The year was 2016, October 3rd. Vitalik Buterin proposed an idea to “run on-chain decentralized exchanges.” The idea gave birth to what we called Decentralized Finance or, in short, DeFi.
Uniswap, Maker Protocol, and Compound were the first few to experience the idea of Decentralized Finance. This idea of Finance or Banking (If some will call it that way) is credited to the first truly decentralized financial system created by Satoshi Nakamoto in the aftermath of the 2008 financial crisis: the Bitcoin blockchain.
The concept of a decentralized financial system built on the distributed open ledge allows anyone from any part of the world to transact freely, peer-to-peer, without the need for any centralized intermediaries. For the first time in history, revolutionary technology was created free from any tyrannical power, state force, or corporate greed. The Bitcoin network went on to reach more than $1.3 Trillion worth in November 2021, while Vitalik’s idea of Decentralized Finance has reached close to $200 billion in total value locked.
But today, amid global geopolitical conflict, rising inflation, rising debt, and as the world continues to recover from the COVID-19 pandemic, we are in chaos. As we look for a better solution, even Bitcoin's market cap is down less than $400 Billion from its All-Time-High at $1.3 Trillion, while the Total Value Locked (LTV) on DeFi is down less than $60 billion. To add more fuel to the fire, we saw billion dollars wiped out when Terra UST Stablecoin depeg as its value lost to $0 for $1, leading player Three Arrows Capital files for bankruptcy, CeFi lenders Celsius, BlockFi, Voyager and more suffer from the contagion 2022 “crypto winter.”
So, how do we move forward from all of these?
We are less than 100 days to 2023. How do we build a better and more secure financial system for 2023 and forward?
The answer doesn’t lie straight forward. Yet, we can learn from the past to create a better future. Of course, there will be many great ideas out there to revamp our market economy; I am especially bullish on the future of an Immutable, Transparent, Open Financial System built on blockchain technology. Therefore my views here are primarily focused on Blockchain technology for financial services in 2023.
Here are my Five key technology themes for financial services in 2023:
While DeFi is still nascent, the IMF finds DeFi to be cost-effective due to the absence of “labor and operation cost.” This is important as DeFi offers lower capital cost, more accessibility, a low entry barrier, and an open source information flow.
Today we are already seeing Real World Asset(RWA) moving on-chain, and this trend will continue. In a recent report, “An Unreal Primer on Real World Assets,” Teej Ragshale, Jack Chong, and Mukund Venkatakrishnan concluded that DeFi would eat TradFi via RWA.
Real World Asset is usually supported by legal contracts enforced by courts and government, and so for it to be entered into a smart contract on the blockchain, it has to be acknowledged first by the entitled enforcement body to give the ownership right and protections of the asset. This has been done in Switzerland’s Distributed Ledger Technology Act. Once the enforcement recognizes the RWA entries, developers embed the entries into the smart contract giving higher security, immutability, and transparency.
Real World Assets can be moved on-chain in two ways:
Create a new asset class (Birth) - Create a new asset class that does not yet exist. These asset classes will be DeFi native. E.g., Hashpower-backed loans, DAO bonds, Decentralized Parametric insurance.
Re-ledgering the existing assets (Rebirth) - Existing asset class like Corporate loan, Mortgages, and Sovereign debt will be ledger on-chain as DeFi continue to offer cheaper capital cost, better accessibility, low barrier of entry, and guarantee security.
Some of the new asset class projects;
LandX - The Perpetual Commodity Vaults Protocol.
Debt DAO - A permissionless marketplace for crypto-native credit
Etherisc - Decentralized Insurance Protocol to collectively build risk transfer solutions.
“Stablecoin,” the god of Crypto.
If Bitcoin is the King of Crypto, to some extent, we can call Stablecoin the god of Crypto. No doubt, Stablecoins are the best invention of decentralized finance. It maintains the peg to real-world value and opens many opportunities for use cases: collateral, yield rewards, value transfer, and more.
But like blockchain, Stablecoin also has its trilemma: Stable, Capital Efficiency, and Decentralized. Fiat-backed Stablecoins like USDT, and BUSD achieve great in term of stability and capital efficiency but suffers from decentralization, while crypto-backed Stablecoins like DAI solves decentralization and stability but again suffer from capital efficiency. In the last few years, we have seen Algorithmic Stablecoins gaining popularity, but the industry is seen to have learned the lesson from the Luna Terra UST saga.
So what is in the next generation of Stablecoin?
Nobody has the right answer yet. But it might lie in the combination of the existing one, for example.
