What's Holding DeFi Back From Mass Adoption

Level 3 - Virgin DeFi Analyst

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Volatile times in crypto markets, innit?

As a prelude to this article, we’d like to remind everyone that the mark to market value of your portfolio, your networth, your trades.. They are not everything. The last decade has been a time of easy returns and largely up only. The last two years represented the most aggressive financial gains in markets in our lifetimes.

Nothing stays gold forever, ponyboy.

If you are bullish on crypto long-term (we are), there will be major buying opportunities to come. If you stick around, you will learn what you need to succeed in the next bull run (it will come). In the mean time, keep stacking cash and building your career and/or business.

Now, on to the article.

One of the questions in our recent Q&A was “what’s holding DeFi back from mass adoption?”

We think this is a pretty important topic and deserved its own post.

We can all agree that in 2021, crypto achieved mass attention. The wealth effect for long term crypto participants brought an influx of speculative activity to crypto. Those hoarding coins and “selling shovels” like centralized exchanges became some of the most valuable and profitable companies in the world. They bought up tons of advertising, sponsorship and promotions across the world in sports and entertainment.

Bitcoin became an institutional grade asset and large cap crypto is covered daily by the world’s largest financial media companies like Bloomberg and CNBC.

DeFi, which is largely responsible for unlocking the value of cryptoassets like BTC and ETH in a permissionless manner, benefitted from the growth in speculative activity.

However, real usage and adoption has lagged.

In today’s post we’ll cover what is holding DeFi back and what, if any solutions, we see on the horizon.

First we need to understand what “DeFi” actually does today.

What Does DeFi Do Today

DeFi in essence aims to replace traditional financial products and services with products and services that operate on blockchains. These DeFi services are open source, permissionless and trustless.

DeFi means anyone can use it, anyone can see the code, and no one can stop or otherwise prevent a user from using it as intended.

Tokenization also creates additional use cases and composability that isn’t available in traditional financial markets.

Let’s say you have a blue chip store of value asset like BTC or ETH. You don’t want to sell because you think the price may rise or because you don’t want to pay taxes on the sale. You can go to Aave or MakerDAO or another DeFi platform, deposit your asset and borrow a USD stablecoin. You can then withdraw that stablecoin to a CEX, convert to cash and withdraw it to use it in the real world (aka “off chain”).

Or, you could head over to a decentralized exchange like Uniswap and exchange your stablecoin for another cryptoasset. If that cryptoasset outperforms the asset you borrowed against you just netted a profit by borrowing.

Alternatively, you can use your stablecoin to provide liquidity for other people to trade using decentralized exchanges, thereby making your borrowed position a yield generator.

These core use cases stem from the desire to unlock the value of something like ETH, which is an asset that keeps its value as more people build on top of the Ethereum blockchain (among other reasons).

DeFi’s main use cases of borrowing, lending, trading and earning yield on cash are not too dissimilar from traditional finance. DeFi provides stable yields of 5-20% - well above traditional finance.

So why aren’t people using it more?

What’s Holding DeFi Back

Complexity

We’ll start with the most obvious one first. DeFi is too complicated. You have to set up with a centralized exchange, buy a hardware wallet, download a browser extension, keep track of your private keys - and that’s before you do anything in the ecosystem!

After that, you have to understand convoluted concepts like “yield farming” and “collateralized debt positions.” Once you figure these things out and start experimenting, you learn that two protocols that do the same are not equal risk and you might get rugged either directly by the creators or by some hack or exploit.

This alone is enough to send many people back to traditional markets - at least your stonks aren’t going to disappear while you sleep overnight!

The solution to complexity is likely to arise over time. DeFi just had its mainstream moment recently - we expect a lot of tools to be built (including better frontends) and hopefully improved security practices that make DeFi easier for newcomers. There’s also DeFi Education - here to help newbies get up the curve safely :-)

Perception

Whether it’s environmental concerns or “it’s all ponzis and scams” DeFi has a perception problem. And it’s not entirely unfair either. A lot of terribly designed projects capture attention, and many bad actors (both developers and VC funds) maximize profits at the expense of ecosystem development.

The perception shift for DeFi has to come from inside. Teams need to focus on building things that people actually use and benefit from rather than short-term unsustainable products that only work as long as there is another sucker to buy in.

Of course, scenarios such as yesterday when UST depegged to 65 cents and wiped out billions in “stable” value do not help with crypto’s perception. Between Frog Nation, Andre Cronje, and the UST depeg, it’s no wonder many people decide to stay away from the Wild Wild West (while they can!).

Lack of Regulatory Frameworks

We are going to have a hard time seeing significant institutional adoption without a regulatory framework they can comfortably operate under. Institutions want to enter DeFi, but the risk simply isn’t worth it for many of them. These institutions need to know how regulators will treat DeFi activity. What you’re seeing for now is many institutions getting exposure to crypto by investing in crypto native funds. Until tokens, NFTs, stablecoins, etc. can be held by institutions we’re unlikely to see the true potential of DeFi.

Current System Isn’t Bad Enough

Despite record inflation and a financial market that serves large asset managers and the “old guard,” it seems the current system still isn’t bad enough for a mass exodus for the general population (we disagree with them - it’s bad out there).

Given the complexities and risks associated with DeFi, we are unlikely to see people use DeFi unless the feel like they need to. We think the real value of crypto is realizing that you could need it one day. Most of the strongest believers today understand this deeply. For everyone else? They’ll need some sort of external shock that wakes them up.

Security & Risks

You need a separate computer (yes, you really do).

Many people don’t even bother to own a computer any more, as ‘smart phones’ take up their whole personal IT budget. You can’t use a phone to custody more value in crypto than the amount of cash you’d be comfortable keeping in your wallet.

If you don’t have a separate computer? You’ll get hacked, eventually. If you don’t have a few hours and a few hundred bucks to spend you’re better to move on.

Want to swap some tokens? Careful it’s not an illiquid pool, or bots will deliberately trade ahead of you to slip you for thousands of dollars before your trade completes. Unless you knew about MEV protection and aggregators you likely just went to Uniswap and got rekt.

How do you know a protocol is safe? Google if it has an audit?

Problem is, the difference in 1 line of code between <= and = can mean your funds can be stolen. Such small bugs are easy to miss under the time pressures of an audit.

Even if the smart contracts are audited, the frontend might get exploited and you’ll only notice if you’ve studied how to read transaction data before signing it with your wallet.

There are solutions but it takes effort.

People who study DeFi Education will do fine. We’ve given out all the information you need to be more secure than 95% of users. But. There’s a learning curve and most people just won’t make the effort.

Regular people might want fair alternatives to clown banks and rip-off brokerage accounts - they don’t want a ton of complexity or the risk of losing their funds because they forgot where they wrote down their password. They’ll be the eventual users but they won’t get rich here. On the other hand, the early builders and power users can continue to create fortunes.

That covers it from our end. While we love this space and think there continues to be massive potential for crypto to change every aspect of the economy and society, there is still a long way to go.

Until next time, anon…

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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.