DeFi Defensibility: How Decentralized Protection Works

Decentralized Finance or DeFi can be defined as an ecosystem of financial applications that run on the blockchain (Ethereum, Binance Smart Chain, etc). DeFi enables traditional financial services: lending, borrowing trading, asset management; without a single entity having control over user-assets. According to DeFi Pulse, there are over $79.34 billion in total value locked in DeFi. One of the key defining factors of any decentralized finance place is DeFi defensibility.

DeFi Pulse - Total Locked Value
Source: DeFi Pulse – Total Locked Value

Staying Ahead of the Curve

There are certainly competitive advantages that can give a protocol a lead in the competition, such as capital, teams, timing, and its unique strengths, however, these might not allow it to stay ahead of the curve.

Bancor for example is an on-chain liquidity protocol that enables the automated and fully decentralized exchange of crypto assets on Ethereum and had the advantage of being the first crypto automated market maker (AMM) when it originally launched in 2017. Furthermore, it had a capital advantage by having a $153 million token sale.

However, after it, we saw Balancer and Uniswap which came to the market and overtook Bancor by a long shot in terms of market cap, as well as value locked, trading volume, and anything else you might want to compare them to.

This means that in order for a protocol to succeed the most it has to leverage all of the competitive advantages it has so it can kick start its path to success, however, it also needs to be able to craft its defensibility master plan and take advantage of the early success it ends up achieving as-well alongside all of this, which brings us to the next point of staying ahead of the pact.

The Frontline 

If you want to determine your competition, you need to look at it from the point of perspective of a barrier of entry. There are two main ways through which you can achieve a high level of success and remain ahead, and this is through building brand trust and ecosystem strength. This makes a protocol unforkable as a result.

Brands can be seen as consensus systems through which reputation, as well as narratives, can pop up from users that share their impressions. One of the main functions of a brand is to signal quality by letting the protocol’s funding team and key stakeholders play an iterated game. Brands can get a reputation through their interaction with both the stakeholders as well as the community.

Trusted brands are earned over time, and in the case of decentralized finance (DeFi), until a protocol matures past its progressive decentralization, its brand is about its trustworthiness. 

There are two core components to building trust, one is social, and the other is technical.


Think of it from the perspective of a potential user of the protocol, they might be asking themselves, why should I trust the people behind the protocol, and does the platform align with the values that specific person has.

Compound, for example, is an open money market protocol, where Robert Leshner is the founder and is an active member of the DeFi community. This led to public discussions of governance proposals as well as industry trends. There are also VC funds such as a16z that have backed Compound as well. Its brand, as a result, is an elite one that a user can interpret however they want to, however, for many people, it means that the founder isn’t really going to give up on the project in the near future. Do anonymous founders such as the ones behind SushiSwap have this kind of defensibility to back them up? This reputation plays a key part in the trustworthiness of the protocol.

Moving along, you have Synthetix which is an open synthetic asset issuance protocol that is built on Ethereum. Havven was its original name, and it was originally called a scam by many of the Ethereum community members in its early stage. However, it is now seen as part of the DeFi establishment and has received a lot of backing and investments.

Synthetix succeeded in building a brand through its founder Kain and the team who engaged with the community directly and mentioned things as transparently as possible every step of the way. The tokenomics also helped the platform get a lot of interest, however, it was the team’s consistent and transparent communication that helped the platform build a trusting relationship in its community and gave it the high level of success it has today. 

Then we have Yearn.Finance which is a DeFi yield aggregator built on top of Ethereum, where the community alignment and the idea of a fair launch proved to be one of the most powerful tools when it came to quickly build a trustworthy brand. When each new user publicly asserted their support, belief in the protocol grew quickly which resulted in more value accruing for each YFI stakeholder. 

When we take all of this into consideration, we can come to the conclusion that social network effects, such as the ones listed here have historically proven to be extremely powerful.

Keep in mind that even though Yearn climbed up the ranks quickly as the community built the DeFi platform, its untainted reputation over time lost its touch. A DeFi platform’s brand can only truly become solid when it is not affected by single points of failure. Founding teams have to put in the work and keep adding to their credibility in order to achieve their rewards later on.


This is a difficult task, however, focusing on the things that matter can be a good starting point. Protection is a must-have, as liquid investors will typically classify the riskiness of a protocol based on the length of time it has gone without getting hacker or compromised. In other words, the longer a protocol has been online without any kind of breaches that have occurred to it, the longer it is likely to continue that trend, and as such, trust compounds over time. Furthermore, you can look at it from another viewpoint as well, due to the fact that even if there is a flaw in the code, it does not specifically mean that the code or protocol should not be trusted. 

If a protocol has just recently launched, it does not mean that it has to start with zero balance in its trust account, as builders have the opportunity to develop much greater trust by open-sourcing the code and creating amazing documentation that engages the community with bounties for the specific bugs and runs incentivized testnets. The main pattern you might have noticed in all of this is that transparency brings with it a high level of reputation, and being communicative with your community when any issues arise can make or break your brand.

Incentivizing Success

When we experience upsides as well as downsides, we might tend to care about the outcomes in a specific way. DeFi systems typically contain direct and indirect stakeholders every single one of which will have different motivations and as such have different incentives to do things the way they do. In any case, symmetry is essential, and the contribution is one of the main aspects of importance. This indicates how a protocol can be designed that incentivizes the most value to be exchanged between a protocol and its stakeholders, and this is done through a close alignment between the stakeholders and the protocol. 

