The Future of DeFi: Overcoming 3 Key Blockers for Mass Adoption—Insights from the SBC Conference

Decentralized Finance (DeFi) has come a long way since its inception, proving its value through various applications such as Automated Market Makers (AMMs) like Curve and Uniswap, and lending platforms like Aave and Compound. These protocols have demonstrated that DeFi can offer significant benefits to digital assets, making financial services more accessible, transparent, and efficient. As we approach the mass adoption of on-chain financial services and witness their convergence with tokenized real-world assets (RWAs) and Central Bank Digital Currencies (CBDCs), it's crucial to address the remaining challenges that hinder DeFi's full potential.

At the Science of Blockchain Conference (SBC), held recently at Columbia University in New York City, top researchers and protocol founders gathered to discuss these very challenges.

This post explores three major blockers highlighted at the conference:

• suboptimality in DeFi,
• the lack of confidentiality,
• infrastructure limitations.

Each of these areas is ripe for innovation, and recent advancements show promise in overcoming these challenges.

1. Suboptimality in DeFi

One of the significant issues plaguing DeFi is suboptimality. While DeFi protocols have made significant strides, they are still not operating at their full potential. This was highlighted in a notable talk by Aviv Yaish which addressed inefficiencies in lending markets and Flashbots auctions (paper).

For example, MEV arbitrageurs can yield higher rewards by not trading precisely the same price from the target exchange, but allowing for bigger error tolerance, thus increasing the probability of successful trade execution. Similarly, the allocation of tokens to lending pools is not done optimally, as LPs forget that the more capital they provide, the lower the yield of the pool is.

As the Chief Economic Officer of Circle, Gordon Y. Liao, pointed out, better strategies are necessary for RWAs in the DeFi pools. Liquid Staking Tokens (LSTs) and RWAs often yield coupons, yet the strategies to maximize these yields are not fully optimized (paper).

2. Confidential DeFi

Privacy is another critical issue in DeFi. While transparency is one of DeFi's strengths, it also poses challenges when it comes to confidentiality. Recent discussions and panels at the SBC conference shed light on the importance of privacy-preserving technologies in DeFi.

One promising solution is the concept of solvers and intents. Solvers are agents that execute trades or other actions based on predefined conditions, while intents represent the desired outcomes of users. By using solvers, DeFi platforms can execute transactions in a way that conceals the user’s strategy, enhancing privacy without sacrificing efficiency.

As described by Tarun Chitra (paper), confidential DeFi as an optimization problem enables marketplaces with:

• Solvers offering users discounts for decreasing statistical privacy level
• Users run dutch auction for cost of privacy (e.g. “privacy fee” for CFMMs)
• Off-chain matching of solvers/users based on privacy constraints, optimization outcomes

3. L2s as DeFi Infrastructure

The question of whether blockchain and DeFi are ready for mass adoption is closely tied to infrastructure capabilities. Public Layer 1 (L1) blockchains like Ethereum and Bitcoin have their limitations, particularly regarding scalability, transaction costs and privacy. Private L1s, on the other hand, often lack the smart contract capabilities needed for complex DeFi applications and are generally only suitable for simple value chain management.

This is where Layer 2 (L2) solutions come into play. L2s are designed to enhance the scalability of L1 blockchains by offloading some of the processing tasks. However, L2s themselves are not without challenges. Issues such as decentralized sequencers, shared sequencers, base rollups, and decentralized provers are still being worked out.

• Sequencer
• Prover
• L1 Smart Contracts

At the SBC conference, many attendees and venture capitalists focused on solving these pressing issues such. For example, Arbitrum, one of the optimistic rollups, has been exploring ways to improve the decentralization and efficiency of sequencers, which are crucial for the integrity and speed of transactions on L2 networks.

Decentralizing sequencers could be more easily achieved through ZK rollups like zkSync and Polygon zkEVM, thanks to the use of zero-knowledge proofs for transaction verification, which allows for faster transaction finality (30 minutes compared to 7 days in optimistic rollups). However, the decentralization and efficiency of the prover present challenges, as generating ZK proofs is inherently expensive.

Similarly, innovations in shared sequencers and base rollups are being developed to ensure that Layer 2 solutions can meet the demands of the growing DeFi ecosystem.

• Shared sequencers are used among several rollups, facilitating smooth communication and resource sharing.
• Base rollups leverage Ethereum validators as their sequencers to produce blocks.

Conclusions

DeFi and blockchain technology are evolving rapidly, with new research and developments continually pushing the boundaries of what’s possible. The current shortcomings—suboptimal usage of DeFi protocols, the lack of confidentiality, and infrastructure limitations—are all being addressed through innovative solutions like optimized DeFi strategies, privacy-preserving solvers, and decentralized, efficient rollups on Ethereum and Bitcoin.

As these challenges are overcome, the path to mass adoption of DeFi becomes clearer. The insights from the SBC conference suggest that the future of blockchain and DeFi is bright, and we are on the cusp of a new era where on-chain financial services are not only widely adopted but also optimized for efficiency, privacy, and scalability. Stay tuned for more exciting developments in this space!

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