Distributed Ledger Technology (DLT) is the backbone of Decentralised Finance (DeFi), enabling secure, transparent, and efficient transactions among multiple parties who may not fully trust each other. DLT ensures that all parties in a network maintain a consistent and synchronised record of transactions. It excels at coordinating and aligning facts between various stakeholders, but, as Richard Crook insightfully noted in 2018, “there is only so much fun you can have on your own with a blockchain.” His comment underlines the reality that the true potential of DeFi is realised not through isolated efforts but through the dynamic interplay of numerous organisations within an ecosystem.
Understanding the DeFi Ecosystem and the Role of the Ecosystem Digital Twin
A DeFi ecosystem comprises many different organisations that interact and collaborate to deliver value. How these parties operate together defines the ecosystem, and understanding this interplay is crucial. A powerful way to represent and analyse these interactions is through an Ecosystem Digital Twin.
An Ecosystem Digital Twin is a live, digital operating model of the DeFi ecosystem that describes how services provided by each organisation combine to create value for the entire system. It is essentially a digital replica of the ecosystem, reflecting the roles, services, and interdependencies of all the participants.
Example: A Retail Central Bank Digital Currency (CBDC)
Consider a retail Central Bank Digital Currency (CBDC), which involves a diverse set of stakeholders:
- A network operator manages wallets and payment services for commercial banks, merchants, and citizens.
- A cloud provider potentially offers infrastructure and computing resources.
- A central bank issues the digital currency and oversees monetary policy.
- A DLT technology provider provides the distributed ledger.
- Commercial banks offer banking services to citizens and businesses.
- Payment System Providers (PSPs) supply payment hardware and software to acquirers.
- Acquirers provide payment services to Merchants and citizens.
- Merchants provide goods and services to citizens in return for the CBDC.
As we can see each of these entities provides a business service that contributes to the overall functioning of the CBDC ecosystem. Each organisation offers a service based on its unique capabilities, and these services are consumed by other organisations that in turn gives them new or enhanced capabilities. This consumption typically incurs a cost and is governed by contracts.
Why You Need an Ecosystem Digital Twin
The need for an Ecosystem Digital Twin can be understood by exploring three key audiences: explaining the ecosystem to investors, explaining it to regulators, and optimising the ecosystem’s operations.
1. Explaining to Investors
For investors, understanding the DeFi ecosystem is crucial for two main reasons:
Viability and Incentives: The viability of the ecosystem depends on understanding the value supplied by each business service to its consumers. The amount a consumer values or is willing to pay for a service determines the ecosystem’s incentive structure or economic model. These incentives drive behaviours, including investment decisions. An Ecosystem Digital Twin provides investors with a clear visualisation of these incentives, helping them assess the potential profitability and sustainability of their investments.
Confidence in the Business Plan: Building and integrating a DeFi ecosystem often involves significant upfront investment, and it may run at a loss initially as the ecosystem is developed and scaled. An Ecosystem Digital Twin helps build confidence by demonstrating how the ecosystem functions, the interdependencies, and the potential for growth. It gives investors a data-driven model to validate assumptions and projections, making them more likely to commit their resources providing the ecosystem with a longer cash runway.
2. Explaining to Regulators
For regulators, understanding the DeFi ecosystem is essential to ensure compliance and protect public interests:
Novel Business Models: DeFi can be viewed in two ways: as decentralised technology and / or decentralised operation and governance. Both interpretations often result in novel business models that require regulatory scrutiny. An Ecosystem Digital Twin provides a detailed view of how the ecosystem functions, allowing regulators to understand how existing regulations apply and where new guidelines might be needed.
Operational Resilience: Regulators are increasingly focused on operational resilience, not just for individual organisations but also for the ecosystem as a whole. They care about how the failure of one organisation might impact the viability of others—a phenomenon known as contagion. This risk is transmitted through the services provided and consumed by each organisation. An Ecosystem Digital Twin can map these relationships, helping regulators assess and mitigate systemic risks.
3. Explaining to the Ecosystem Operation
For those involved in running and optimising the ecosystem, a shared understanding of its functioning is crucial:
Continuous Improvement: Whether the ecosystem’s operation is centralised (as in a permissioned DLT like a CBDC) or decentralised (like MakerDAO), it must continuously improve to remain competitive and effective. Continuous improvement requires a shared understanding of how different parts of the ecosystem work together—what the fundamental processes are and how they operate.
Optimising Operations: With a shared model like an Ecosystem Digital Twin, each component of the ecosystem can be evaluated over time, improvements can be identified, and best practices can be implemented. This collaborative understanding helps ensure that the ecosystem evolves and adapts to changes in the market, technology, and regulatory environment.
An Ecosystem Digital Twin is more than just a model; it is a dynamic tool that brings clarity and insight into the complex interactions within a DeFi ecosystem. By providing a real-time view of how value is created and exchanged, it helps investors, regulators, and internal stakeholders understand and optimise the system. As the DeFi landscape continues to evolve, leveraging tools like the Ecosystem Digital Twin will be crucial for building resilient, transparent, and sustainable financial ecosystems.
