unknown future adaptation of current technology that will pave the way for the future of finance.

Regardless of the solution, the pain point is that no blockchain today has the ability to handle the usage of a substantial portion of the global population without charging end users (and protocols) exorbitant gas fees. We may be another 5 - 10 years from reaching a truly scalable blockchain ecosystem.

Anotha’ One: Regulation

It should come as no surprised that one of the most prominent pain points is regulation. Crypto has both enjoyed and suffered from a decade of minimal regulatory enforcement.

However, large scale events such as the failures of FTX, Celsius, and Luna/UST as well as the international prominence of crypto in the public forum, crypto has become too big to ignore. Regulators stormed out of the gates in 2023, bringing enforcement actions against a wide range of crypto entities. It’s rumored that many DeFi protocols have been subpoenaed by the SEC. FTX founder Sam Bankman-Fried and Celsius founder Alex Mashinsky have both been arrested and criminally charged by U.S. agencies. Luna founder Do Kwon is currently in prison in Montenegro.

Small-time scams continue, but we anticipate that in the next 12-18 months many people will be deterred by further actions from regulatory agencies. Regulation is bittersweet. In one sense, crypto is intended to exist outside the purview of any nation state. Using and building on blockchains should remain permissionless. However, it’s a fool’s errand to expect the crypto community to self police. That has been an epic failure so far.

The future of crypto regulation is uncertain. While there is a push for more regulation, there is also criticism of the SEC's approach to enforcement, with some accusing the agency of pursuing regulation by enforcement instead of promulgating clear rules.

The Biden administration has called on Congress to expand regulators’ powers and strengthen transparency and disclosure requirements for cryptocurrency companies. If Congress acts and the administration continues to highlight the need for improvements in crypto enforcement, we could see a more regulated and transparent industry, with increased market stability and investor protection.

However, until such legislation is passed, crypto companies will need to navigate the current regulatory landscape with caution. They will need to keep a close eye on enforcement actions to understand where the federal government is drawing the lines and exercise heightened levels of caution in this space.

In conclusion, the crypto industry is at a crossroads. The decisions made by regulators and lawmakers in the coming months and years will have a significant impact on the future of the industry. It is crucial for anyone involved in crypto to stay informed about these developments and understand their potential implications.

Concluding Thoughts

For crypto to evolve past the boom and bust cycles it has become known for, there has to be a steady stream of users. There continues to be significant friction in the onboarding process, turning most users away before they even get to try on-chain products and services. Those who brave the journey often arrive to find themselves in digital Las Vegas, with the main value proposition being degenerate gambling.

Despite these hurdles, there are far more participants today than in the previous bear market. While some institutions (such as pension funds) were burned in the bull market and are licking their wounds, others like Blackrock, Fidelity, and Citadel have continued to expend resources on their crypto businesses. The regulatory backdrop they participate in will be very different from what existing crypto market participants are accustomed to.

Remaining nimble and adaptable in the face of extreme change will be the key differentiator going forward. The crypto industry is not just cyclical, it is evolving.

Join our paid members for full access to DeFi Education. We’re doing a deep dive on Worldcoin next and will provide a thorough, independent, and rational analysis (not emotional or promotional).

Until next time…

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Disclaimer: None of this is to be deemed legal or financial advice of any kind. These are opinions from an anonymous group of cartoon animals with Wall Street and Software backgrounds.

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