Why Privacy Will Play a Huge Role in DeFi’s Future

After the 2017 ICO bubble burst, anyone could easily dismiss the word “blockchain” as nothing but hot air, but not anymore. 81 out of the top 100 global companies already employ blockchain technology one way or the other. It has gone beyond cryptocurrency as its most obvious use case. With approximately 41 000 listed companies in the world as of 2019 data published by the OECD, powering a combined market value of more than USD 80 trillion, there’s still a lot to be done to bring more companies to adopting blockchain technology, especially DeFi’s revolutionary narrative.

This year, a meteoric rise in both individual and improved institutional interests with concurrent capital inflows into the DeFi — decentralised finance sector saw its TVL, the niche’s most popular metric, soaring to almost $200 billion in September 2021. Yet, from the unusual stickiness of DEXes — decentralised exchanges even with crippling transactions charge decentralised double digits APY (annual percentage yields) of lending protocols or the ease of stacking different protocols together to enjoy the money legos or DeFi composability, only just 5%-7% of wallets are involved in these groundbreaking DeFi activities. In a nutshell, penetration is still limited to just a few.

Chart displaying the TVL of the DeFi industry. Source

DeFi’s radical transparency cuts both ways

Trying to wrap your head on how much DeFi has grown within just two years since it picked up steam eludes even the most ardent DeFi advocates. No one would have thought triple-digit billions would be locked up in smart contracts today, so much so that DEXes now rival centralised cryptocurrency exchanges in daily trade volume. Last DeFi Summer (a season of increased activities around DeFi) when Uniswap narrowly overtook Coinbase in daily trade volume, it was all news. One year later, dYdX, another revolutionary DEX not even in the first eight most traded upon platforms, comfortably beats Coinbase. Why traders would opt for DEX over CEX is a no-brainer. Non-custodial, composability, multiple yield farming opportunities, and liquidity bootstrapping are among the few advantages of DEX over CEX.

Source: Antonio of dYdX

But just like a double-edged sword still cuts both ways, the radical transparency espoused by the idea of DeFi brings along with it some native problems. One such fact is that since anyone from anywhere can monitor the entirety of DeFi’s onchain transactions, it breeds front-running as a common problem most DeFi users face while interacting with some of their preferred protocols. Although this may not have been the original intention of creators of DeFi protocols, malicious actors can track and monitor incoming transactions before they execute onchain. With this sheer amount of information, even validators of a blockchain who are supposed to act in good faith helping to maintain a blockchain by confirming transactions can hijack incoming transactions causing others to pay more for their transactions. This is one of the cases where radical transparency, no matter how well-intended, can lead to bad outcomes.

Domain experts like Tim Rainer, CEO, and Co-founder of PolkaCipher, address this lack of privacy in DeFi transactions. In his words, Rainer says:

If individuals harbour these concerns, many more enterprises thrive on keeping their business edge secret to protect them from the severe onslaught from their competitors. So does it come as a surprise that even with heightened favourable coverage of DeFi by mainstream media, institutions with their leaders still posture a skeptical stance towards the sector? The apparent truth is that we just can’t wish away the concerns of privacy advocates for the DeFi sector without building the needed infrastructures to accommodate their concerns.

Privacy vs anonymity — one preserves the other could turn out catastrophic

One of the notorious misconceptions around the word “privacy” in DeFi and other crypto-related transactions is that privacy is an attempt at anonymising and obfuscating data for malicious reasons. Little wonder why some, especially regulators, still demonise the whole cryptocurrency industry even though less than 0.5% of all crypto transactions are tied to illicit activities. Yet, privacy bears stark differences from anonymity.

Borrowing a leaf from Rainer’s example, it is my right to keep the content of my wallet private away from the knowledge of just about anyone connoting that privacy is, in fact, a right. Apart from statutory reports from regulators, organisations do not appreciate their internal information and sensitive data flowing in the public domain unsanctioned. Privacy, therefore, preserves the integrity (more especially their financial transactions) of individuals and corporations. And only when entities try to anonymise their data to bypass regulations are they treading a line that could blow up their business integrity.

