Stefan Grasmann on the Exciting Future of DeFi

29 Jan, 2021 · 4 min read

Stefan Grasmann is a computer scientist with over 30 years of experience in the software industry. As Managing Director of Zühlke’s Competence Center in Germany, a global innovation service provider, he is responsible for roughly 220 engineers, analysts, consultants, project managers and designers.

Grasmann’s recent series of blog posts covering his adventures in DeFi has been racking up thousands of views since he published the first one at the end of December. For anyone thinking about venturing into the space, the series will serve as an informative and entertaining jumping off point.

Recently, we looked at the challenges and opportunities for crypto adoption in 2021 with Jackie Berleen, and now we’re exploring how DeFi enters the picture. We reached out to Stefan Grasmann on LinkedIn amid his busy schedule to ask him some questions about some of the finer points of the DeFi landscape.

Keep reading to find out more.

CoinTracking: The DeFi projects you describe in your blog series seem to represent a completely new era in the ongoing story of blockchain’s emergence.

Trading crypto assets requires a certain set of skills. To trade crypto on a frequent basis you have to know how to interpret charts, place trades, etc.

DeFi projects that offer yield farming seem a lot more simple and beginner-friendly by comparison. They also seem to be more grounded in the real world, since there are a lot of practical things you can do with smart contracts and liquidity pools.

Do you think that the growth of DeFi projects will be steady from here on out or will there be boom and bust cycles (like BTC price swings) as DeFi matures?

Stefan Grasmann: I really thought about that question and it’s an interesting one. The level of complexity involved in DeFi investing is somewhere between day trading and HODLing. I think you can come from different angles.

If you already have invested in Bitcoin and Ethereum, you may wonder– can we make a bit more? That’s where DeFi has an attraction, since it allows you to earn interest on those investments.

Certainly there is risk with permanent loss, so you do have some exposure. You might need to lose a little bit of money to fully understand the concept of permanent loss. The second approach to consider is that DeFi allows the use of stablecoins.

If you don’t want exposure to volatility of Bitcoin and other cryptos, you can limit your investment in DeFi to stablecoins only – a stablecoin “pure play”. This may make DeFi look appealing to banks and institutions eventually.

DeFi’s search for maturity

CoinTracking: In your DeFi series, you mention how DeFi aggregators are beginning to emerge. Are you using aggregators only now or are you still experimenting with individual DeFi projects?

Stefan Grasmann: DeFi aggregators like Yearn Finance are promising because they seem to eliminate some of the risk involved in lower level DeFi investing, but they are not very mature yet. You don’t have control over the DeFi projects they decide to aggregate in their vaults. In fact Yearn was a one-man show for a while with Andre Cronje running everything single handedly.

Now there is a community that picks the DeFi projects that go into the aggregator, but it is anonymous. I would be hesitant and watch what they publish officially. If you’re investing small amounts of crypto, it may be better to use aggregators to avoid fees and other costs.

CoinTracking: Given the decentralized nature of DeFi projects, is there any way a government could shut them down? I find it hard to imagine how a government could shut down a decentralized exchange, for example.

Stefan Grasmann: As far as government intervention goes, the founders are still exposed, as long as they have a say in the government of the project and its revenue distribution. That’s why more and more DeFi projects issue government tokens and hand over governance to their community of token holders.

If projects are not completely decentralized (like Tether and Circle, for example), then governments might also be able to freeze users’ funds. However, DAI and other truly decentralized projects are harder to stop. Governments can’t stop the complete DeFi ecosystem but they can target certain projects. If one of the major DeFi gets targeted, the resultant fear could slow down the industry.

Most DeFi projects want to keep their operations legal. The cyberpunk oriented projects won’t mind going underground, but the big players will want to play by the rules. If you’re investing in DeFi, you should ask: what is this project’s stance on government cooperation? That should be an investment consideration.

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Does DeFi and ICOs have something in common?

CoinTracking: I like how you described all the ways that DeFi platforms are competing for investors by offering all kinds of giveaways and airdrops. It reminds me of the ICO era that came with the crypto boom of 2017. Is real innovation happening this time around or is DeFi just another passing crypto fad?

Stefan Grasmann: There are some parallels between DeFi and ICOs. The difference between them is that the DeFi projects usually have a running product before they collect money from investors — and that they want to attract long term investors.

There are more incentives for this now. So, the DeFi projects seem to have learned lessons from the ICO crash. However, beginner DeFi investors would be wise to be wary of the short term high-yield liquidity farming projects. They usually bear a lot of smart contract risk and might be an interesting target for hackers. Sticking with an established DeFi project for at least a year is a good rule of thumb.

Also, find out how the rewards are distributed before you commit. Often you have to pay a transaction fee to get the rewards. These fees add up – especially when rewards are paid in a weekly or bi-weekly cadence. This is what I discovered by investing in several different DeFi projects. As long as transaction fees remain high, it seems to make more sense to stick with a few well-known projects.

CoinTracking: You wrote that PayPal, Apple Pay and other payment apps are posing threats to the traditional banking system. Do you think blockchain technology– perhaps spearheaded by the DeFi space– will make these payment apps obsolete or rather contribute to their popularity?

