The Tribal DeFi Mullet Manifesto
First principles for scaling DeFi while minimizing centralization risk
Crypto-powered lending is in crisis. Though centralized finance (CeFi) like Celsius, Voyager, and FTX spoke the language of crypto, they employed highly centralized and opaque decision-making processes, building houses of cards that ultimately came tumbling down, leaving ordinary people to pay the price. Satoshi was proven right once again: Financial systems that require trust in central intermediaries, whether TradFi or crypto-savvy intermediaries, leave unacceptable room for mischief.
In contrast, even amid crypto market turmoil, decentralized finance (DeFi) protocols like MakerDAO, Aave, Compound, and Uniswap have functioned exactly as designed, following clear, code-dictated rules for economic interactions. The lesson is clear: Hope for a trustless, democratic financial future lies with DeFi, not CeFi.
But a problem remains: in its current form, DeFi is only accessible and useful for a small minority of highly-sophisticated crypto users. For the vast majority of potential users, DeFi’s high technical barrier to entry and heavy collateral requirements make it a poor alternative to TradFi.
To surmount these challenges, the DeFi mullet model (“fintech in the front, DeFi in the back”) has been proposed as a way to bring DeFi to the masses. But can DeFi mullet products be successful without substantial centralization risk? At Tribal, we believe so. Read on for our thoughts on the power of DeFi mullet products, as well as core principles for infusing them with transparency and responsiveness to decentralized governance.
DeFi’s potential: Expand access to inclusive financial services
So far, DeFi’s principal benefit has been to enable greater efficiency and liquidity in crypto markets (e.g., through DEXs). This is helpful for the development of the crypto ecosystem, but it has limited benefits for the financial lives of most people. We believe DeFi can do so much more.
In our view, the true (yet-to-be-unlocked) potential of DeFi is to truly democratize access to credit, permitting more people to borrow the money they need to grow their businesses or finance their homes. Emerging markets (EMs) are particularly credit-starved. According to the International Finance Corporation, micro, small, and medium enterprises (MSMEs) in EMs have an unmet financing need of $5.2 trillion annually.
Thanks to the borderless nature of blockchains, DeFi protocols have the potential to extend credit to borrowers that might normally be excluded or priced out by traditional lenders. A healthy, inclusive DeFi ecosystem would connect eligible lenders and borrowers for mutually beneficial loan arrangements, regardless of their geographic location, resulting in more efficient global credit markets.
But DeFi remains inaccessible and uncompetitive for most potential borrowers
DeFi has two principal scaling challenges:
First, DeFi protocols often have high technical barrier to entry and a poor user experience. To access DeFi protocols, users must complete numerous, high-friction steps, each with potential points of failure. Even for crypto-savvy users, this onboarding process can be burdensome. But for average users, especially the millions of under- and unbanked consumers around the world, DeFi’s technical barrier to entry can be all but insurmountable.
Second, DeFi lending protocols have heavy collateral requirements for borrowers, often well north of 100% of the loan principal. For example, to borrow 100 USDC via Compound, a borrower must supply roughly $118 worth of collateral. Further, most DeFi protocols only accept highly liquidable assets (e.g., ETH, WBTC etc.) as collateral. This contrasts with traditional loans, which may accept items of value (e.g., a home, car, cell phone) as collateral. These high collateral requirements are necessary to mitigate credit risks and volatility risks related to the underlying crypto collateral, but they make DeFi loans unaffordable and unappealing for average borrowers.
The DeFi mullet can help connect the on- and off-chain worlds
First proposed by Ryan Sean Adams from Bankless, the “DeFi mullet” model suggests that fintechs can build a better UX/UI on top of DeFi protocols, allowing for seamless, intuitive access even by non-crypto-native users.
Fintechs have a long track record of building smooth, easy-to-use products on top of legacy payment rails. In the United States, for example, applications like PayPal, Venmo, and Cash App have made it easier for individuals and businesses to receive, send, and spend funds electronically. These applications build upon a range of traditional money transfer networks (e.g., ACH, card networks, and SWIFT for international transfers) to help users get their money wherever it needs to go.
Fintechs can do the same sort of building on top of blockchains and DeFi protocols. Indeed, “DeFi mullet” products are already launching to market. For example, major digital wallets (e.g., PayPal, Venmo, Cash App, and Latin America’s Mercado Libre) now permit users to buy, hold, and sell crypto assets directly within their applications. PayPal and Cash App also enable on-chain transfers.
Crypto-backed debit cards are a particularly powerful DeFi mullet product. Outside of markets like Venezuela, merchant-side cryptocurrency acceptance remains very uncommon. Crypto-backed cards allow customers to seamlessly spend their cryptocurrency balance (through instant crypto-fiat conversions) at the point-of-sale.
But what about the centralization risk?
On the one hand, especially in the early days of building, some centralization for crypto products might be helpful to optimize UX and unlock real-world use cases. For example, currently, a crypto-backed debit card is the easiest way to spend crypto to buy a cup of coffee. Until Visa is ready to sign an issuing agreement with a DAO (that would be neat), a centralized legal entity must exist in order to issue such a card.
On the other hand, centralization in crypto products can end in tragedy (see e.g., Celsius, Voyager, and FTX). Any crypto tools that rely on the good faith and trustworthiness of intermediaries will invariably risk abuse and capture.
So what does this mean for DeFi mullet products? How might centralization be counter-balanced?
First principles for a DeFi mullet product
At Tribal, our current thinking on the issue is this: Wherever centralization occurs, it should be accompanied by radical transparency and on-chain accountability.
On the transparency front, distrust of central actors should be the default setting in a DeFi mullet product. Any such actors should be made to constantly prove their good behavior on-chain in an ongoing manner to operate in the ecosystem. Any failure or delay in supplying this evidence would result in an immediate shutdown of access to the ecosystem. This on-chain proof of good behavior would be tailored for the specific use case addressed by the DeFi mullet product (see e.g. CZ’s suggestion that crypto exchanges submit proof-of-reserves). In the case of a crypto card issuer, this might consist of on-chain, easily verifiable attestations as to where withdrawn or off-ramped funds are going (e.g., to settle a card transaction in fiat).
But even more crucially, any centralized actors should be held strictly accountable to decentralized governance processes. This accountability would ideally be enforced through on-chain bonds posted by the centralized actor and subject to immediate slashing or confiscation in the event of abuse. Some protocols (see e.g., Centrifuge and Goldfinch) are experimenting with accepting real-world assets (RWA) as loan collateral, enforceable through off-chain legal agreements. But these mechanisms remain in their infancy, and for the time being, on-chain accountability is the best way to keep people honest.
In a successful DeFi mullet model, any centralized actors would be treated as service providers for DeFi protocols and their users, enabling helpful functionalities under strict conditions. We can imagine centralized actors in a DeFi mullet model like a clothing company hired to make t-shirts for a DAO. The clothing company only has access to the information (e.g., a logo) and funds needed for its specific task. If the company fails to deliver on the task, payment is withheld and the company can be immediately replaced by a better provider. And throughout the process, the service provider is responsible to a decentralized governance process.
Ok, so what next?
Building a safe, powerful DeFi mullet product is no easy task, but at Tribal, we believe it is best way to scale the crypto ecosystem. We look forward to sharing more of our thinking on this topic in future publications, addressing such issues as:
- How to reduce collateral requirements in DeFi;
- The role of underwriting in a DeFi environment;
- Enabling decentralized identity verification.