Gen Z’s Money Legos Have to Mature for Mainstream DeFi Adoption

Creative destruction — a term coined by Joseph Schumpeter in the 1950s, refers to capitalism as an evolutionary process of continuous innovation and creative destruction — might ultimately become the driving force towards a more open and fair financial system. The first signs of this development can already be seen in an emerging anti-institutional ethos stemming from communities like Wallstreetbets (WBS).

On the surface though, WBS may not have much in common with the DeFi community, yet on the grand scale of things, it actually serves as an enabler to democratize finance. The WBS ‘degenerates’ typically see Wall Street professionals as greedy predators, short selling stocks of stricken companies in an effort to capitalize on retail investors.

This anger is shared by the broader DeFi community, yet the paradigm to tackle this issue differs. While DeFi wants to build a new financial system, WBS wants to burn down the current one. By disrupting and destructing the current system, WBS is attempting to beat Wall Street at its own game, while the DeFi innovators are already in the starting gates to roll out their applications to the masses. Before this materializes though, DeFi has to overcome countless technical and regulatory obstacles, especially as the space attempts to align its interest with the ones of the WBS community.   

DeFi as an interconnected thriving ecosystem, forming a financial spiderweb made up of independent ‘money legos’ with a slew of applications for saving, investing, derivatives, options and insurance, has to mature in order to rival these incumbents and the current legacy financial system.

During 2020, DeFi grew from a playground for early adopters, where value has exchanged hands via protocols with such fancy names as ‘Sushi’, ‘Yam’ or ‘Pancake’, to a behemoth with a current total value locked (TVL) in all DeFi projects of US$65b. Yet to take on the big boys in the industry, the DeFi community has to first get their act together by playing by the rule book of governments and regulators. This is especially true, as more money is channelled into these innovative protocols.

Just recently, Heister Peirce, SEC commissioner, said the following in an interview: “DeFi has posed a challenge for the SEC in a similar way that the ICO boom did in 2017. What is different here is that the pace of DeFi has actually been much faster. I also think that the legal issues are more difficult to sort out on the DeFi side”. We are already seeing first tendencies towards more regulations coming and will see many more in the course of 2021 — especially in the US. 

It is not a secret that most DeFi applications are suffering from the current astronomically high transaction fees, making them unfit to handle the load of a mainstream wave of new users. Most of DeFi is currently associated with Ethereum, which, in its current shape, can arguably be compared to calcified and constricted arteries in the human body.

In the course of this year, though, we will see a growing number of DeFi applications shifting its focus towards L2 networks in order to raise DeFi’s glass ceiling by freeing it from the current limitations and ‘illnesses’ of the Ethereum ecosystem. More projects will run their computation intensive tasks off chain — on a L2 network —, while still enjoying the security and liquidity advantages of tapping into the vast Ethereum ecosystem.

The only remedy to stop this knowledge drain into other projects, is a quick upgrade to Ethereum 2.0. Yet there are still more questions than answers when it comes to the full roll-out of Ethereum 2.0 and its capability of supporting emerging DeFi applications. On the other hand, it is also not clear, if users and developers will migrate, considering they are already locked into the current infrastructure. It will definitely be a tough undertaking to induce this change in habits.

Ethereum has vastly benefited from its first mover advantage, yet new ecosystems are taking a fast follower approach, emphasizing their scalability and data throughput. This lucrative market has also caught the attention of big exchanges like Binance, which are also heavily investing in DeFi projects. At the same time, second generation blockchains like Polkadot, Solana, and notably DeFiChain, are also developing their own decentralized exchanges, lending and derivative protocols.

DeFiChain, for instance, launched its decentralized exchange (DEX) in November 2020 as the first dApp on their proprietary blockchain. Since then, not only has adoption grown, but the total value locked in the blockchain ballooned to an astonishing $US300m. Unlike other competitors, DeFiChain is focusing on having a robust blockchain that is custom-made for financial applications. Hence, it is perfectly suitable for DeFi applications while not sacrificing on throughput and security.

What makes DeFiChain so well positioned in this upcoming DeFi craziness in 2021 is its focus on the huge Bitcoin community. Built on top of the Bitcoin blockchain, it is tapping into a user potential which is ten times that of Ethereum. As a result, Bitcoin holders can easily put their precious coins to work without having to go the extra mile to exchange them or to wrap them. Yet this is just the beginning — we will see many more protocols in 2021 jumping onto this bandwagon and attempting to fish in the Bitcoin pond.

All these companies may be lacking the user base or the financial “money legos” of the incumbent ecosystems, but they can greatly benefit from observing and learning from past mistakes of these communities. 

One last major DeFi trend in 2021 is the liberation of staked assets, enabling users of POS networks to also enjoy their piece of the DeFi cake. Thus far, users who engage in securing the network via POS, are rewarded for their duties in the form of staking rewards, yet they are missing out on more lucrative investment opportunities as their coins are ‘locked’ away.

In 2021, we will see a shift towards freeing up these coins and making them more liquid by allowing the minting of synthetic versions of these staked coins. A synthetic version is nothing else than a one-to-one copy of the staked coin, fully collateralized by the ‘locked’ up coin, and easily deployable in a myriad of DeFi protocols, waiting to gobble them up.

Although the future looks bright for DeFi in 2021, there are still obstacles to overcome. Yet one thing is sure, DeFi as a new paradigm is here to stay. The only questions which remains are – in which form it will, and, whether it will be able to unleash its full potential in 2021, or rather in the years ahead. Nevertheless, institutional investors are already making notable investments into this flourishing space. If DeFi fulfills its promise, we may undergo a true democratization of finance, not just a short-lived one envisioned by WBS.