Is the quiet DeFi world at a turning point: A review and outlook

The recent market response to DeFi has been lackluster, with the focus of the market shifting away from it. Discussions related to DeFi have also decreased in intensity compared to last year. However, has the DeFi market truly come to an end? Or are we at a turning point now?

This article is sourced from "DeFi – Past, Present and Future," translating the content of the video and adding to it. Readers are encouraged to use this in conjunction with the original video for accuracy.

With NFTs, the metaverse, and DAOs becoming the focus of the public and funding, DeFi has lost momentum for a while. Tokens in the current market have lost 90% of their value for various reasons, including DeFi 2.0 losing growth momentum, DeFi contracts being vulnerable to hacks, regulatory uncertainties in the future, and the negative effects of individualism worship. On the other hand, considering that protocols built in the past are still functioning normally, the DeFi ecosystem on Layer 2 is just beginning, and multi-chain DeFi is in a rapid growth phase, can we expect a revival and prosperity of DeFi in the future?

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This article will review the history of DeFi, analyze its current state, imagine possible future developments, and speculate whether the current DeFi market has reached a turning point.

The Past

Since the beginning of 2021, the market has not been optimistic about DeFi. Despite the continuous growth and ongoing innovation in DeFi TVL, it has not reflected in the prices of its tokens. Even when the prices move in line with the market, the performance of DeFi tokens has generally been inferior to ETH in most cases. Attention and funding from the public have shifted towards NFTs, meme coins, metaverse, and emerging public chains. Although DeFi 2.0 brought some hope to the DeFi market, it ultimately led to market overheating and painful price adjustments.

Layer 2 did not arrive as quickly as expected, creating good opportunities for emerging public chains. Existing protocols are easy to deploy on other EVM-compatible Layer 1 chains, leading to the emergence of many blue-chip DeFi protocols like forked versions of Uniswap or Aave, where Olympus may become the most forked protocol among all protocols, fostering more Ponzi games across all possible EVM-compatible chains.

Unprecedented hero worship has also proven futile. Perhaps in a world where "handling transactions worth billions of dollars can be operated by anonymously coded programs," there should not be too much focus on individuals, but on what truly matters: code and community. Based on past experiences, hero worship tends to fade quickly.

In the past, there have been many ethical discussions in the DeFi space, such as whether individuals who have engaged in fraudulent activities should be allowed to anonymously handle new protocols without others' knowledge. The answer may vary depending on individual backgrounds; for those from traditional finance, this is unacceptable, but for some, becoming contributors to the ecosystem is paramount. There is no correct answer, but one key point is that anyone involved in DeFi protocols should not be able to personally access funds in the protocol, regardless of who they are.

Hack attacks have also been rampant in the past, affecting projects including Poly Network, Compound, Cream Finance, Badger, among others, with hundreds of forks and updates failing to slow down the pace of Rug Pulls. Just the Wormhole vulnerability alone resulted in a loss of $326 million. Statistics show that since early 2021, hack attacks have caused a total loss of approximately $2 billion. This figure does not include the potential losses from many unexploited vulnerabilities in DeFi protocols. For example, a vulnerability discovered by white-hat hacker Sam Sun in SushiSwap could potentially lead to a $350 million loss.

The lack of clear regulations in the past for DeFi and the entire cryptocurrency space is another issue, bringing much uncertainty to users, investors, and project teams. Countries that ban or restrict cryptocurrencies are attempting to regulate DeFi using existing financial laws.

With seemingly many negative news in the past, how has DeFi quietly developed now?

The Present

According to data from DeFi Llama, DeFi TVL has been hovering around $215 billion. Note: The content of this article is based on March data, and at the time of writing, it has dropped to $112 billion, slightly lower than the $255 billion at the end of 2021, but still relatively high. In terms of decentralized exchanges, the monthly trading volume is around $500 to $600 billion. This is slightly lower than the record of over $1 trillion in trading volume at the end of 2021. Although some new project teams have joined the AMM race, Uniswap still maintains a very high market share, accounting for approximately 75% of total trading volume. In the lending market, liquidity on seven different networks of Aave has stagnated at around $20 billion, also lower than the $31 billion at the end of 2021.

The DeFi market seems to have stagnated for some time. However, the main DeFi indicators such as TVL or DEX trading volume do not fully reflect the overall development, as these indicators are always related to the current market conditions. This means that deeper information needs to be explored. Here are a few aspects to consider:

Layer 2

Optimism and Arbitrum are continuously improving, making them more cost-effective to use. Polygon is currently developing various scaling solutions, including ZK rollup technologies such as Hermez, Nightfall, and Maiden. StarkWare, after successfully scaling single-purpose protocols like dydx, DeversiFi, and Immutable X, is developing a more general ZK rollup technology solution called StarkNet.

Competing Chains

DeFi on other chains like Avalanche, Fantom, Solana, Terra, among others, is also experiencing rapid growth. Although most DeFi protocols on these chains are mostly forks of Ethereum protocols, the development teams of these protocols are actively working on new features. While there are criticisms, the multichain theory is gradually showing results, as DeFi users are willing to move assets across chains to seek better returns.

