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May 2022 marked the end of Crypto’s last bull run, with the collapse of the TerraUSD stablecoin – an event that saw $45 billion in market capital wiped out in one week. The events that followed resulted in an unrelenting bear market finally ending. However, during this Crypto Winter, projects continued to be built and innovation didn’t stop. The events of the past 18-20 months have seen the industry at large actively trying to remedy the damage done, showing resilience and signs of maturity. How? Well, to start with, regulations have taken a central role in building the industry’s credibility, for example the EU’s regulatory framework “MiCAR”. But this too comes with challenges, with many jurisdictions still lacking clear guidelines and definitive legislative frameworks.
After the DeFi (decentralised finance) summer of 2021, we had high hopes that DeFi as crypto’s first “real” use case would keep on growing, replace big parts of TradFi, and drive blockchain adoption in the process.
None of this has really happened.
Despite great innovation and creativity, DeFi as a sector has been a huge disappointment. Today, the DeFi Pulse price index is even lower than it was BEFORE the beginning of summer 2021.
According to the Boston Consulting Group, the value of tokenised illiquid assets is set to be at $16.1 trillion by 2030. For this to happen, DeFi systems need to gain widespread acceptance. However, is the crypto industry ready to provide trusted solutions that instil confidence in potential customers and investors? While the developments in DeFi present unprecedented opportunities for the TradFi world, those that stand to truly gain the most from DeFi are the end users. Where concepts like financial freedom may have traditionally been limited to a few, the tide is now turning towards democratisation and inclusion. Now, financial empowerment is within everyone’s reach. However, one critical aspect needs more attention: building capital markets in DeFi that are truly democratic, which is dependent on effective governance.
The key to unlocking DeFi’s true potential, governance stands as the cornerstone of decentralised ecosystems, offering a framework for collective decision making and protocol evolution. We are in a loop. The essence of DeFi lies in decentralisation, but without fair and effective governance mechanisms, it risks inefficiency, instability, and vulnerability to manipulation.
Through secure governance, stakeholders can actively participate in shaping the direction of DeFi protocols, ensuring alignment with community interests and values. Decisions that are related to upgrades, parameter adjustments and risk management can be transparently deliberated upon and executed, which fosters trust and confidence among users and investors.
Robust governance structures also enhance adaptability and innovation, enabling DeFi platforms to swiftly respond to emerging challenges and capitalise on new opportunities. By empowering stakeholders to contribute their expertise and perspectives, governance can foster a dynamic environment conducive to thoughtful experimentation and evolution.
Ultimately, effective governance is essential for safeguarding both the integrity and sustainability of DeFi, unlocking its true potential to democratise finance, foster financial inclusion, and reshape the global financial landscape. As DeFi continues to mature, governance will remain a vital enabler of its growth and resilience.
DeFi has been slow to gain mainstream adoption, in part due to its questionable past. Earlier stages of DeFi were characterised by the launch of highly incentivised ecosystems, leading to unsustainable and artificial yields. This ultimately resulted in a collapse of yields, which were unattractive, particularly considering the risk-to-return perspective. While yields have recently gone up again, many TradFi actors are still sceptical, fearing a similar pattern as we have seen in the last cycle.
Clever media promotion marketing and PR campaigns are not enough. DeFi needs adoption of sound governance standards to offer financial solutions that both empower and protect users, so that all stakeholders, including government bodies, institutions and regulators are confident to adopt. Together with policy and law makers, industry players need to create solutions that show their commitment to trusted services that protect users.
In the last year, as DeFi protocols continued building, it has become clear that we need better governance in place. Proof is seen in the recent governance proposal at decentralised exchange Uniswap. This proposal focuses on redistributing protocol fees to UNI token holders, at the same time empowering them by granting them a more active role in decision making processes
While the example of Uniswap is encouraging, something remains fundamentally broken. Even in Uniswap’s case, there is a feeling that the protocol is effectively controlled by a select few. How can end users be confident that the odds are not stacked against them? What’s missing in unleashing the true power of DeFi is effectively secure decentralised governance infrastructure.
The bulk of hacks result from poor protocol governance. Some DeFi rug pulls can be attributed directly to governance attacks, but also many smart contract exploits can be traced back to poor governance.
Governance tokens don’t work: one token/one vote is not effective, as voter turnout is low and the majority of token holders do not understand the implications of frequent votes. Delegation of voting power does not solve the problem: giving power to random ‘experts’ is wild, to put it mildly. Agency conflicts abound, with no concept in place of how to solve them. Expertise misplacement is simply not acceptable in DeFi. An unhealthy mix of “DeFi politicians” – literally people with low expertise and with a vested interest in a given protocol – is simply not sustainable, nor does it add any credibility.
Getting rid of governance entirely is not an option either. Believing that immutable code can solve everything is delusional, given the complexity and dynamism of financial systems. Simply put: DeFi needs to go beyond “code is law” to be useful for a mainstream audience.A few examples where governance is inevitable: effective code upgrades that do not rely on founders having admin keys, selection of key protocol parameters or the definition of eligible assets in lending protocols.
Currently, decisions are typically made in one of two ways: Either centrally by a few insiders, or via community/token holders. Both ways are flawed. Having insiders make decisions opens up obvious attack vectors. The community, on the other hand, typically has no expertise in the specific subject matter. For governance to work, we need the right balance of expertise, oversight and independence. A side benefit if we get it right: Protocols are shielded from arbitrary and legal overreach.
A project I think is on the right path is Q.org, which has managed to create a framework for secure decentralised governance that empowers the community and enables token holders to make legally sound decisions while ensuring that expertise and independence are duly considered. Using the International Court of Arbitration (ICC), which is one of the world’s leading arbitration institutions, Q.org has a structured process in place to resolve disputes and enforce awards. The ability to use this framework lends the DeFi space unprecedented credibility. This addresses the historically poor (or often non-existent) way in which disputes have unfortunately been handled in DeFi.
q.org’s governance framework provides legal clarity for participants. It is based on an end-to-end system including the three pillars of governance: rule setting, enforcement and dispute resolution. The private arbitration solution employed tends to be quicker and more reliable than nation-state-based jurisdictions – another plus because, as mentioned before, the regulatory landscape remains clouded, despite much traction being made.
If we don’t fix governance, DeFi won’t scale or gain any meaningful adoption. Think about it – will mainstream users join a system where they always end up on the losing side without protection?
The good news is that governance can be fixed. If it’s fixed, it will truly improve people’s lives and unlock exponential opportunities for DeFi and financial inclusion and freedom.
ENDS