But beyond the permissionless nature of DeFi, institutions looking to venture into the space have regulatory requirements they have to conform to, like KYC, which is still largely within the private domain. As a result, open-source protocols within the niched DeFi sector, after serving retail users, now see reasons to roll out customised versions of their offerings. For instance, Aave, a leading lending protocol in its bid to break into the institutional lending sector, has had to roll out Aave Arc. The product implements the Aave version 2 code designed to allow institutions to enforce regulatory compliance. Working with Fireblocks, Aave Arc ensures customers can access permissioned lending pools within the ambit of pre-set rules in compliance with relevant laws depending on the user’s jurisdiction.

Off-chain data computation via zk-Proofs, a remedy for privacy concerns in DeFi

A common denominator amongst the latest Layer 1 networks is that most offer EVM — Ethereum Virtual Machine compatibility (ability to port assets between Ethereum to them easily and vice versa), from BSC to Avalanche or even Fantom. Others like Polkadot shine as a credible interoperable bridge between Ethereum, home to some of the most prominent DeFi protocols. Even Polygon, which has shot up to enviable heights among its Layer 2 peers like Arbitrum, Optimism, etc., rides on the wave of being the cheaper gateway to Ethereum.

Since the future of DeFi is multichain, it makes profound economic sense to break away from the siloed approaches to solving some of DeFi’s issues. Ethereum, Polkadot, and other base layers easily position themselves as settlement layers. Building bridges to these networks in such a way that allows for the exchange of information while not exposing sensitive data is the missing link. zk-Proof technology allows exchanging information without exposing this information, i.e. proving that you know something (could be a secret) without actually revealing that secret. An example of a Layer 2 infrastructure employing this technique is the zk-Rollup. The main idea here is that most of the data computation is done on a separate layer (offchain), reducing the economic burden of paying high transaction fees (gas charges) if they were to be computed onchain.

For us at PolkaCipher, our primary aim is to expand the applications of NFTs & DeFi use cases beyond the usual retail appeal into business settings, making it easy for entities to transition their legacy settings into Web3 applications. We aim to achieve all these with privacy at the forefront of each move. How so?

We are building a suite of products to address the lack of privacy within the DeFi domain as part of a comprehensive ecosystem. Some of these features are:

  • Privacy Protection
  • Data Matching Mechanism
  • Business Focused NFTs — bNFTs
  • Community Governance
  • Multi-chain Interoperability

We explained how bNFTs, one of our flagship products, help organisations looking to leverage Web 3’s tech stack in report sharing and payroll management in deeper detail here. As payment details and data are usually highly confidential, bNFTs ensure that this information is publicly viewable but encrypts confidential data. All the business adopting bNFTs needs to do is seamlessly mint bNFTs using PolkaCipher’s platform. bNFTs are PolkaCipher’s privacy-enabled business document solutions which can be privately minted, distributed, and collected. Businesses get to mint and then send a bNFT to their employees. The bNFT will include the stated data and access a specific fund that enables their payment. The bNFT can also be time-stamped and have an expiry date as to which period the employees will withdraw their funds. If there are any changes or removal of employees, an organisation or business can permanently lock the issued bNFTs to safeguard its privacy.

The novelty in the above example is that businesses can rest assured their adopted solution rides on the battle-tested nature of public blockchains while still enjoying needed privacy.

You see, privacy shouldn’t have to be a trade-off to DeFi but a crucial supporting component that has the potential of unlocking a vast trove of opportunities, especially the institutional sector still somewhat skeptical of the DeFi niche.

About PolkaCipher

PolkaCipher is a privacy-preserving oracle network on the Polkadot Blockchain focused on bringing the use case of private NFTs to off-chain businesses and be a bridge for seamless integration to on-chain Defi apps.

PolkaCipher’s unique offerings help push the use-cases of the NFTs in real-world scenarios while still being connected to a cross-chain network that is fair and accurate. PolkaCipher intends to achieve business goals by helping users transact privately and securely using NFTs as a mode of access to different decentralized apps (Dapps) and real-world business rewards.

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