Last year we saw the DeFi space boom independently from Bitcoin. The DeFi summer of 2020, as it became known, acted as a prelude to this year’s bull market.
It all started when the Compound protocol released its own governance token Compound (COMP), thus popularizing the concept of staking. COMP helped usher in the liquidity mining frenzy we see today and, during that time, we also witnessed how Yearn Finance’s native token, YFI, became the first cryptocurrency to ever surpass the price of Bitcoin.
With the recent price correction and looming predictions from analytics predicting bearish times ahead of us, is it possible that a DeFi summer 2.0 is just around the corner?
Characteristics of the last DeFi summer
The industry is much more mature now than it was last year according to the data. The Total Value Locked (TVL) on DeFi protocols now sits at $54 billion after peaking at $86 billion just last month, a massive surge from the $680 million registered at the beginning of 2020.
The volume and number of users on decentralized exchanges (DEXs) have also registered exponential growth with each passing month. Just last month DEXs reported a record of more than $140 billion in trading volume.
Interoperability wasn’t a thing back then either, which meant that DeFi projects operated primarily isolated from each other. Nowadays, thanks to the advent of cross-chain technologies, DeFi is becoming an increasingly connected space.
New trends in the DeFi market
The trend of food-related tokens like SushiSwap and Pickle Finance seems to be here to stay, but what else can we expect in the eventuality of a second DeFi summer?
There is now a surge of “second generation” DeFi tokens that offer a variety of use cases and a multitude of cross-chain liquidity partnerships, where protocols are able to leverage liquidity between each other. These second-generation tokens can be used in multiple different blockchains and can be used for different use cases such as minting NFTs, staking, etc.
New derivative services, including synthetic assets that represent stocks and other real-life commodities, new insurance services, from which Tether insurance is becoming increasingly sought after, and the continuous growth of the non-fungible tokens (NFTs) space are some other tendencies to keep an eye on.
Another trend that has been building for a while is the evolution of Automatic Market Maker (AMM) exchanges. This breed of DEXs provided an entirely new trading model and has taken the crypto world by storm. Instead of conventional order book-based exchanges, AMM-based DEXs allow users to trade directly with liquidity pools and use an algorithm to set up the prices based on the depth of the assets available.
Now, these exchanges are evolving and becoming more complex, providing aggregation models, privacy features, among many other useful tools that further add to the use cases of DeFi
New technology spells bullish signs for DeFi
Perhaps the most crucial development in the space is the scaling solutions being adopted.
With Eth 2.0 potentially still years away from its final release, the high fees and congestion of the Ethereum network have highlighted the need for alternatives. The state of the network has improved considerably in recent weeks, transaction fees have already plummeted from their all-time highs due to fewer transactions, but there is a growing usage of Layer 2 scaling solution like Polygon (MATIC).
Older networks like OMG, previously known as OmiseGo and of one the oldest scaling solutions, and Raiden network, Ethereum’s version of Bitcoin’s Lightning Network may be not meet the high demands of the DeFi ecosystem.
Binance Smart Chain (BSC) has gained a lot of ground in the last couple of months, foregoing some decentralization in favor of scalability. But although many DeFi projects choose to migrate to or adopt BSC, the network has recently been faced with congestion and a rising number of attacks on its DeFi projects.
On the other hand, Polygon is now emerging as a serious contender, recently surpassing BSC and even Ethereum in daily transactions. Polygon offers many scaling solutions that include sidechains and rollups, a technology to bundle transactions off-chain. Many Ethereum native DeFi projects, such as Aave and Kyber Network, are migrating to Polygon as the platform becomes fast-tracked to become the go-to scaling solution.
Impact of institutional investors flocking to DeFi
After the large $1.5 billion Bitcoin purchase by Tesla, more and more companies are looking to enter the crypto space.
Seen as a valuable and secure store of value, Bitcoin gives institutional investors an alternative form of investment and a hedge against fiat inflation and geopolitical uncertainty.
DeFi, however, takes it a step further. Yield farming protocols offer a most valuable alternative to traditional banking interest rates, which are already near-zero in countries like the US. A multitude of different financial assets catered towards institutions is also being developed on the blockchain, including decentralized insurance services like Nexus Mutual that allow significant risk mitigation.
Institutions also worry about the legitimacy of DeFi platforms, that is why the Chicago DeFi alliance and other companies like Trustology are launching liquidity launchpads that act as “DeFi firewalls”. DeFi projects are filtered and evaluated in terms of compliance, governance, and smart contract code for institutional and professional investors to safely enter the industry.
While multiple venture capital firms like Grayscale and Chicago DeFi alliance have already dove into space, extensive blockchain research also shows that several Ethereum whale wallets belong to larger Fortune 500 companies such as Microsoft, IBM, Amazon, and Walmart.
With added capital flowing into the market from these companies, the DeFi space will gain credibility and become more liquid and less volatile.
What can we expect in the long term future for DeFi
The potential of DeFi is so great it is often hailed as the future of finance. We are witnessing the democratization of financial services, as DeFi allows anyone to build their own financial instruments and share them with others over the blockchain.
In a recent interview, shark tank investor and crypto enthusiast Mark Cuban was quick to highlight the considerable threat DeFi poses to traditional finance, stating that “banks should be scared.”
Replicating the current financial infrastructure on the blockchain could prove highly beneficial and help reduce costs in global payments, investment banking, and asset management. The advantages of automated and trustless systems like DeFi could potentially cannibalize a large portion of capital currently held in the traditional financial market.
However, it is almost sure that both ecosystems will co-exist. Some of the great advancements concern interoperability within the sector itself and building bridges between DeFi and the traditional financial sector.
Improved oracles, which feed increasingly more accurate real-world data, as well as crypto-backed derivatives that represent real-world commodities like stocks are some examples of increased interconnectivity between DeFi and CeFi.
The road ahead
However, for mainstream adoption to happen, user experience needs improvement. Complex protocols need to be made even more straightforward for end-users through friendly interfaces. Another major hurdle is also the lack of legislation.
In order for Decentralized Autonomous Organizations (DAOs), the governance model behind many DeFi projects, to have an impact outside of crypto, they must abide within a legal framework. However, the whole DeFi is still in the wild west stages and resembles the ICO craze of 2017 with unsupervised activity and a lack of regulatory clarity and Know Your Customer (KYC) policies.
If these hurdles can be overcome, it only speeds up the DeFi revolution that will happen in upcoming decades.