Radical rethink: How ReFi can help DeFi to build back better

DeFi is in a state of flux. On the plus side, DeFi protocols have boldly democratised inclusive financial instruments previously only available to the financial elite. But for all the innovation, the bear market has forced a cascade of deleveraging that has led many to question whether the emerging DeFi ecosystem can survive. Critics have welcomed DeFi's implosion because they question its bold claims about decentralisation and democratisation.

But from the old emerges the new, offering a more robust, anti-fragile platform to improve the financial status quo: ReFi. Also known as regenerative finance, ReFi aims to use blockchain technology to help tackle climate change, support biodiversity and conservationism and build a fairer financial system. And it is built on solid foundations.

So what should the next iteration of DeFi look like? Here are three lessons that advocates of decentralisation can - and should - borrow from the burgeoning ReFi space.

1.Diversify with the help of real-world assets.

We've recently seen how a system built entirely around web3 assets that is also collateralised by web3 assets can unwind cyclically (and rapidly) during a downturn. The downturn in the web3 space is largely because DeFi protocols were built entirely around web3 assets that were also collateralised by web3 assets inherently price-linked to the protocol itself. Basic portfolio theory (and common sense) dictates that the less diversified a portfolio, the less resilient it is to shocks.

There is another way. Asset diversification is not a new concept for any investment portfolio but is critical for the next iteration of Web3. For example, a stablecoin partially backed by carbon credits – an asset class that has largely retained its valuation – would be far more resilient in any future bear market. Likewise, DeFi loans collateralised with real-world assets (RWA) would be protected from cyclical web3 downturns.

The beauty of ReFi is that it introduces a generational economic transition that incentivises regenerative assets over extractive financial instruments, instead creating profitable returns to investors using underlying assets that support regenerative practices. Where DeFi captures value, ReFi creates it. At the heart of the shift towards ReFi lies the carbon markets; carbon credits are real-world assets that represent climate solutions and regenerative projects across the globe.

2. Double down on consumer protection.

In its early phase, DeFi has proven to be a double-edged sword. On the positive side, Web3 protocols offer a ‘trustlessness’ (in web3, trust is placed in code rather than in centralised institutions like banks) and a depth of verification never before seen in traditional markets, which is a big stepping stone on the path to the democratisation of finance.

On the negative side, a lack of regulatory protection often leaves unwitting consumers in the lurch. Some DeFi adherents revel in this fact – presenting the unbridled capitalistic instincts of 'degenerates’ as an attribute almost to be welcomed. But this failure to protect users is a self-destructive trait that threatens the undoubted benefits of DeFi.

ReFi, inherently, is more minded to protect consumers – a fact that is evident in the context of real-world assets like carbon credits. Put simply, bringing RWAs on-chain requires integration with real-world infrastructure. This infrastructure often comes bundled with complex structures and stringent regulations. For this reason, web3 – naively - has largely ignored RWA until now. It's also why trailblazing projects like Toucan that have tried to circumvent legacy institutions in the carbon market have been roadblocked by those players. 

True, the legacy system for voluntary carbon credits is slow-moving. But the reason for this is strikingly simple: consumer protection. If the builders in web3 are serious about democratising finance, they must follow the ReFi lead and protect users. This approach involves taking the parts of the legacy system that are mandatory for such protections - like independent quality assurances - and combining these with the swift iteration that web3 offers.

In the case of the carbon market, innovators are exploring ways web3 can democratise access. But their approach involves collaborating with legacy institutions to restore confidence in the underlying carbon credits and to ensure they can be used within innovative, regenerative financial products across the ecosystem. Ultimately, the benefit to DeFi innovators is that web3 can leverage the years of effort undertaken by legacy carbon gatekeepers to protect consumers and build trust in the market.

3. Embrace ReFi pioneers as paradigms. 

There is ample opportunity to build foundational infrastructure for the carbon markets in web3, and early adopters have noticed this. Several ecosystem heavyweights have pledged capital and resources to foster a new, more responsible and resilient iteration of web3, paving the way for others to follow suit and expand ReFi into new areas.

Polygon has retired over $400,000 worth of credit and pledged $20m to become carbon negative and support community initiatives.

Ripple has committed an incredible $100m to strengthen global carbon markets, with a considerable allocation toward blockchain initiatives. 

Celo is working to responsibly collateralise its stablecoin reserve with carbon credits to ensure adequate diversification as part of its mission towards regenerative finance.

There is a real opportunity for DeFi to follow the example of ReFi and reconsider the possibilities for a more resilient and responsible iteration of web3 infrastructure. This rethink could have the added benefit of returning some of the liquidity DeFi has haemorrhaged in the last year. 

Final Thought

The idea of working with legacy structures may seem like anathema to DeFi purists. But the truth is that innovation rarely involves building an entirely new infrastructure. In reality, it is more complex than that, requiring a bridge between the legacy and the future. The lesson here for DeFi is that if trust in the underlying asset itself is non-existent, web3’s benefits are useless. The next iteration of web3 must derive legitimacy from the real world.

No one knows when today's bear market will turn, but ReFi tells us we have a rare opportunity to build back better. We can embrace DeFi's promise of decentralisation and democratisation while ramping up adoption and safeguarding resiliency. And the tenets of ReFi - including bridging to real-world assets - offer a roadmap for how to get there.