The first quarter of 2023 provided much-needed relief to the entire crypto community — from investors and miners to businesses and developers — as Bitcoin’s (BTC) bull sprints helped crypto market participants recoup losses from prior investments.
However, not all sub-ecosystems managed to replicate the recovery with the same intensity. In particular, the decentralized finance (DeFi) sector suffered massive hacks, ultimately shaking investors’ confidence.
The DeFi ecosystem initially attracted investors seeking passive revenue streams, but 2022’s unforgiving bear market nullified many of the gains made from assets earned over time. As a result, both new and seasoned crypto entrepreneurs are now faced with the task of reinventing the DeFi wheel to offer sustainable investment opportunities as well as taking proactive measures to instill trust among investors.
Cointelegraph spoke on this topic with Julian Hosp, co-founder and CEO of Cake DeFi, taking a deep dive into what makes a DeFi ecosystem sustainable.
Cointelegraph: Crypto exchange volumes are recovering as a result of bull sprints, and nonfungible token volumes are up as well thanks to Bitcoin Ordinals — but volumes are still very low in DeFi despite promises of high yields. What went wrong?
Julian Hosp: On the contrary, the days of platforms touting sky-high yields are over. Today, we see yields adjusting at healthy, realistic, albeit much lower levels. We believe that this is actually a good sign, as it indicates that the industry is moving toward what we call “true DeFi.”
The corner of the crypto market that promised customers outrageous annual returns mainly attracted people looking to make a quick buck, those who were not necessarily true believers of DeFi.
Further, most of these lending platforms operated via a “black box” model whereby they offered limited transparency and control over customer funds. In these cases, customers do not have clarity on where the yields are being derived from or if their funds are being commingled with operational funds, which leaves them susceptible to mismanagement and misuse.
This was the case for companies like Celsius, Voyager, FTX and many others that imploded along with the market crash. Unfortunately, it took a fallout of this magnitude to clear out these bad actors.
The aforementioned collapses resulted in many mistakenly blaming DeFi as the cause when, in reality, these companies failed because they essentially repurposed the outdated big bank model under the guise of DeFi.
While DeFi has immense potential, more education is needed to quell the confusion and fear plaguing mainstream users. Additionally, it is crucial that crypto companies provide both assurance and protection to their users and their hard-earned money to build trust, especially in volatile times/during the crypto winter. Going forward, taking a transparency-first approach will become the gold standard for exchanges and custodians, and we expect customers to seek out CeDeFi [central decentralized finance] platforms.
CT: Gaining back investors’ attention often translates to rebuilding trust in the DeFi ecosystem. How does one achieve that in DeFi, considering that most projects are new?
JH: The spate of critical events that have occurred over the last year have rippled across the industry, sowing widespread distrust among investors. The industry has to rebuild that trust by going back to the roots of blockchain technology and putting the focus back on transparency. With that said, we believe that investors recognize that the issue is related more to traditional finance, not DeFi. However, more time and education are still needed to dispel confusion and rebuild that trust.
The string of bank collapses caused some people to lose confidence in TradFi and CeFi and to look for alternative ways to store and manage their wealth, such as DeFi. DeFi provides an alternative to CeFi by allowing individuals to access financial services and products without relying on traditional intermediaries, such as banks.
As a result, the DeFi ecosystem remains robust despite the volatile market. Liquidity does not leave DeFi. Even when prices drop, usage stays consistent. For instance, 1inch, one of the top DEXs on Ethereum, saw high volumes in the thick of the FTX crisis. Further, the global decentralized finance market size is expected to reach $231.19 billion by 2030, expanding at a CAGR [compound annual growth rate] of 42.5% from 2022 to 2030, according to a study conducted by Grand View Research, Inc.
CT: Investors are often advised to “do your own research” before trusting any project. What parameters do you recommend investors keep in mind?
JH: Investing in cryptocurrency can be a confusing and intimidating experience for even the savviest investor. With over 500 crypto investment platforms available, it is essential for investors to do their research before committing to one.
