DeFi 2.0: What’s missing? Clear communication and education for the community, and caring for ecosystems as a whole, says Hisham Khan, the CEO of Aldrin.
DeFi 2.0: Origin story
Since its genesis, decentralized finance (DeFi) has been termed as “the wild west” of finance, where rules are dictated by code and smart contracts, no intermediaries exist, and investors and users are free to make their own decisions with their digital assets.
Over time, DeFi has picked up traction due to the promise of financial inclusion and freedom, and its potential to build projects. Investor profits can be maximized from the removal of intermediary fees, but they also have to take full responsibility for investment decisions in exchange.
This also means that users are more vulnerable to the scams, rugpulls, and exploits plaguing the DeFi, blockchain, and crypto ecosystems as they continue to mature past nascent stages.
Last year, an astounding $10 Billion was lost from hacks and exploits. Projects and platforms have their own fair share of challenges, especially in managing the dynamic relationship between their investors and capital providers.
Many platforms implement growth hacking programs such as yield farming and staking to incentivize token holders and investors to provide liquidity and capital, but face issues with huge sell-offs and price dumps when the rewards run out.
Such events cripple the long-term growth of the platform, stifle investor confidence, and reward mercenary behavior while punishing loyal investors who can suffer huge losses from the drops in token price.
To mitigate the negative impact in such areas, projects like Olympus DAO have emerged, where they own their own liquidity and treasury and use it to create a decentralized reserve currency with a backing price for their tokens. In the event the token price falls to or below the backing price, the protocol will then use the treasury to buy back and burn tokens to reduce supply, providing a form of stability.
DeFi 2.0: The dark side
While the premise seems logical and revolutionary in theory, there are further complications requiring investors to follow the Nash equilibrium and 3,3 game theory, where all parties have to co-operate to win by doing the following 3 steps: buying, bonding, and staking.
The underlying rationale is that:
1. Buying action increases price, allowing investors, members of the project who hold the token to benefit from the increased value in their token holdings.
2. Bonding allows investors to buy tokens at a discount which is released over a vesting time period (often 5 days) from the protocol, and the funds go into the treasury of the protocol. The protocol also greatly benefits from this with minimal expense similar to seignorage in Traditional Finance (TradFi).
3. Staking, where investors “lock up” their tokens with the protocol removing them from circulating supply, further increases the price and keeps it healthy, while enjoying returns in the form of token rewards added over time.
However, there remain issues from this model, as selling pressure mounts together with price increases, inevitably leading to large sell-offs and price drops with further cascades from panic selling.
Hyperinflation may also occur from excessive minting of new tokens, similar to how fiat has been devalued in countries like Greece, Hungary and Yugoslavia in the past. While the protocol treasury can come into play to burn tokens and reduce supply to stabilize prices, the funds are not unlimited and will likely run dry over time, causing the backing price to spiral downwards.
This is especially so when the protocol treasury is only built from investor funds and is not organically implemented to generate additional value if there are no new investors (hence the similarity to ponzi schemes).
Rising from the ashes, success stories in the making?
The genesis DeFi 2.0 project Olympus DAO, and its fork, Time Wonderland, have managed to pivot away from this, with Olympus providing a “bonds for service” program to aid new projects and Wonderland has taken the route of a specialist purpose acquisition company (SPAC) with seed investments and suite of products such as liquid staking protocols to generate returns.
While such success stories are yet to be set in stone as both platforms continue to battle with price stability, the fundamentals remain the same; innovative and interesting business functions are great marketing tools, but solid tokenomics, utility, coupled with clear communication and education, is what will determine long-term success and growth.
These massive platforms seem to have recipes for success based on their business models, but have faced obstacles arising from confusion among investors, and also taken hits to credibility and confidence from being embroiled in scandals.
Additionally, token holdings and vesting periods to project leaders and members have to be suitably designed to ensure they have a long-term vested interest in the growth of the project, and a multi-sig and secure wallet have to be in place to protect the treasury of the protocol.
Missing puzzle pieces: Community, education, and transparent communication
Critically, what even relatively successful protocols neglect aside from solid tokenomics and roadmaps, are clear communication and education for their community, and also the importance of caring for ecosystems as a whole.
While it is natural to assume that many investors in such complex and experimental projects are educated enough and aware of what they are getting themselves into, the reality is far from it.
As DeFi does not usually require any filtering or KYC processes, anyone with varying levels of financial literacy can participate. This financial inclusion is part of the beauty of DeFi; as a mother from the countryside in Mozambique, to a college student from Ivy league, and a CEO of a Fortune 500 company can all have the freedom to invest, but that can also be a double-edged sword.
On the user front, UX and UI are steadily improving for a seamless and fuss-free user experience, but more effort needs to be placed into educating investors, especially for those with complex mechanisms. Otherwise, updates or changes which are actually beneficial for the protocol may be misinterpreted as negative and cause panic and confusion.
While the underlying technology may be complex, the code and smart contracts are relatively transparent, meaning anything new is easily replicated or reproduced in a similar fashion by another project team without proper understanding internally and communication externally.
When all this is taken advantage of, individuals with questionable histories that are otherwise not credible enough to take on key roles may remain unfiltered out, increasing the opportunities for bad actors to continue malicious behavior and impact the reputation and security of DeFi.
The Role of Founders
As such, founders and key members of projects should either be required to have doxxed identities and held to higher standards, or have their history shared with investors in a transparent manner through platforms like Rugdoc. They should be held accountable to navigate through failures and successes, and not be given an easy way out at the first sign of trouble. Otherwise, investors will be exposed to an additional level of risk.
Protocols are not just competitors and rivals, but rather comrades working together to build up the DeFi, blockchain, and crypto ecosystems. When one project suffers a mishap, be it hacks, exploits, or any other negative events, it hurts the reputation of the space as a whole. Projects and their communities need to start working together to lift each other up, instead of being only focused on self-interests, as every individual can contribute to the strengthening of the space.
Project members and leaders also need to put in the effort to engage with their community, with regular AMA sessions on their channels like Twitter and Discord to clear doubts and confusion, and simple and easy-to-understand articles on announcement channels like Medium. Only then will the full potential DeFi offers be maximized.
In 2022, effective communication and education, coupled with standards of accountability, transparency, and mutual cooperation from project leaders with the investor community will determine whether the DeFi, blockchain, and crypto ecosystems can mature and become safer and more accessible.
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