Stefan Grasmann: PayPal gave confidence to the industry when it added crypto features in the US. Some people think that PayPal’s involvement is negative, but there are benefits for both investors and the payment apps themselves.

It’s the right move for PayPal and others to get involved now so that they can evolve with the space. Blockchain doesn’t have a killer app yet, but rollup technology, which offers lower transaction fees, could eventually offer competition to payment apps.

Stefan Grasmann: “Insurance could be the next big thing”

CoinTracking: In the first generation of blockchain projects, exchange hacks created some very real risks for individual investors.

By comparison, it seems to me that in the DeFi space, these risks don’t seem to be as much of a threat because of crypto insurance and other new safeguards. In other words, the DeFi jungle doesn’t seem to be as wild as the ICO jungle was in terms of security. Do you agree?

Stefan Grasmann: I’m a big fan of insurance and other things that have worked in the traditional finance world. Insurance could be the big next thing. These insurance projects will start with DeFi but they won’t stop there.

There will be other use cases but we are still in the early days. I think that insurance projects need to be integrated seamlessly into the apps. The claims need to be handled fluidly as well. Crypto insurance is not ready or mature yet but we will see enormous innovation here.

Zapper finance is a good example of how DeFi should feel like. It would be the logical next step to integrate different insurance options into Zapper. Insurance could also be aggregated, so that the cheapest option will always be selected. Traditional insurance companies aren’t fast enough to keep up with crypto insurance tech right now, so I don’t see them getting involved anytime soon.

CoinTracking: The potential for pump-and-dump style DeFi scams still seems to be very real. The video you embedded in your series highlights how impermanent loss is a potential risk factor for DeFi investors. Do you think celebrity-endorsed DeFi scams will start popping up soon?

Stefan Grasmann: I expect to see several DeFi scams appearing in the coming months. It is all open source. It’s easy for scammers to fork existing projects and create a questionable copy. Of course, we are in an upcycle now.

Everyone can promise yields in an up market. There is so much money in the markets but nobody is checking. Who can understand all the factors? I am a computer scientist, and I have a hard time analyzing projects and verifying DeFi smart contracts. The complexity there creates a trust issue.

Some DeFi project founders don’t even have LinkedIn profiles. Why are they acting anonymously? They could be afraid of regulations, which is understandable. But given this kind of lack of transparency, there will be a lot of money loss in DeFi soon.

People should be really careful. Find information about the project, the token economics and the people behind the project before you make a move. Established DeFi projects that already have tokens launched and listed on exchanges can attract liquidity faster.

However, the new kids on the block have an advantage because they can create new governance tokens and issue high rewards to attract liquidity.

CoinTracking: Could you explain what happened with Uniswap and Sushiswap?

Stefan Grasmann: In summer, the liquidity in Uniswap had eclipsed some of the centralized exchanges. Uniswap was the rising star among decentralized exchanges.

Suddenly, Sushiswap appeared arguing that since Uniswap was founded in a hackathon, it wasn’t really decentralized and still dependent on some VC investors. E.g. users didn’t have a say in Uniswap’s exchange fees of 0.3% in each trade on the platform. So Sushiswap simply copied Uniswap’s open source code and released their own token for yield farming.

Liquidity providers on Sushiswap earned the same trading fees percentage as on Uniswap and additional Sushi tokens on top. Everything was going well. Sushiswap attracted a lot of liquidity and users moved from Uniswap until the creator of Sushiswap sold all his Sushi coins and walked away with millions. However, he apparently felt bad and returned the funds to the project.

DeFi’s Future Landscape

CoinTracking: Do you think that projects similar to Sushiswap could spring up and cause problems for other DeFi projects?

Stefan Grasmann: There are still some projects out there that might suffer similar problems. Metamask, OpenSea and other projects that don’t have tokens yet might be vulnerable to this. In many cases, big parts of the software is open source.

Established projects want to take their time to develop a good token release strategy, but the demand for tokens could create more Sushiswap-type shenanigans. Eventually, after the DeFi landscape settles down a bit, this will likely be less of a problem.

CoinTracking: Do you think the DeFi space will collapse into a small number of dominant DeFi projects or will there be many small projects?

Stefan Grasmann: Compound, Aave and others will suck up liquidity, but innovation will happen on the UI to draw in more newcomers. We may see more layers of abstraction– perhaps two to four– and more players could enter into the space there. However, I don’t expect too many newcomers to shake things up.

On the other hand, Yearn has a huge amount of influence and they could help newcomers get off the ground. I expect a lot of turbulence to come in the competition for liquidity soon. It is so easy to attract liquidity at this point.

CoinTracking: Why is gas cost an issue with all the scalability tech that’s now available?

Stefan Grasmann: High gas price means expensive transactions that can easily eat up big parts of your yield. More innovation in this area should help drive down gas fees soon. Rollups are the best short-term solution for this according to Vitalik. DeFi projects are moving quickly and giving grants to rollup research projects.

There are, however, some pros and cons to them. Are they applicable in a generic way and compatible to existing DeFi contracts? Do they compromise security? DeFi creates a lot of value due to its composability with many projects playing together seamlessly. Rollups will only work out if this core feature remains untouched.

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Disclaimer: All the information provided above is for informational purposes only and should not be considered as professional investment, legal, or tax advice. You should conduct your own research or consult with a professional financial advisor when investing.