Iron Finance is a fractional algorithmic Stablecoin which is a combination of seigniorage and collateralized model.
Frax Protocol, another Stablecoin pegged to the Consumer Price Index (CPI).
RAI, a debt-based and algorithmic Stablecoin minted by leveraging against Ethereum.
OHM, the decentralized reserve currency of DeFi.
In the DeFi ecosystem, more concepts will be tested and iterated until the right one that serves best is found. For the industry to reach mass adoption, Stablecoins are the key. The current volatility of cryptocurrency is not yet suitable to use for everyday life, but Stablecoin is, and thus its success is important for the industry.
JP Morgan, HSBC, Nasdaq, and Goldman Sachs, to name a few, have embraced open distributed ledger technology, and it is a matter of time before more institutions will start using blockchain technology in one way or another.
Apart from adopting blockchain and crypto assets by Wall Street bankers, one interesting trend we will see in the coming years is CeDeFi and DeFi mullet.
DeFi Mullet, as Bankless called it, is a concept of FinTech in the front and DeFi in the back. Here are some trends where FinTech is becoming the greatest ally of Crypto:
Robinhood launched the DeFi wallet with the Polygon network.
Coinbase integrates dApps.
Stripe launches USDC payments on Twitter.
As more institutions embrace Blockchain crypto and FinTech steps up to integrate decentralized finance on their platform, more retail users will adopt crypto, and this will be one of the biggest opportunities to look at for financial services in 2023 and beyond.
Wallets are the gateway to the world of decentralized finance; without them, non-tech users will find it difficult to interact with any blockchain applications and protocols.
As more retail users enter the DeFi ecosystem, the demand for specific features in the web3 wallet increases. The first generation of web3 wallet is simple and shows only sent and received transactions, but the next evolution of web3 wallet will need to address specific needs for different verticals of blockchain. Metamask is currently leading with the highest number of active users, but it is unlikely that it will win the race. The race for digital web3 wallet is on, and we will likely see multiple players serving different needs of the different sections of users.
Web3 gamers will like to have a wallet that shows their in-game items (skins, weapons, characters) like Fractal; NFT creators and owners will go for wallets that show their NFT art collections category-wise like Phantom and Coinbase wallet, while DeFi traders, investors will go for wallets that gives clear stats of their portfolio.
While custodial wallets serve users with faster accessibility and better UX, non-custodial wallets will likely play a greater role in web3 adoption and other financial services as it gives full ownership of assets.
Crypto wallets are prompts to hack and steals of users' assets and unidentified addresses. We will likely see wallets implementing reversible transactions for stolen assets and zkSNARKs for a greater degree of privacy while still being able to prove the source of funds. The key to winning in this race is also for multi-chain wallets, better integration with marketplaces, real-time on-chain data, and ultimately a simple and easy onboarding process.
The last few years saw multiple verticals and subsectors of blockchain-based economic and financial model-based ecosystems. But in the years to come, we will likely see them moving horizontally rather than vertically. Be it NFTFi, SocialFi, GameFi, or MetaFi; all will need to move hand in hand with DeFi.
Arunkumar Krishnakumar put it perfectly here,
“Without the DeFi elements, a metaverse would lack commercial scalability. Without the GameFi elements, the community would lack the experience motive for continually returning to it. Finally, without the SocialFi angle, the ecosystem’s credibility would not be established. The SocialFi elements ensure users and creators get credentials for their value addition.”
Currently, the web3 gaming ecosystem is experimenting hugely with DeFi by incorporating DeFi elements like Staking, Liquidity mining, Fractionalization, and NFTs into their ecosystem. NFTs trading in 2021 was as high as $17 Billion, and most NFT holders hold them as value appreciation assets. With NFTs and DeFi, NFT holders can perform financial activities like Derivatives, Lending, borrowing, rentals, etc.
After thirteen years, Satoshi Nakamoto’s Bitcoin has become a legal tender for El Salvador and several developing countries. While some national governments still remain hostile to Bitcoin, blockchain technology has become inevitable. More and more countries are embracing open ledger technology, and some are experiencing it with their nation's economy.
Following China, the big economic nations in Europe, the UK, India, Australia, and now the US is building their own Central Bank Digital Currency (CBDC). More than 600 million Chinese citizens are now set up digital wallets for digital Yuan, China’s version of CBDC.; Australia has launched a pilot project for CBDC. With bigger economic nations continuing to push for CBDC, more nations will follow suit in 2023 and in the years to come.
