Decentralized Finance (DeFi) which is pegged to be the next frontier of fintech innovation has grown exponentially over the past year. The DeFi market cap has shown a 382% increase since the beginning of the year, setting a new all-time high at $95.7 billion. The continued growth of DeFi in the first quarter of 2021 is directly proportional to the growth in other sectors within DeFi for example increase in — (a) the price of top decentralized exchanges’ (DEXs) governance tokens, (b) supply of stable coins, (c) investment in DeFi platforms, and (d) surge in DEXs’ trading volume.
With DeFi quickly gaining traction, it is essential for the industry players — from crypto businesses and financial institutions to regulators and law enforcement agencies — to understand the lay of the land and how the DeFi ecosystem works. Merkle Science recently published “Diving into DeFi: Fundamentals from the Financial Frontier” — a comprehensive primer that gives an overview of types of DeFi platforms, regulatory concerns, DeFi risks, and emerging trends.
Below are some of the key trends that we think are shaping the future of the DeFi industry.
As DeFi TVL hits $157 Billion, DeFi Native Tokens Show Substantial Growth
With the total value locked (TVL) in DeFi reaching a new all-time high, the market cap held by native decentralized tokens has also gone up. According to DeFi Llama, on 22 August 2021, the TVL, which measures the amount locked into DeFi platforms for liquidity purposes, in the DeFi sector reached an all-time high of $157.06 billion USD.
Cointelegraph also recently published an article, analyzing the data from Messari’s DeFi index, which reported that between July and August of this year, “a majority of the top 10 DeFi tokens gained more than 20%, with the top gainer, Terra (LUNA), seeing its price increase more than 116%.” Further, projects like Bancor (BNT) and THORChain (RUNE) are seeing gains in excess of 115%. According to the article, three developments make the bullish case for the DeFi token: “a rapidly recovering total value locked, rising trading volumes on decentralized exchanges and the non-stop addition of new users into the DeFi ecosystem.”
Uniswap (UNI) continues to lead in terms of the reported market cap, with PancakeSwap (CAKE) quickly gaining ground. Further, new DeFi protocols such as DinoSwap and Avalanche are also garnering investor attention due to reduced transaction cost and faster processing.
Surge in Stablecoins
Stablecoins — pegged to a dependable fiat currency such as the US dollar — have become a cornerstone of the DeFi ecosystem. As per the industry reports, there has been an increase in the issuance of stablecoins and the value of stablecoins have grown 18 fold over the past year, surpassing $100 billion USD in May 2021. Tether USDT, which dominates 79 per cent of the market, continues to remain the most significant participant, with Circle USDC being one of the other most prominent figures.
In Glassnode’s overview of stablecoins in DeFi, there are several demand drivers behind their continued growth, including (a) their use in decentralized lending, exchanging, derivatives, etc. Using stablecoins removes the risk of exposure to volatile tokens, but is usually associated with lower returns because of lower risk; (b) using stablecoins for collateral to borrow and leverage, and (c) flight to stability from volatility and risk exposure without using fiat currency amongst other things.
DeFi Monetizes the Blockchain Gaming Industry
One of the several subsectors of crypto that have witnessed (and continue to witness) a rise is the gaming and the gamification of crypto. In this system, video games may run on a blockchain instead of a central server and players may get to mine DeFi tokens upon completion of certain tasks in the game. A survey by Toptal showed that 62% of gamers and 82% of developers said they were interested in creating and investing in digital assets that are transferable between games.
Taking into account the monetization of the gaming industry, DeFi protocols may have to ensure in-game transferability. BitSport, Ubisoft, Axie Infinity, F1 Delta Time, and Cryptokitties are a step forward in this direction.
The Emergence of Ethereum Scaling Solutions
Though Ethereum remains the most used platform for DeFi protocols, high ETH gas prices, network congestion, and scalability problems continue to be issued for various DeFi protocols.
In response to the increase in gas fee which went up by almost 400%, ethereum introduced layer 2 solutions. Presently, there are four major scaling solutions such as Optimism, Polygon, ZK Rollup, and xDAI. Though Ethereum still dominates as the leading DeFi platform, there has been an expansion of DeFi protocols, non-fungible tokens (NFTs), and gaming DeFi applications onto other chains such as Polygon and Binance Smart Chain. For example, NFT marketplaces such as OpenSea and Decentraland have opted for Polygon.
Recently, Ethereum introduced the London Hard fork update, with the objective of lowering the gas fee. It does this by burning most of the gas fee and taking it out of circulation. However, despite the London hard fork update, the Ethereum blockchain is not entirely able to solve the challenge of scalability, and congestion on the network is driving the gas prices higher.