Year in Review: Shaping the Next Wave of DeFi Innovation with Cumberland Labs

Written by: Naveen Agnihotri and Tama Churchouse at Cumberland Labs

Naturally occurring wildfires, while disastrous on the surface, serve a fundamental purpose to their respective ecosystems. They release valuable nutrients in the litter of the forest floor and open up forest canopies to sunlight, stimulating new growth and clearing away the excess decaying vegetation to make room for new life.

The bear markets we’re currently observing in crypto markets fulfil a similar need: to eliminate the deadwood and the excesses (sometimes spectacularly so) that characterize the antecedent bull market bubbles, making way for the new shoots of growth that germinate amidst the destruction.

Cumberland Labs is a team of blockchain developers, product managers, traders, founders and business builders with a mission to ideate and build products internally, as well as partner with founders and creators to launch the next generation of Web3 ventures.

Part of our focus on the ultra-early stage of blockchain product and business development involves assessing what will take root in the aftermath of such a combustible 2022.

To frame our outlook, last year (2021) witnessed a crescendo in terms of crypto asset prices and blockchain venture capital valuations and deployment. The liquid crypto market peaked in November 2021, with a subsequent peak in terms of venture capital deployment (approximately $12.7b) in the first quarter of 2022, some 12x the amount of Q4 2020.

The fuse may have been lit by the Luna/Terra collapse, but if not that, then something else: the rapid buildup of deadwood and excesses throughout the ecosystem needed to be burnt out, and so they have.

Going forward, we believe that a core component of industry growth will come from the next wave of innovation in DeFi. Contrary to seemingly widespread belief, DeFi has been a foundational component of the industry far earlier than the DeFi summer of 2020. Well before even the mainnet launch of Ethereum in 2015, decentralized exchange ‘Bitshares’ went live, which itself was inspiration for Rune Christensen’s ‘Maker’ protocol.

The notable adverse events that have defined 2022 – the Luna implosion, high-profile failures in Celsius, Three Arrows Capital, and FTX amongst others – will fundamentally shape this next wave of DeFi innovation.

First, the “trust” that was mistakenly placed in individuals and companies operating in grey CeFi will be replaced with the black and white “trustless” nature of open source blockchain. Throughout the year, DeFi has excelled against the backdrop of severe market turbulence and operated as normal. In the immediate aftermath of the FTX collapse we heard louder calls on centralized exchanges for increased transparency in terms of proof-of-reserves, an admittedly crude measure with which to ascertain audit-level balance sheet transparency; we expect the industry will continue to demand more on chain. It will no longer be acceptable for an industry purportedly built atop the transparency and trust that blockchain provides to not directly embed those principles into its own businesses.

Second to trust is “privacy”. Fully open ledgers will never be the basis upon which DeFi can go mainstream. If you don’t want your existing bank account, investments and transactions residing in a publicly readable database now, then why would you accept that in crypto? Historical technical limitations are the only reason technologies like zero knowledge haven’t been widely implemented yet. But the last two years have seen huge advances in capabilities, and we expect privacy to be fundamental in DeFi innovation over the near to medium term.

We are already seeing a trend of CeFi-DeFi hybrid approaches that leverage the strengths of each respective area to provide a best-of-both-worlds approach. A good example is Hashnote, a company backed by DRW and supported by Cumberland Labs. Hashnote leverages the transparency and security of on-chain options vaults, with a regulated and fully compliant investment wrapper, providing an investment product that is superior to both its traditional CeFi and DeFi counterparts. Ankex is another example, a hybrid derivatives exchange that seeks to pair the liquidity and low latency of centralized exchanges with the self-custody, full proof of reserves and on-chain settlement of DeFi.

And we will continue to see growth flow to companies and protocols focusing on a single shard of the DeFi stack rather than attempt to provide a full stack solution, with composability as a must.

Finally, we expect that DeFi built with a grounding in established institutional and regulatory frameworks, which leverage trust, privacy and a hybrid approach, will more easily find capital, traction and ultimately product-market fit. We are particularly enthusiastic about the public launch of protocols like Canton from Digital Asset, which we are building on. Canton offers application-specific privacy on a public enterprise-grade blockchain with a strong suite of established companies already building and deploying independent sovereign applications.

Bear markets make our job as an incubator and capital allocator easier. Founding a company and getting funded are far more challenging for entrepreneurs in this environment. The rising tide of a late-stage bull market will not lift your boat. Founders need demonstrable grit and determination, not to mention a far more compelling product or business idea today, compared to 12 or 18 months ago. By the same token, substantial headcount reductions spanning the entire technology sector as well as the blockchain industry mean that while capital is scarcer, tech talent is more abundant.

This crypto market wildfire has burnt off the marginal capital for the marginal founder with a marginal business idea. Now is the time for the strongest founders to build, and we will be there alongside them.

Read Part 7 of our Year in Review series, “The Importance of Trust.”