Last year was one of the most tumultuous in crypto history, yet moving forward in 2023 there are many reasons to be optimistic about its future while acknowledging the large problems that still need to be solved, according to the latest Pantera Blockchain Letter released this week.

“It seems fairly evident that the historical arc of the world’s financial rails will end up as blockchain-based systems using smart contracts,” Joey Krug, Pantera’s co-chief investment officer, wrote in the letter. “The real questions are how we get there and what needs to happen to get there.” Pantera, based in San Francisco and founded by Dan Morehead, is one of the original crypto asset managers and offered the first Bitcoin investment fund.

Krug said that two areas that  need to be improved for crypto to be successful are increasing the ease with which decentralized finance (DeFi) projects have access to money, known as liquidity, and making these same protocols as easy to use as possible.

More than $1 trillion was erased from crypto markets in 2022 as several large centralized institutions failed, including the hedge fund Three Arrows Capital, lenders Voyager, Genesis and BlockFi, and the second-largest crypto exchange at the time, FTX. Much of that failure was directly tied to borrowed money, or leverage, as we wrote about in our newsletter last week and as Krug points out. The alleged fraud and mismanagement have shaken belief in crypto for many and led to almost certain regulatory action.

To keep the industry moving forward, Krug said there needs to be more direct use of the Ethereum blockchain and an easier path for new money to flow into the system. That means institutional investors must be more comfortable deploying their cash into DeFi protocols, yet these same huge investors are tightly regulated by the U.S. Securities and Exchange Commission. The SEC unfortunately hasn’t given clear guidelines to investors about what digital assets or DeFi protocols qualify as securities which must be registered with the commission and traded on regulated markets. Krug mentioned Fireblocks and BitGo as helping in this regard, “but still other regulated custodians must also add support for using DeFi protocols. This should bring much more liquidity and capital into DeFi.”

Read more: DeCential’s 2022 Year-End Web3 Rewind

Another way to get more institutional money into crypto is to aggregate the capital on different blockchains. So, not just look for cash on Ethereum, but also on Solana and Avalanche ect. The problem is that the current way of doing that involves cross-chain bridges, which connect those various blockchains in a somewhat clunky and time-consuming way. There have also been several large hacks on cross chain bridges in the past year. Krug is not impressed with the current state of the tech.

“Many of the cross-chain bridges constructed to-date strike me as hacky — not in a cool ‘hacking the PlayStation’ sort of way but more ‘slapping some stuff together that really only works if you trust (insert trusted third-parties here),’” he said. Zero-knowledge proofs, a way of confirming the state of a ledger without giving away any other information about it, is a solution here, Krug said.

“Once Ethereum ships ‘single-slot finality’, [it] should enable the ability to bridge to other chains exceptionally quickly.  At that point, pooling liquidity becomes much more feasible,” he said. [That’s Krug’s punctuation, by the way, commas outside of quotation marks. We at Decential do not approve.]

The second issue to improve is the usability of DeFi. One pain point is the state of digital wallets such as MetaMask, Krug said. “I love MetaMask and what it’s done for the space as much as the next person, but there’s just something about the UX there that leaves me wanting,” he said.

Another problem is that transaction fees on Ethereum must be paid in ether (ETH), the blockchain’s native token. “The idea of economic abstraction solves this issue,” Krug said. “That’ll be a protocol-level native upgrade to Ethereum that makes it so you can pay transaction fees in tokens other than ETH.” This isn’t as clear as Krug might want his readers to believe, as EIP 1559 – implemented into Ethereum in 2021 – made it explicit that only ETH be used for transaction payments. It’s hard to see the entire community going back on that issue that was updated so recently.

Last year in terms of total crypto marketcap source: CoinMarketCap

Lastly, Krug said that decentralized applications (dApps) need to have an easy, non-centralized way to get fiat currencies – dollars, yen, euro – onto their systems. “A mass-market, Stripe-like integration, — where dApps can add a fiat on-ramp to allow users to buy crypto in a few clicks and where the fees aren’t exorbitant — doesn’t exist yet,” he said. “It needs to be embeddable as a widget within a UI, where no one controls the UI (i.e., dApps).  While cool, Stripe’s new crypto on-ramp product doesn’t solve the problem here.”

If these problems can be solved, Krug sees a path to where blockchain-powered dApps are on a person’s phone in a similar way we use smartphones for everything else today. “The average person will have apps on their phone that give them access to DeFi, where they’ll be able to engage in financial transactions without banks/brokers, with lower fees, global liquidity, and markets operating 24/7,” he said. “The Internet, but for finance.”

Looking back on 2022, Krug kept the spotlight on the centralized institutions – and not DeFi – that brought so much misery.

“While there’s a temptation to say ‘this time is different because…’, things are rarely that different,” Krug said. “While the exact cause of destruction was different, the theme of centralized entities failing because they were either hacked or became greedy and started doing sketchy/illegal things is a tale as old as financial markets.”

So what was different last year? “Three Arrows Capital, TerraLUNA, BlockFi, Celsius, Voyager, FTX, and Genesis have a pervasive thread: effectively lending vast amounts of capital to relatively risky counterparties, either without sufficient collateral posted or sufficient risk limits on that collateral, if any collateral was posted at all,” Krug said.

“What’s interesting to note here, on the other hand, is that decentralized finance protocols, which lent to largely unknown counterparties, didn’t blow up,” he said. Protocols such as Compound, Aave and Maker,  “force people to post collateral and enforce aggressive risk controls. The great irony is that those risk controls are the same kind of controls centralized entities often anecdotally said were ‘too tight, just inefficient’. They’d tell us, ‘these protocols can’t monitor risk like we do’”.

So while the year ahead should focus on getting more institutional money into DeFi while making it easier to use, the 2022 lesson is DeFi over CeFi.

“Nick Szabo put it best: ‘trusted third-parties are security holes.’” Krug said. “2022 crypto in a nutshell.”