For Mainstreaming Blockchain, DeFi Leads the Way

One often-heard criticism of cryptocurrencies and the blockchain technology that underpins them is a dearth of practical use cases for their application in the real world. Beyond some niche cafes, few retailers will accept digital currencies due to the difficulty of off-ramping into fiat, the time and energy needed to convert and receive coins, and the obvious fear related to price volatility (no one wants to find out that the bitcoins they used to buy that pizza a year ago are now worth millions). Despite much talk, bankers and institutional investors especially remain conservative in their approach, citing a lack of regulatory oversight, and the failure of Bitcoin to evolve as a unit of account, medium of exchange or store of value, not to mention the absence of regular accountability and central bank guarantees.

While many of these concerns remain valid, the emergence of DeFi is beginning to spawn a pipeline of very real applications. DeFi, or decentralized finance, is recreating traditional financial instruments such as loans and interest-earning accounts in an architecture that is free from third parties and centralized systems. As an industry, DeFi is growing rapidly – in one sense, too rapidly: the constant flow of new tools and platforms is causing development to be spread too thinly across multiple blockchain technologies and cryptocurrencies. A recent DeFi user report commissioned by ConsenSys Codefi on the use of cryptocurrencies and DeFi dispels a few myths. Firstly, it turns out that people are not solely motivated by speculation and potential profit. Cryptocurrency holders (or hodlrs as they are referred to) are more often interested in the underlying technology and how it can be applied for practical means. Hodlrs follow discussions online and go wherever building is happening. Once they have discovered DeFi, hodlrs remain cautious while experimenting to learn and grow. Users will try out a protocol with a small amount before investing anything larger.

Take one DeFi application as an example: Collateralized Debt Positions. These are smart contracts which run on the Ethereum blockchain. Nineteen of every 20 CDPs are opened purely for testing purposes. How do we know? Because their value is below 0.0058 ETH, equivalent to a little more than a dollar (at the time of this article). 

At the same time, crypto whales (early investors and people who built the digital tokens used) are keen to use CDPs at scale. That is why the remaining 5% of CDPs are on average collateralized to the tune of more than 1,000 ETH (US $4.5m), according to ConsenSys Codefi’s survey. 

CDPs are in demand as an alternative to the more traditional slow, expensive and inefficient financial apparatus, in which transferring money between accounts typically takes three working days. DeFi provides instantaneous, immutable transactions at very low cost, and without the centralized third parties. 

Along with tech geeks and crypto whales, DeFi is also being tested by a broader public who are naturally more reserved when placing their money with unregulated new systems. Trust is the No. 1 hurdle for retail DeFi users. After all, the word for credit derives from the Latin “credere” – to believe. Without trust or belief in a system and its underlying infrastructure, there is no foundation for customers.

Given that DeFi is still perceived as risky – as is crypto in general – creating trust demands a combination of education and experimentation. The negative publicity surrounding hacks and loss of codes makes it all the more vital for users to take their time to research and test systems before putting their capital into coins.

Throughout their phased initiation into DeFi, users are continually testing their reservations, probing potential flaws in programming by humans that can lead to hacks (as most notably happened with MakerDAO). Determining the trustworthiness of a protocol depends on multiple factors, not least the collaborative nature of the internet, or Web2.0. Users bring their own experiences that are shared, aggregated and built on top of other people’s data and records. Although a smart contract might be “trustless” — in as much as no human needs to be trusted — users who are unable to audit a contract themselves will seek validation from the community and people they are engaged with.

Apply this to the world of banking and big finance. There is no doubt given the state of western financial systems that have been built up over decades and yet leave 2 ½ billion people in the world unbanked, the vision for an alternative decentralized financial system holds mainstream appeal. DeFi has the potential to enable people to borrow and lend, buy and sell products and securities, using a completely decentralized network and protocols, free from central banks, brokers or third parties. Such institutions and infrastructure are replaced with irrevocable and implacable software, and with “code as law.” Users and their counterparties interact on their own terms, granting permission to those they choose to engage with. 

There remain massive obstacles in building trust – not just in the technology itself but also in the humans programming it. However, we continue to see barriers broken down through the effective use of blockchain technology and cryptocurrencies. DeFi will increasingly impact the established financial networks and systems that dominate our monetary systems. The tools to build the future of finance are within our grasp.

Take a look at our most recent DeFi User Research Report for more findings.