While countries pushing for CBDC is a sign of embracing blockchain technology, we are not sure how central banks worldwide will take their approach. The Reserve Bank of India says CBDC as “It is the same as a fiat currency…. Only its form is different,” while it is unsure whether CBDC will be deployed in the public or private blockchain. The United State FED Chairman Jerome Powell says a US CBDC "would not be anonymous,” and its four characteristics would be Intermediated, Privacy Protected, Identity Verified, and Transferable.
It is likely that the developing nations will design their CBDC more open to benefit from Bitcoin and other cryptocurrency networks, while the bigger economy nations will have their CBDC design that fits their banking policy with lesser anonymity and stay a larger distance from Bitcoin and other cryptocurrency networks.
Amid a paradigm shift in the financial system, economic market, and technological development. For the first time in human civilization, the financial system is more transparent, immutable, and open to anyone anywhere, the economic market is more volatile and accessible, and technology is getting more powerful and reaching more people. In the process of this paradigm shift, access to the financial system and services will serve the most important part. So how do we build better, secure, safer financial technology for all?
These implementing tips are limited to blockchain technology for financial services.
With zk-proofs technology and on-chain KYC using Soulbound token, Decentralized Identity, Parallel Id, and under-collateralized lending can be implemented.
Most of the DeFi protocols we have now are based on over-collateral lending as on-chain KYC are not implemented. Future DeFi protocols can implement ZK-proofs for on-chain KYC and even start to issue loans against the user's credit or spending history.
As Social and Finance are getting increasingly connected, the next generation of finance can be built on top of Social NFTs, Gaming NFTs, and Metaverse. This will attract more users as these subsections get more audience based.
Financial products can be built to give loans against Social NFTs, Gaming NFTs, and Virtual land as collaterals.
It is not sure how financial services can be built around DAOs, guilds, or even web3 communities. But we are already certain that DAOs and guilds are the next generation of organizations and even corporations.
DeFi protocols innovation in lending loans against DAOs and guilds will serve a huge purpose and will definitely have the market for it.
Financial services built only on one chain will be so isolated as the future DeFi will be multichain. As the asset of one chain can only live natively on its native chain, wrapped assets and bridges can be built to interact with other chains.
For example, Polygon has over seven chains,
Polygon Mainnet- a modified Proof-of-Stake blockchain,
Polygon Supernet- an application dedicated to blockchain,
Polygon Avail- a data availability-focused blockchain,
Polygon Zero, 5. Polygon Miden, 6. Polygon zkEVM- zk-rollup blockchains.
The current onboarding process for DeFi is too complicated; an average person with little technical know-how will not be able to process the 5,6 steps of onboarding. For the next generation of financial services built on blockchain, simple and easy onboarding will be the key. ENS domains like should be implemented for easily readable addresses. Above all else, for DeFi, simple UX and easy onboarding will serve an important part.
For mass adoption, we will need better marketplaces infrastructure, tools, and discovery platforms for NFTs, DApps, and DeFi protocols.
Unlike web2 companies, web3 organizations are hugely community driven. To win the race in web3, community and DAOs will play the central role.
Apart from being community-driven, next-generation protocols, projects, and services will all be open source, taking community feedback periodically, iterating them, and building along with the community's support in an open-source collaborative manner.
Some of the technologies that are changing the competitive landscape:
Zero-knowledge proof is one of the most innovative concepts in cryptographic technology. Protocols and services that integrate with zk-proof will be a huge success in the years to come.
As Leyer1 blockchains suffer from Scalability by taking a stronghold on Decentralization and Security, L2 chains like Polygon are the solution for Scalability. More and more DApps and services will be built on top of the L2 chain instead of building directly on the L1 chain.
Soulbound tokens are one of the recent development in the blockchain. Unlike NFTs, Soulbound tokens are not transferable but represent a person's identity. It will be one of the most interesting technology in cryptography and will change how we look at online identity, online social status, and even academic records, medical records, credit records, and more.
As protocols are going more multi-chain, Inter-bridge will serve the main purpose for linking and bridging the gap of multi-chain. Inter-bridge protocols will be the future to host most assets and the solution to Interoperability across chains.
The market is experiencing “crypto winter,” the ecosystem is holding the narrative tight, builders are building without sleep, and everything is evolving steadily. Better protocols are being built, VCs continue to pour cash, and communities hold strong. The next few years will hold to answer the fate of the entire ecosystem. From Soulbound to zk-proof, community to open-source, L2 scaling to bridges, the next generation of financial systems will be owned completely by users and asset holders.
My Twitter @Kuzotelohe