After deciding which type of crypto investment platform — a crypto exchange, crypto wallet, online brokerage, decentralized exchange — is the best fit, investors will then be able to make an informed decision about which specific platform best meets their needs. I believe that the best crypto investment platforms provide security and transparency, stable rewards, and ease of use.
Recent: Foreign trade and pensions: What’s next for Russia’s CBDC project?
First and perhaps most importantly, investors should consider the security features offered by the platform — if it has measures in place to protect customer funds from potential hacking attacks or other cyber-related threats. It is also important to check the platform’s track record when it comes to customer support. Transparency is also essential, as it gives investors peace of mind that their funds are secure and that the company behind the platform is legitimate. Without transparency, there will always be a cloud of doubt hanging over any given platform — something that no investor wants to experience.
When it comes to generating rewards on crypto, investors definitely want a platform that offers yield percentages that are both reasonable and reliable. Since yield percentages differ on every crypto investment platform, investors must carefully look into how or where the yields are generated, and whether the percentages in their preferred platform fluctuate too often or are too high. It is definitely a red flag if such information isn’t available or if the yield percentages are too good to be true.
DeFi protocols can be complex and challenging for the average user to navigate, and not everyone has the time or capability to understand the intricacies involved in crypto investing. For this reason, investors — especially beginners — should put ease of use on their list of considerations when choosing their crypto investment platform. Is it user-friendly? Is it available on mobile? Is it functional? These are some of the questions that you should be asking yourself before signing up for an account.
CT: As a service provider, what measures do you take to ensure investors’ safety?
JH: Last year, we published our proof of reserves using the cryptographically audited Merkle tree method in a continued effort to build trust and provide transparency around user funds. Proof of reserves is a means for platforms or exchanges to demonstrate that they are capable of honoring withdrawals on their platforms at all times. Cake DeFi was among the first in Asia to offer a comprehensive approach to proof of reserves that verifies not just assets but also liabilities as well.
Further, we provide full transparency on how yields are generated, with real-time on-chain data about customer funds. Users can ensure that their funds are safe and completely accounted for because all transactions can be verified directly on the blockchain.
CT: Q1 2023 saw Euler Finance hacked in one of the biggest DeFi exploits, with its CEO saying this occurred despite conducting 10 audits over two years. How effective are audits when it comes to security? Can the DeFi ecosystem solely rely on audits?
JH: In the crypto space, companies have a unique opportunity to demonstrate their financial health and liabilities through proofs of reserves and blockchain transparency. However, auditing these reserves can be prohibitively expensive for most companies, proving to be a major challenge. While some companies undergo audits, most players do not do so simply due to the high costs involved.
Additionally, demonstrating assets and liabilities can be difficult for exchanges compared with other types of companies in the crypto space. For example, as a CeDeFi provider, there are almost no idle funds on our platform, allowing such platforms to easily show customers where their funds are allocated. On the other hand, for exchanges, 99% of the funds are usually idle, making it difficult to show where the remaining 1% is — whether they be stored in a hot wallet or somewhere easily visible on a blockchain.
Furthermore, no code is perfect, and we have to understand and acknowledge that at the end of the day, there will always be unavoidable risks. While audits are effective at least in capturing some of the known issues, it does not mean that they are foolproof and will prevent all attack factors.
With that said, regulators should prioritize ensuring that companies have adequate safeguards in place to protect customer funds. I think having audits as a bare minimum is a good start. Comparing this to home safety — everyone implements basic safety measures such as locking their front door at all times, even if that doesn’t fully prevent a burglary from taking place (a burglar can climb in through a window, for example). Likewise, audits should not be viewed as a be-all, end-all solution, but rather a basic safety measure that everyone should implement.
CT: What are some best practices for security?
JH: The general rule of thumb is that the more opaque something is, the safer it is. Obscuring the exact security system so outsiders and insiders don’t know what the attack factors are is key. Even internally, no one person should know who holds certain keys and their locations. This will ensure protection and keep the ecosystem secure.
