Following the crypto hype-cycle of 2017-18, it’s safe to say that the industry has made some progress. Today, there is a spectrum of crypto-enabled financial services available; from stable coins, synthetic assets, peer-to-peer insurance, and peer-to-peer borrowing and lending, to name a few.
They challenge the established order of centralised financial services in ways that create new income-generating opportunities that are open and accessible to everyone.
Take peer-to-peer borrowing and lending marketplaces as one example. Think of this like Airbnb, where, instead of renting out your room, you’re renting out some of your savings to borrowers in return for interest. Where Airbnb allowed you to be your own hotel, now you can be your own bank.
The key difference, however, is that here there are no middlemen and there are no rent-seeking middleman fees. The only fees passed onto the user are those that are necessary to cover operating expenses to process the transactions.
A new system of community-delivered financial services that rewards its participants, governed by software running on the unbreakable, non-corruptible blockchain… It all sounds like riveting stuff.
But I wonder… What percentage of your social circle have taken advantage of the new income-generating opportunities that crypto-enabled financial services have to offer? I assume not many.
Even today, fewer than 5% of internet users in Europe own any cryptocurrency at all and, despite rapid growth, still only 0.000003% of global wealth is collateralised in Decentralised Finance (DeFi) services.
Source: DeFi Pulse (March 2020)
If this is our financial future, then why still are so few of us taking part? Ironically, the crux of the problem lies with the decentralised economic design of crypto networks. By rewarding network participants at the expense of middlemen, decentralised systems do a poor job of incentivising the very actors they rely upon to attract new participants.
Control and wealth are redistributed away from application developers, marketers and user experience specialists to be entrenched with miners, liquidity providers and low-level protocol engineers.
The end result is a negative feedback loop that deepens the inequalities of wealth and income in crypto-networks, as the new income-generating opportunities that crypto has to offer are inaccessible to those that have limited technical knowledge. This cycle threatens the long-term sustainability of crypto-networks, potentially impacting the incentive for new consumers and businesses to participate, and dampening the viral potential of crypto-economics.
Is it time to bring back the middlemen?
In recent years, we’ve seen a variety of companies step into the user experience abyss and try to make cryptocurrencies and crypto-enabled financial services more accessible.
Although there is some overlap, these firms can broadly be categorised into three groups:
- DeFi aggregators such as Argent and Zerion
- Crypto-friendly mobile banks such as Crypto.com and Revolut
- Cryptocurrency exchanges such as Coinbase, Binance and Kraken
While many of these apps have gained some early traction, we question their ability to break crypto into the mainstream and the sustainability of their business models, or lack thereof.
Breaking crypto into the mainstream
To change consumers’ financial habits, it would be prudent to assume that any new proposition should either be more rewarding and/or less risky than the status quo.
When we consider how rewarding some of these new crypto financial services are, at first glance the rates appear rather compelling. Typical staking rewards range between 7–10%, whilst interest on decentralised lending platforms ranges from 4–8%.
For crypto-natives, these services offer viable investment opportunities, given the risk/reward ratio. However, when you consider the time investment for an average consumer in education, trial and error and risk of moving their wealth into an entirely new, volatile asset class, the reward is simply not big enough.
Furthermore, if your money is lost on a crypto-enabled financial service, who can be held responsible? It was not Zerion or Argent’s fault when many of its users were affected by the recent MakerDAO fallout, losing millions in value or unable to move their assets due to congestion on the Ethereum network where gas prices rose to $564,000 on March 12th.
Business model uncertaintyBlockchain disintermediates and drives fees to near zero. Yet, the majority of these platforms have reverted to the traditional retail banking model of scalping fees on transactions and imposing subscription fees to access premium features.
A select few do not charge fees for now and are funding their losses via Silicon Valley strategy of selling equity until a large enough moat is formed to aggressively monetise, but neither of these approaches fills us with confidence.
We believe that crypto-enabled financial services represent a paradigm shift and demand fresh business thinking.
Is a new model necessary?
Wouldn’t it be great if there was a way of creating an accountable intermediary who provided the same service and support that traditional middle-men provide, but without the fees?
Well, in a previous post, we explored some of the new business models that are evolving out of crypto-networks. One such model, which we referred to as “Red-Hat 2.0”, involves distributing block rewards to value-adding businesses, allowing for a company to increase its revenues by building software that increases the utility of its token.
An organisation experimenting with this approach is Divi Labs, a development lab that is building a mobile bank and crypto wallet with DeFi add-ons. The underlying Divi blockchain is similar to alternative layer 1 protocols, whereby the native crypto-asset serves as a means to secure and govern the system. The Divi network rewards not only transaction validators but also front-end developers that will build applications serving to ease accessibility to the ecosystem.
As a result, front-end development businesses can build a profitable business without scalping middleman fees on transactions while offering enough of an incentive to develop and maintain good user experience. The end result is a mobile wallet where anyone with no technical knowledge can easily deploy a masternode, earn staking yields and access DeFi protocols.
That said, the viability of this approach in the long term will depend on how accurately performance is measured. Key ‘governance’ related questions will need answering, such as:
- How will block rewards be distributed meritocratically?
- What measures will be put in place to ensure accountability / public verifiability?
Note — the token model described above is fundamentally different to the few crypto companies that have also issued a crypto asset (Crypto.com / Binance) since the purpose of their token is usually to act as a discount token that compliments their fee driven model.
We believe that eventually, everyone will own a crypto wallet, in much the same way everyone owns a smartphone today. If we were to compare cryptocurrency to the early internet, crypto wallets are like the web browser or email client of tomorrow.
Blockchain should drive fees to or near to zero. But, existing wallets that are scalping or destined to scalp fees risk evolving into businesses that are either unsustainable or indifferent to web 2.0 applications. Until a new revenue model emerges offering equitable participation for front-end developers, we believe existing wallet providers will struggle to attract and retain mass-market users.
Our view is that these new business models will look something similar to how low-level consensus protocols operate and incentivise their stakeholders. Divi looks like a promising contender — we’ll be watching.