Direct Stakeholders

Direct stakeholders can include liquidity providers or LPs, developers, token holders and so on. They can be thought of in the sense of community, as they have primary exposure to the ups as well as the downs of the success of the protocol, and rely on its defensibility as a result. 

Data that is relevant to this can include diversity and frequency of community-driven contributions on GitHub as well as the community-built tools and the number of interactions on social media platforms such as Discord alongside the level of community engagement in the governance process. Think along the lines of the comments on forums or the numbers of the proposals as well as the proportion of the network staked. This activity is used as a data point with the intention of building up a reputation for relevant contributors that can be rewarded in economic and non-economic ways by the protocol alongside the initial stakeholders. 

To further bring this point across, Uniswap made a lot of its earlier supporters happy by allocating 60% of its tokens to the community.

Uniswap - Genesis UNI Allocation
Source: Uniswap – Genesis UNI Allocation

The buying power of each of Uniswap’s winners might be small on an individual level, however, it is powerful when we see it from the perspective of an aggregated basis. 

We can also look at SushiSwap here, which showcased those incentives can have impressive short-term effects in terms of growing supply and demand, however, without sufficient trust in direct keyholders, the effects might not always turn out the way you intend them to be.

SushiSwap was saved by FTX’s founder Sam Bankman-Fried who supported the protocol after SushiSwap’s founder Chef Nomi’s exit became public

He had a good reputation and had laid down some groundwork through his involvement with Almeda’s capital locked in the network. With this increase in credibility, public figures started staking their reputation publicly through agreeing to be involved which gave the project a lot more groundwork for the success of the governance proposals. 

Despite this success, however, the launch of Uni removed much of the incentives for users not connected to Almeda to continue supporting the project, and as such, we saw a case where the community contributions had to go beyond liquidity provision or demand for the service on the platform in order to equate its usage. 

Specifically, the case with Chef Nomi showed us the impact the decision had, where stakeholders did not show any symmetry in their commitment to the protocol. In fact, long-term commitment to anything has to go both ways for it to work. Imagine how well Sushi might have progressed if Chef Nomi distributed control of the protocol to key stakeholders. This would have given it the change it needed to evolve more efficiently and quickly, as governance is not the only thing that defines control, however, it enables systematic evolution and defines defensibility.

We can always take a look at Chainlink as well, which serves to be yet another example of a protocol that has an engaged group of stakeholders, While we can clearly see that the token price is what incentivizes the marines, it is important to see that much of its incentives are also in the highly engaged community which has encouraged other protocols to integrate with Chainlink and take advantage of the aforementioned marines. 

More integrations increased the price of LINK, which incentivized the marines even further. 

So, ensuring that stakeholders groups have their teeth slinked in the protocol can give you a successful outcome in regards to the protocol’s level of popularity and acceptance, and it is one of the most powerful ways through which a protocol can be built. 

A protocol’s biggest barrier to a fork Is to maximize the voice of its stakeholders, which makes them more likely to believe that they can suggest changes which in turn would increase the platform’s benefit. This increases their reputation as well and makes them more serious about the protocol, as they would have more to lose by leaving, and the best way through which this can be achieved is through governance. 

Indirect Stakeholders

Indirect stakeholders are the B2B relationship or the protocol-to-protocol relationships. They can be thought of as other protocols that the protocol integrates with. These relationships typically differ from direct stakeholders, as the indirect stakeholders will only have secondary exposure to the ups and downs of the success of the protocol. 

As an example, we will be yet again looking at Uniswap. You see, Uniswap’s sUSD pool for Synthetix has played a key role in providing liquidity for many other upstart protocols. These protocols benefit from Uniswap’s liquidity and are incentivized to see it succeed. They send more value that way as a result. 

Then you have Ren’s integration with Curve, where Ren managed to bring hundreds of millions of dollars in BTC (Bitcoin) to the Curve platform and both Curve and Ren incentivized each other’s platform to succeed due to this. Their communities were in turn incentivized to support each other with big catching, governance protocols, and so on.

DeFi Defensibility Summary

When you look at the network effects in decentralized finance (DeFi), and compare them to traditional technologies, they are weaker. There are in fact two types of relevant network effects in decentralized finance (DeFi) and these are the two-sided liquidity network effects and the bandwagon network effects.

Speaking about the former, it is in regards to more supply-sider capital, which leads to lower slippage for the demand side that incentivizes more supply-siders. Speaking about the ladder, it is in regard to the belief in something, such as a protocol’s approach to governance and the fairness of its launch. 

Economies of scale effects can serve the role of a measurement of how well costs can be saved at a scale. They will be a powerful tool for the leading decentralized finance (DeFi) platforms, as the scale will make gas optimization and transaction batching a lot more efficient. 

So, you have trust in the sense of a social aspect, there you need to communicate publicly and transparently with your stakeholders and be consistent while acting in accordance with the protocol’s staked ethos and values. 

Then you need to have trust in terms of a technical aspect, where you can successfully protect the funds of your users and open-source your technology, while also being able to communicate publicly and transparently about any of the risks or failures. 

Furthermore, there are direct stakeholders, where you can engineer reciprocity in all protocol and stakeholder relationships, where symmetry is important. 

You can build a specific, stakeholder-owned platform that has a governance model that optimizes long-term incentives, and consider how to give back to the community with the goal of building status, reputation, and a brand voice. 

Then you have indirect stakeholders, where you have to consider how to give back to the platforms that might integrate or have integrated with your protocol, and see how to best engage with them and how to give them even more of a foundation through giving them access to more of the ups and downs of your protocol’s success.

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