Why The Current Model for DeFi Will Break Under Its Own Weight
Disclaimer: The Industry Talk section features insights by crypto industry players and is not a part of the editorial content of Cryptonews.com.
Did you know that a Ferrari 488 GTB can deliver up to 660 horsepower? This allows it to go from 0 to 60 mph in just 3.0 seconds. Why would you want this in a car? Frankly, because it allows you to feel the absolute definition of fast.
Humans have an interesting fascination with speed. We’ve realized that when harnessed, we can see more, do more, create more, experience more. Speed is fun, but it’s also critical for growth, improvement, and doing things we couldn’t accomplish before.
But what if our theoretical Ferrari had a fatal constraint? What if 90% of the horsepower had to be dedicated to run the radio, electrical system, the brakes, and the AC? What if you were only allowed to drive it on the freeway, during rush hour? Yes, it’s still a great-looking car. But you’ve taken away its biggest feature.
This is an absurd “What-If”, and yet this is exactly what is happening in the world of DeFi. Let’s look at why this is, what the root causes are, and what it will take to create a real solution.
Not What You Think
Before we can dive into this issue, it’s important to get a solid understanding of the current state of the industry. From a 10,000 foot perspective, DeFi is still in its infancy. A lot of growth and development has happened, but it’s still just learning how to walk. That said, it’s matured past the point of a fad, and is here to stay. With the recent centralized meltdown surrounding the industry, especially with the FTX collapse, this maturity could not come soon enough, showing that crypto’s biggest (and perhaps most necessary) value is in decentralization. There are enough truly valuable forms of utility that DeFi can offer the world – moving beyond borders and banks – that it has the momentum it needs to avoid an industry collapse. Yes, prices have dropped this year and the industry is facing a serious bear market. However, this is to be expected with any financial market, and given what the world has been through since 2020, it’s safe to say this is understandable. Market corrections are much healthier than unchecked bubbles, and this is a sign that the industry will bounce back even stronger.
That said, future growth under the current system is actually a serious issue. Although there are a number of L1 and L2’s touting massive speed and capacity, not all of this is usable, and basically none of them can scaleexponentially. Even Ethereum 2.0, a major improvement to be sure, will quickly face limitations if the market truly takes off. As of now, DeFi is facing a two-pronged threat:
If mass adoption never happens, the market will falter; if mass adoption does happen, how will it be able to support that type of growth?
Key Insights to Critical Limitations
Simply put, the exponential power of DeFi will be realized when multiple actions can be stitched together in one transaction, saving time and money, while accelerating the economy. DeFi platforms like DEX aggregators (1inch is a key example) have made a business out of accomplishing this while guaranteeing the best price for users. They take what become complex transactions, reaching out to multiple exchanges at once, and rely on their bundled actions to create value.
The trend of this complexity is growing fast. Consensys reported as far back as 2019 that: “Contract interactions accounted for almost 80% of the gas usage of the Ethereum network this week. This breakdown bodes well for the Ethereum network and its intended use as a dapp platform. People are using Ethereum to mostly interact with contracts, proving that Ethereum’s applications extend well beyond the scope of a cryptocurrency.”
The larger crypto ecosystem is growing, finding new utility, and trying more complex interactions. This is great, and exactly what the industry needs. But the question becomes, can it handle this growth while keeping transactions affordable? The answer, it seems, is no.
RDX Works, the core developer of the Radix smart contract platform, investigated this question by diving into the data. The team took a log of every Ethereum transaction performed on October 16, 2022 using a data dump from Blockchair. The first insight is that out of the 988k transactions using gas, there were 251k ETH-only transactions (25%). These simpler transactions used only 5% of the gas, meaning that the complex transactions were much more expensive. While this complexity is exactly what we want in the DeFi ecosystem, creating the backbone of a sophisticated financial system, the added cost (and inevitable clogging of the pipeline) strips away much of DeFi’s potential usage. When the cost of a transaction is more than the value created from it, you’ve just put a hard stop on ecosystem growth.
Looking further, the team wanted to see just how complex the transactions were, and split the data into transactions containing a single contract call vs. those that contained multiple contracts. The result was again both encouraging and worrying. 45% of transactions called more than a single contract, which is an excellent sign of increasingly complex financial utility. However, these transactions accounted for a massive 78% of gas fees. This shows us that looking at “average transaction cost” is misleading when we are planning more complex DeFi infrastructure. Super simple finance is cheap, but sophisticated financial transactions are increasingly expensive. And since this is where the vast majority of undiscovered potential is for a thriving DeFi ecosystem, this means that the ROI might never make sense, killing the DeFi 2.0 or 3.0 before it can take off.
As if we needed more bad news, there was one more insight the RDX Works team uncovered. In addition to cost, the speed of transactions is important, and is not as advertised for many chains. An analysis from Dragonfly Research showed that while Polygon’s 10k tps, Avalanche’s 45k tps, and Solana’s 65k tps are all technically feasible, these speeds are only for the simplest of transactions. Looking at the more complex transactions needed for sophisticated DeFi yielded different results, with a maximum DeFi tps (theoretical) of just 48, 32, and 273 respectively. For a global financial market, this is far, far, from scalable.
Can We Save DeFi?
Under the current DeFi ecosystem, there is growing concern that the biggest risk to system collapse is its popularity and growth. The weight of DeFi’s success could actually destroy it if major changes aren’t made.
If you look back at the early stages of the crypto/Web3 industryand its severe limits to where we are today, there is some hope. Just looking at the leap made from Proof of Work to Proof of Stake shows that non-linear, somewhat radical innovations can vastly improve the ecosystem as a whole. While platforms like Ethereum 2.0 can help the system hold out for a while, we need that next round of radical innovations and exponential improvements. This innovation is critical for not just DeFi, but all of crypto. FTX has shown beyond a shadow of a doubt that centralized entities can be very dangerous, and that DeFi fixes each of the root causes from FTX’s collapse. We need scalable DeFi, and we need it now.
Right now we are sitting in that Ferrari that looks fast, but is hiding some embarrassing limitations. We need to plan for a system that can handle drastically larger, more complex transactions for a mass adoption, global financial market. If we can build to that scale, we can go full throttle and finally reach the speeds we’ve been dreaming of.
Jeremy Epstein is the Chief Marketing Officer at RDX Works, the development company behind the Radix protocol, with a market cap of over $500 million. Jeremy has worked with some of the leading, most innovative blockchain-based organizations including Dapper Labs, Arweave, SingularityNet, OpenBazaar, and Zcash. Jeremy has written 3 books, more than150 articles, and nearly 1000 blog posts on the impact of blockchain technologies on society and has briefed senior US Department of Defense officials at the Pentagon on multiple occasions.
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