Everyone is talking about DeFi. Few people are asking what DeFi should look like. Ergo has a vision for what the sector can become.
2020 is shaping up to be the year in which Decentralised Finance rose to mainstream attention, in the same way that Bitcoin and blockchain did in 2016 and 2017. In July alone, Total Value Locked – the amount of funds committed to DeFi dApps’ smart contracts – doubled from $2 billion to $4 billion, largely driven by Compound’s distribution of its COMP governance tokens.
DeFi is all the rage, with several well-known projects pioneering the space before our eyes. But while the crypto world is gripped with the short-term opportunities of DeFi, fewer are talking about what it actually is – and fewer still about what it should be. In building a DeFi platform like Ergo, though, that’s exactly the kind of question we have to ask.
DeFi dislikes limits
In talking about what DeFi ‘should’ be, it’s easy to fall into a trap of being prescriptive, of introducing arbitrary conditions and limits. But that’s not what blockchain is about. As we’ve seen with Bitcoin and blockchain more generally, there’s a free market of ideas and nothing is off the table. It’s reasonable (though not particularly helpful) to say that DeFi should be ‘anything and everything’.
Just like blockchain, DeFi brings advantages of transparency, immutability and efficiency (often including speed and/or cost) to financial processes. But in terms of what we believe this new set of technologies should offer, and what decentralised finance can bring to the conventional financial system, it’s worth focusing the conversation on a few other key areas that have been overlooked or under-represented to date: Privacy, Scalability, Interoperability, and Decentralisation.
As Eric Hughes wrote in A Cypherpunk’s Manifesto back in 1993, ‘Privacy is necessary for an open society in the electronic age.’ That is never more true than for financial privacy. Privacy must be a built-in feature of DeFi – not a bolt on extra or a desirable feature. It must be integral.
But, as Hughes continues, ‘Privacy is the power to selectively reveal oneself to the world.’ There is always a balance to be struck between privacy and compliance, between transparency and anonymity. Large scale adoption of DeFi requires auditability, and the regulatory approval that enables.
Thanks to the latest advances in zero-knowledge proofs, Ergo can offer both privacy and transparency, where required. The platform’s Sigma Protocols offer robust, customisable cryptography – and, at the same time, the ability to selectively reveal information where necessary.
The ability to process thousands of transactions per second is also a non-negotiable feature for a thriving DeFi sector. How this is achieved is less important than that it is achieved; in practice, there will be many different approaches, with different users and protocols selecting the ones they prefer.
For example, while we have seen the rise of sidechains and child chains, the reality is that exchanges remain a gateway to the blockchain world for a large proportion of users. Popular exchanges are increasingly integrating DeFi functionality, allowing their vast user bases to access it from their individual accounts, without interacting directly with the protocol.
While this may be less than ideal from a security perspective, it’s a simple reality that centralised services are not going out of fashion, but are integrating decentralised technologies thanks to the advantages they offer. Ergo has its own approach to scalability, but we can’t and won’t ignore the importance of businesses in driving forward user adoption.
One of DeFi’s key strengths is composability: the ability to build new applications from existing components, leveraging the network effect of established dApps and tokens. This is one of the main factors that has enabled TVL to explode over the past month.
But composability currently has its limits. Cross-platform composability currently isn’t possible. Even atomic swaps – the first stage of interoperability – are in their infancy, though Ergo is working on an atomic swap-powered DEX.
Full interoperability means the ability for a user to execute a smart contract on one platform and have it seamlessly interact with another blockchain. This would allow truly frictionless cross-protocol interaction, and is what is needed to enable the flow of liquidity fully throughout the DeFi world. At that point, applications become blockchain agnostic, and the platforms are really more like the programming languages for accessing dApps’ functionality.
Lastly, and specifically in the context of scalability and interoperability, we cannot forget the importance of decentralisation – something Ergo has always taken seriously.
Of course DeFi is decentralised – but there are different types of decentralisation. Ethereum, the home of almost every major DeFi dApp, is just one platform.
Ethereum’s developers are working on a plan for scaling, but even if this is successful, it is still one blockchain. Should we entrust all our funds to one network? What if a critical bug or exploit is found?
Interoperability does more than enable cross-chain liquidity. It decentralises the decentralised infrastructure for DeFi, adding layers of redundancy and security. In the process, it strengthens every blockchain that is a part of that ecosystem, creating a whole that is more than the sum of its parts. At a time when relatively large blockchains still suffer double spend attacks and serious reorgs, and catastrophic vulnerabilities are found in smart contracts holding tens of millions of dollars of value, we cannot assume that one single blockchain will or should rule them all.