Another approach is to have as many multifactor authentications as possible, including automated checks, manual checks and more. Although not a foolproof method, MFA is an effective way to increase the security of cryptocurrency transactions and accounts.
It is also important to keep your platform’s software up-to-date with the latest security patches and bug fixes to stay ahead of potential vulnerabilities.
At Cake DeFi, we have very frequent and extensive manual checks on all our processes, which has its upsides and downsides. While this enhances the security of our platform and user funds, it causes slight delays in processing, and we sometimes get complaints from customers about the longer wait times.
At the end of the day, there is no perfect solution to safeguard one’s ecosystem, so it is crucial to follow best practices for security to protect your users’ funds and your project’s reputation.
CT: How important are user interface (UI) and user experience (UX) for retaining customers? New investors can often be overwhelmed by the amount of information current UIs show.
JH: UI and UX are crucial elements of a successful product or application and have a significant impact on customer retention. A well-designed UI can make a product visually appealing and intuitive, while a positive UX can lead to satisfied customers who are more likely to use the product again and recommend it to others.
We have found that customers are easily put off by a poorly designed UI, which may prevent them from using the product from the get-go. Likewise, a negative UX can cause frustration, confusion and even anger, resulting in a high drop-off rate.
A well-designed UI can make a product easy to use, visually appealing and intuitive, which can lead to a positive experience for users. When users have a positive experience, they are more likely to return and use the product again, and even recommend it to others.
CT: In your experience, what factors do venture capitalists consider prior to making DeFi investments?
JH: Overall, venture capitalists take a comprehensive approach to evaluating DeFi projects and consider a wide range of factors to determine the potential for success before making an investment decision.
In the past, during the crypto bull run, it was all about hype. VCs would just crowd into different projects and throw money at them. This is actually what we are seeing today in the artificial intelligence industry. Whereas today in DeFi, VCs understand that this golden period is over and that they have to carefully look at other factors to determine which projects they should invest in.
One important factor is the market potential of the project, including its size, competition and growth rate. VCs also carefully examine the market fit as well as the team behind the project, including their experience, skill and track record in the industry. VCs will also look at the technology used in the project, such as its utility, feasibility, scalability and security features.
More specific to DeFi projects, VCs will evaluate the tokenomics of the project, including its token distribution, use cases and economic incentives for holding the token. They also consider the strength of the project’s community and its engagement level, as a strong community can drive adoption and increase the project’s value.
Finally, and perhaps most importantly in the current climate, VCs will take into account regulatory compliance, as regulatory uncertainty can pose serious risks to a DeFi project’s long-term success.
CT: “User experience drives adoption”: How accurate is this statement for DeFi? What are your thoughts on offering different UI experiences based on the type of investor, such as if they are new, moderately experienced or experts?
JH: There are many factors that drive the adoption of a product — be it a DeFi product or otherwise — and I agree that user experience ranks high on that list.
Theoretically, offering different UI versions based on investor type could be a useful feature. This approach would help to tailor our platform’s user experience to the needs of different types of investors, and could potentially attract and retain investors of varying levels of experience and investment goals. For example, a new investor may require a simpler and more intuitive UI with basic options, while an expert investor may prefer a more advanced UI with sophisticated investment tools and features.
Recent: Here’s how Ethereum’s ZK-rollups can become interoperable
Realistically, however, offering and maintaining multiple UI versions is complex and would require additional resources and time from the development team, in turn increasing costs.
CT: What is your advice for DeFi entrepreneurs?
JH: Build something that is useful. Build a product or service that people really want to use, something that has actual utility (not just attractive yield) that really adds value to the user.
CT: Is there anything else you would like to add?
JH: At this point in time, people are underestimating the power of DeFi because so much attention is being placed on nonfungible tokens and AI.
Especially with the recent string of banking system failures, I strongly believe there is immense potential in DeFi because there is such strength in having such a secure and transparent system without having a centralized chokepoint. So… don’t sleep on DeFi!