In the past year, I have spent an inordinate amount of time researching, scrutinizing, integrating with and, most importantly, using every DeFi protocol I could find. Those include:
- Maker DAO,
- nüo, and
I followed lending interest rates, watched my CDP debt/collateral ratio, generated DAI to borrow ETH to…generate more DAI. Eventually, I found myself keeping track of debt positions across 5 different platforms. Difficult. And then, the price of ETH dropped by 4% in an hour and I lost all my collateral 😓.
Why would anyone put themselves through all that? My answer is simple: it’s my job! I work for a company that generates crypto credit data, builds tools for DeFi and publishes a quarterly report on crypto lending. I have to use these protocols whether I like it or not (and I do like them 😉). But what about the rest (most?) of the DeFi users out there? What motivates them?
A good place to start would seem to be the self-asserted goals of these protocols. What do they claim they are trying to accomplish? A quick look at their mission statements shows that they all have the same altruistic goals:
Provide high-end financial services at a global scale, while remaining trustless, decentralized and free of regulatory restraint.
Great! Everyone from the hedge fund manager on Wall Street to a farmer in Vietnam can borrow, lend and earn interest on their assets on a global scale. No more exclusionary gate keeper. You can get a loan to start a new business or buy a house, anywhere in the world. Credit score be damned! Financial inequality is solved. The 1%, finally, smote.
Now the world can focus on that Mars 🚀colony!
But scrutiny of the actual data makes it very clear that this is not the case.
The most glaring problem is the extreme collateralization requirements necessary to take out a loan. This idea of “fair credit” for everyone seems to come up empty if “fair credit” means tying up existing assets to borrow digital assets. Sounds like a trading strategy to me. Another key data point is the total amount of users on these platforms. It’s not entire populations of countries with faulty financial systems, it’s not the elusive “unbanked”, and it’s not everyday folks. We’re talking about 100,000 unique users (maximum) who live in large economic centers and most certainly are not spread out across rural areas or across socio-economic classes.
So now we’re back to the original question, but now with ANOTHER question attached to it.
Why do people use DeFi, and who are they?
If we take the high financial barrier for entry (over-collateralization) coupled with the relatively small population of users, its safe to say that many users are the same people who currently act as middlemen in our existing financial system:
- hedge fund managers,
- financial analysts,
- adventurous banking associates,
- software engineers, and
- wealthy individuals aka whales,
all looking for Alpha [efn_note]Alpha – a term used in investing to describe a strategy’s ability to beat the market, or it’s “edge.”.[/efn_note], diversifying their portfolio, or simply just experimenting with the newest, coolest tech. The very group that this system was meant to replace has instead turned it into their own personal laboratory. It turns out that a great replacement for traditional creditworthiness is excessive amounts of wealth. In fact, one DeFi protocol manager I spoke with says that around 20 “whales” control the liquidation side of their protocol, which means 20 very wealthy individuals are profiting off the volatile ebbs and flows of the crypto market.
This paints a gloomy picture, but there’s hope. DeFi is only 2 years old and every day seems to spawn new and creative ideas that will allow less privileged people to enjoy the promises of DeFi. An example is the EOS REX protocol. Built on the EOS blockchain, the REX token allows users to borrow and lend their CPU/NET bandwidth. Developers with great ideas but who lack the necessary hardware requirements can leverage this ecosystem to test their ideas. Those with excess can make a small profit while providing the necessary support to spur innovation. The beauty of decentralization is that we can take traditionally financial ideas and apply them to a variety of resources that can be spread across the globe.
Eventually, I think DeFi can achieve some of the aforementioned goals of trustless, global borrowing and lending and subsequently create a peer to peer network that allows the free-flow of capital to all corners of the world. But it definitely won’t happen without maturation in the surrounding infrastructure. This means tools, analytics, and data that will allow borrowers and lenders to make better decisions and lower the initial barrier for entry. This also means widespread acceptance of cryptocurrency as a viable means of acquiring non digital assets.
So where does that leave us in regards to the original question? What motivates people to use DeFi in its present iteration? When it comes to the group I mentioned previously (let’s call them “the financially savvy”), they are using DeFi to make bets and manage risk. These are perfectly acceptable use cases, but they aren’t why “normal” people put their money into savings accounts or take out a bank loan. Fact is, we’re seeing the emergence of those “normal” use cases[efn_note] Compound and dYdX allow users to earn interest on assets stored on their platforms, analogous to a savings account but with interest rates around 5-6%.[/efn_note] and are, I believe, on the verge of an explosion of these types of services on a worldwide scale.