Reflection on the Decentralized Finance Ecosystem

Recently, the cryptocurrency market has undergone a severe deleveraging process, exposing some issues within the current DeFi ecosystem. This article attempts to explore potential development directions for the future DeFi ecosystem from the perspectives of privacy, credit, and decentralized identity.

1. Growth of Privacy Needs

This market turmoil highlights the importance of on-chain privacy. Although blockchain employs a complex address system, it is still possible to identify the identities behind accounts through continuous tracking and analysis. Therefore, we need more robust privacy solutions.

Privacy not only requires solving simple transaction anonymity but also needs to establish a larger ecosystem that includes various privacy applications to serve users. For example, institutional users may adopt multiple strategies to manage risk exposure in actual transactions, but currently, these behaviors cannot meet their privacy needs.

Projects like Aleo are attempting to build a privacy framework and system, on top of which various privacy applications can be developed. In addition to anonymous asset transfers, it also includes functions such as payments, providing liquidity, governance voting, and identity authentication. Only the interacting parties know the details, and malicious third parties cannot access any information.

2. Challenges Facing Credit Business

This debt crisis highlights the shortcomings of on-chain lending. On-chain lending is still in the early stages of the market, lacking a substantial amount of middleware and infrastructure, and some issues may require modular solutions, such as regulatory permissions, mature DID systems, and reasonable on-chain credit algorithm models.

The core of credit lies in the construction of the credit system and the qualification assessment of borrowers. Currently, mainstream protocols such as Maple Finance, TrueFi, and Goldfinch adopt some form of centralized evaluation model, lacking sufficient decentralization and transparency.

At the same time, due to the large interest rate spread between DeFi and traditional banks, it has created a situation where borrowers are unwilling to pay higher interest rates. This forces credit protocols to adopt methods such as token incentives. Currently, on-chain institutional credit businesses are still searching for suitable business models.

Although the over-collateralization model can better control risks, it also has some issues, such as draining liquidity from public chains, triggering debt ceiling problems, and exacerbating market volatility. In the future, it is necessary to explore better risk control models.

3. The Importance of Decentralized Identity and Reputation Systems

This crisis has also exposed the lack of native certification systems and decentralized reputation scoring systems in DeFi. Projects like ARCx are attempting to build a DeFi credit scoring system, but its actual effectiveness remains to be seen.

An ideal decentralized identity system should have the following characteristics:

• Trustless: Operate on any open network
• Flexible: applicable to any data structure
• Accessible: Supports various identifiers
• Pseudonym priority: No real-name registration required
• Composable: Information can be shared across contexts.
• Separability: Information can be segmented and encrypted on demand.

We need a minimal identity protocol to manage and route trusted data, while leaving other details to the creativity of developers. Projects like NFT3 are exploring this direction.

4. Future Outlook

The DeFi ecosystem is still in its early stages, and there is a long way to go. We need:

• Explore new tracks that can expand the use cases of Web3
• Strengthen education on the market and users
• Provide a good environment for developers
• Improve the retention rate and sustainability of the products

The traditional financial system has undergone hundreds of years of trial and error to establish the current order. The development of DeFi also requires time, but transparency and open code will be invaluable. Let us continue to work hard and jointly promote the healthy development of the DeFi ecosystem.