Cross-Chain

Cross-chain bridges are currently problematic, as transactions on two different chains protected by different consensus mechanisms cannot be atomic, requiring trust in centralized cross-chain bridges or reliance on relay networks, rather than relying on the consensus mechanisms of the two connected chains. Although Cosmos and Polkadot may be solutions to this issue, they still cannot address the problem of transitioning between two different consensus mechanisms during cross-chain activities, but many are working on solving these issues.

DeFi 2.0

Although the market is currently overinflated, some mechanisms of this paradigm shift, such as liquidity utilization, may bring many advantages to the DeFi ecosystem. For example, the Tokemak protocol maintains over $1 billion TVL and introduces new practical features to the entire DeFi ecosystem. Note: Tokemak's TVL in May has dropped significantly. Whether Olympus can once again shine and restore its original influence remains to be seen. OHM's market value is currently largely supported by the treasury value controlled by its underlying protocol, so it can be said that Olympus is still operating as expected even in the worst-case scenario.

Blue-Chip Protocols

Other mature protocols have not remained stagnant but continue to develop.

• Aave recently launched its V3 version, introducing better capital efficiency and improved risk management mechanisms. Bancor also announced its V3 protocol version that can reduce transaction costs, allow unlimited deposits, and provide instant impermanent loss protection.
• Thorchain has recovered from past hack attacks and recently launched synthetic assets that increase network usage, TVL, and depth, allowing for cheaper swaps and providing more income for liquidity providers, among other features.
• MakerDAO is discussing a new strategy to expand into more real-world assets.
• Sushi is also developing Trident, Shoyu 2.0.
• Curve's progress has not slowed down, with its token economic model incentivizing many participants to compete for CRV. This process has even been dubbed the Curve War. The CRV economic model has become so popular that many forked versions of protocols have proven its success.

Ethereum

Returning to Ethereum, despite initial concerns about EIP1559, it has been burning ETH daily as it operates normally. Since the deployment of EIP1559, over 2 million ETH has been destroyed. ETH staking numbers have also significantly increased, with Lido being a major participant in the field, holding over $8.5 billion worth of ETH staked. Rocket Pool has also shown remarkable growth, staking nearly $500 million worth of ETH.

NFT

NFTs, metaverse, and crypto social media, such as the Lens protocol launched by the Aave team, have been hot topics of discussion. Although seemingly unrelated to DeFi, these trends can bring more people into the crypto world and inadvertently introduce them to DeFi.

Institutions

During the market cool-off period, while ordinary users may be reluctant to invest in new projects, venture capital continues to inject billions of dollars into integrating the DeFi ecosystem with the crypto world. This provides early projects with enough funding to focus on development rather than thinking about surviving until the next bull market, thus aiding in the growth of the DeFi market.

Therefore, despite the seemingly subdued market, the DeFi ecosystem is still thriving today.

The Future

A widely discussed major event in the future is the Ethereum upgrade. The merge will transition Ethereum from proof of work to proof of stake, significantly reducing the issuance rate of ETH, which is likely to lead to ETH becoming a scarce currency. The merge is estimated to be completed between June and August this year, which will be one of the biggest changes in Ethereum's history, potentially driving the next bull market for ETH and DeFi. Ethereum also has many other improvement proposals. For example, EIP 4488 aims to reduce transaction costs by lowering the gas cost of call data.

Layer 2 is another catalyst for the future, allowing users to rediscover DeFi. DeFi in the future will be cheaper and faster than ever before, enabling the implementation of new DeFi protocols that were previously impossible on Ethereum, such as decentralized exchanges in order book format. Most Layer 2 solutions also have a secret weapon for the future, enabling them to launch their own tokens and quickly incentivize user growth. Expect to see some turning points in the future, prompting major Layer 2 solutions to launch their own tokens in a very short time.

NFTs, metaverse, and DAOs can also provide momentum for DeFi in the future, becoming pillars of the ecosystem. For example, tokenizing NFTs for trading on AMMs, creating NFT custodial contracts for token exchange among DAOs, trading land in the metaverse, and so on will be new future use cases for DeFi.

Another potential area for rapid growth in the DeFi market is indices: in traditional finance, indices like S&P 500, FTSE100, have experienced tremendous growth periods. This has not yet been demonstrated in the DeFi space, especially because smart contracts allow for easy creation of a wide range of indices, from DeFi blue chips, metaverse, to NFTs. Smart contracts also enable automatic rebalancing of these indices, so we can expect to see more and more DeFi-related indices in the future, rapidly growing.

One thing governments will inevitably do in the future is to clarify the legal and tax regulations of DeFi. The current unclear rules stifle innovation and create an unfriendly environment for DeFi development teams and users. This field cannot become a cornerstone of traditional financial supervision and unfair treatment, as seen so commonly in traditional finance. More detailed regulations will be seen in the future.

Conclusion

It is expected that in the future, most liquidity will flow on-chain, and DeFi will attract the majority of funds from banks, hedge funds, other financial companies, and possibly even entire countries. While each chain has a functioning DeFi ecosystem, liquidity will naturally concentrate on a few chains. It is difficult to predict short-term price changes in DeFi, but as the world realizes what is being built in this space, we can expect to see a resurgence in the DeFi market!

During times when market attention shifts away from prices, developers with a long-term vision will continue to create value and come up with new ideas, which will provide nourishment for the next market cycle. In these seemingly calm times, it is crucial to stay updated on the latest trends and refocus attention on DeFi.