Issue #42: Move Slow and Don't Break Things
Facebook popularized the mantra “move fast and break things” and it was quickly adopted by the rest of Silicon Valley. The idea being, figure out what works and doesn’t work as fast as possible.
Pockets of DeFi have adopted their own version of this mantra with “I test in production”, meaning the quickest way to find out if this new protocol works is to release it into the wild and see if it survives.
Early on, this approach makes sense. But something changes when a blockchain or DeFi protocol reaches a certain level of maturity. There’s now an entire ecosystem of applications and users on top, and they are relying on the underlying platform to work. If an update or change is required, you want to move slow. You don’t want to break anything. The stakes are higher.
Let’s zoom in...
The Ethereum blockchain supports several vibrant ecosystems of assets and applications - DeFi, NFTs and gaming, in addition to hundreds of other decentralized applications. There are tens of billions locked in Ethereum DeFi contracts, and as of today Ether is a half a trillion dollar asset.
All this success comes at a price though. Transaction fees on Ethereum have risen sharply in recent years as activity on the network has increased. Even simple transactions can cost hundreds of dollars of ETH to process. The increasing cost to use Ethereum has alienated newer crypto users and created an opportunity for competing, more scalable L1s and L2s to offer a more affordable blockchain experience.
Transaction fees are based on supply and demand. There’s only a certain amount of space in each block. The more demand for the space, the higher the fees go, because users are willing to pay more to process their transaction first. Increasing Ethereum’s transaction throughput centers around transitioning from proof-of-work consensus (aka mining) to proof-of-stake consensus (aka staking) and sharding, dividing transactions across a number of “shards” and processing them in parallel.
Commonly known as ETH 2.0, this upgrade should dramatically increase Ethereum’s transaction throughput, lowing transaction fees on the network without sacrificing security.
The challenge is implementing ETH 2.0 without breaking the assets and applications running on top. It’s the equivalent of changing the engine on a moving car without losing momentum or injuring the passengers.
A change this significant takes time. It must be designed, built, tested, and then implemented in stages. Each stage requires industry-wide coordination.
ETH 2.0 was conceived in 2017 and the roadmap was officially announced in 2018. There have been a series of small, but significant upgrades to the network since then in preparation for the upgrade, but ETH 2.0 isn’t expected to be fully implemented until late 2022, possibly 2023.
That’s five years. Minimum.
Slow and steady is the name of the game now for Ethereum.
Don’t Break Anything
Composability is one of the defining features of DeFi. It’s the idea that each smart contract, or set of smart contracts, is a lego piece that can be integrated with other smart contracts to compound functionality. Composability a beautiful thing to experience, like a symphony of software.
It’s also a double-edged sword. When everything is working, things run smooth. But remove one of the core lego blocks, and things start to break. Like a digital version of Jenga. Removing a load-bearing piece destabilizes the tower and everything comes crashing down.
I group DeFi protocols into two categories: upstream and downstream. Downstream protocols are core protocols that everything else in the industry relies on. They are the technical foundation. Upstream protocols sit on top of the downstream protocols, and often pass their liquidity down.
Examples of downstream protocols include:
MakerDAO (central bank for DeFi)
Compound and Aave (borrowing/lending), and
Uniswap (asset exchange).
Examples of upstream protocols include:
Dozens of DeFi applications need access to cheap capital, so they integrate with MakerDAO, lock collateral and borrow DAI. Dozens of wealth management platforms need to generate a return for their users, so they pass liquidity to Uniswap, Compound and Aave to earn yield.
Composability naturally leads to downstream dependencies. So what happens when a downstream protocol needs to be updated?
A great example of this came in the wake of the recent Compound Finance bug that resulted in over $100M of COMP tokens being accidentally distributed to users. When members of the community proposed alternatives to fix the issue, the feedback from upstream protocols was “if you do that, you’ll break my application”.
See below screenshots from Yearn and Idle.finance:
The Compound community found a reasonable solution that didn’t cause too much damage, but it required a lot of input from upstream protocols to figure it out. At least one team - Origin Dollar (OUSD) - had to implement a change through their own governance process to accommodate the Compound patch. Pretty interesting.
The conclusion I’ve arrived at watching how L1s and large DeFi protocols evolve is this...if you’re successful building an ecosystem on top of your protocol, you inevitably become less nimble.
Composability forces the most composable pieces to harden.
At some point, protocols probably have to get comfortable with being good enough.
There are so many examples of this same concept playing out under different circumstances.
Early stage companies that haven’t found product market fit can invest in a radical idea or pivot quickly with virtually no consequences. There’s nothing to lose. As the company matures, it’s harder to make radical changes because you have an ecosystem of customers and partners relying on your product or service. The stakes are higher.
Similarly, when you’re young, it’s easier to take risks in your professional and financial life because you don’t have anything to lose. If it doesn’t work out, you can recover. As you get older, the calculus changes. You might have a family and kids that are relying on you for support. Your personal ecosystem. The stakes are higher, and you become less nimble.
Thanks for reading,
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