For the last few years, decentralized finance (DeFi) has emerged as a fundamental financial backbone of the digital assets space and as a parallel ecosystem to traditional financial markets. The space keeps evolving, creating new experiences and uses for participants.
The first few years of DeFi have been marked by the establishment of programmable financial primitives such as lending, automated market making (AMMs) or derivatives that could serve as building blocks of new financial services and applications. Lately, DeFi has begun powering more abstracted user experiences, building even smaller, more granular micro-primitives. This trend is happening everywhere in DeFi and challenges some of the established patterns in technology markets.
Jesus Rodriguez is the CEO of IntoTheBlock.
We are entering the era of DeFi micro-primitives.
DeFi micro-primitives are not an industry-acknowledged trend. I think we might be the first ones to have coined this term, but it seems to be happening everywhere. DeFi protocols are becoming more granular, more decentralized, more trustless and, yes, more complex. This trend seems a bit counterintuitive to the normal evolution of infrastructure technology and could have severe implications for the future of DeFi.
Conceptually, the idea of DeFi micro-primitives is extremely simple. Imagine taking the functionalities of an automated market maker (AMM), such as pool rebalancing logic, token swapping, and fees collection, and customizing each of these functionalities using different smart contracts. In this way, each functionality becomes its own micro-primitive.
Let's explore the notion of DeFi micro-primitives through the lens of familiar DeFi protocols:
- Uniswap v4: The proposed architecture for the largest AMM introduces the notion of Hooks as smart contracts that can incorporate logic across the lifecycle of pools. Unlike the current versions of UniSwap that include a single approach for managing the lifecycle of pools, v4 changes that by introducing new micro-primitives. For instance, Hooks can execute post-trade arbitrage logic and auto-compound LP fees to change the rebalancing logic.
- Eigen Layer: This popular platform that pioneered the restaking approach can be seen as a collection of micro-primitives for validators. Traditionally, validator clients encapsulate the entire logic of the validation process. However, Eigen Layer introduces the concept of an Open Marketplace that includes different security capabilities for validators. In this marketplace, validators can opt-in for each micro-primitive to enhance their capabilities.
- Maker: In their recently published Endgame, Maker fragments its capabilities further by introducing the notion of SubDAOs. Before SubDAOs, all functionalities of the Maker protocol were governed by a single governance and tokenomics process. The goal of the Endgame is to allow each SubDAO to focus on specific capabilities of Maker and follow its own governance process and tokenomics.
- Flashbots: The main MEV protocol is working towards the implementation of the Single Unifying Auction for Value Expression (SUAVE), which introduces new micro-primitives by unbundling the block builder and mempool roles from existing blockchains, offering a plug-and-play alternative. The current version of Flashbots has already taken some steps towards more decentralization with the separation of the proposer and builder roles, and now SUAVE is expanding that pattern with more micro-primitives. The SUAVE architecture includes micro-primitives such as the optimal execution market, which allows multiple executors to add their logic to provide the best execution for a given transaction.
There are plenty of other examples of DeFi micro-primitives within the new generation of DeFi protocols. By employing DeFi micro-primitives, these protocols are becoming more customizable, decentralized, and capable of offering a wider range of services. This trend could significantly shape the future of DeFi and its applications.
Counterintuitive DeFi micro-primitives
To some, the move to granular and extensible DeFi micro-primitives might seem counterintuitive. After DeFi has built a strong foundation for capital formation and trading with primitives such as AMMs, lending, bridges, or derivatives, one might argue that the obvious step is to create higher-level experiences that attract more capital into the space. Certainly, there are initiatives in that area, but now we have this trend of DeFi micro-primitives, which can certainly make the user experience in the space more complex.
Read more: Jesus Rodriguez - A New Blockchain for Generative AI?
The obvious benefit of the DeFi micro-primitive movement is that it makes DeFi more extensible, programmable and composable. An additional interesting benefit is that it might reduce the number of unnecessary forks of DeFi protocols when adding a handful of features, as these features can be well encapsulated as micro-primitives of the parent protocol. This could also lead to the reusability of security and robustness from larger DeFi protocols for smaller functionalities, avoiding the need to build smaller and potentially more vulnerable forks.
However, the DeFi micro-primitives trend also introduces plenty of challenges. For starters, the surface for attacks in DeFi protocols based on micro-primitives is drastically larger than that of more monolithic alternatives.
For instance, think about Uniswap v4 using hundreds of Hooks, each with several potential attack vectors. Additionally, if the level of complexity of DeFi micro-primitives is too high, it might hinder developer adoption, effectively making DeFi protocols more vulnerable with no obvious benefit in adoption. Striking the right balance between granularity and complexity becomes crucial for the success of this trend.
A more granular DeFi
In the coming months, we can expect more DeFi protocols to divide their functionalities into extensible, programmable micro-primitives. This will lead to a DeFi landscape that is more granular, flexible, and developer-friendly, but also more complex. If DeFi is to become a true parallel alternative to traditional finance, primitives such as lending and AMMs won't be sufficient to build sophisticated financial services. Smaller, more targeted, and programmable micro-primitives are necessary. As DeFi continues to evolve, the adoption of these smaller, focused building blocks will likely play a significant role in shaping the future of decentralized finance.