Anytime cryptocurrency and the blockchain become a subject matter in any discourse, the easiest thing that comes to mind is DeFi. Wait! DeFi? Decentralised Finance is undoubtedly the hottest thing that the crypto-verse is experiencing today. With DeFi, anyone in the world can lend, borrow, send, or trade blockchain-based assets using easily downloadable wallets without having to use a bank or broker. If you are thinking, “does DeFi basically mean bringing traditional financial attributes on the blockchain and eliminating the custodians of traditional finance using smart contracts”, then you’re absolutely correct.
How has it fared so far, and what will DeFi look like in the next five years? Before we begin to tear this apart, let’s understand the four epochs of the blockchain since 2009.
Contrary to popular opinion, Satoshi didn’t just take the world by storm in 2009. He started out in 2008 by publishing the Bitcoin whitepaper to a cryptographic mailing list. His idea was to create a digital cash system that could help facilitate peer-to-peer transfers without the need for an intermediary like the states or centralised financial houses. A few years down the line, Ethereum was created by those who saw that the blockchain, which was the underlying technology powering Satoshi’s Bitcoin protocol, could be extended in several ways. Ethereum would be the first Turing-complete blockchain network that allowed anyone to interact with smart contracts built by developers using Solidity as their programming language. The third epoch was the ICO craze of 2017. As people saw the vast opportunities around Ethereum, project developers could then crowdsource funds directly from the community to launch their adventurous decentralised applications (dapps), having its hallmark as being censorship-resistant. The fourth epoch? Yes! That’s where we are today - DeFi.
What’s happening in DeFi today?
The total value locked (TVL) in DeFi stands at $52 billion, a 140% shoot up YTD. Before this and at the height of the 2021 bull run in May, prior to the seeming apocalypse that has wiped off about $1 trillion from the crypto industry’s market cap, data from DeFiLlama reported $160 billion TVL.
From the big DeFi primitives like Compound, Aave, Maker to the applications built atop the former like Yearn, Frontier, Plasma Finance, composability allows innovators to stack applications over themselves as “money legos”.
One thing DeFi prides itself about is that it is permissionless with radical transparency. Anyone, whether protocol developers can always leverage the rich open-source code repositories of other DeFi applications to build theirs and run it on the blockchain without any fear of censorship. Any user with an internet connection can equally explore these DeFi applications without any restriction or fears as they can basically audit the entire money supply on the protocol on the public ledger.
DEXs fueling DeFi growth
The massive growth within the DeFi sector is unarguably due to the revolutionary experiments and success of Decentralised exchanges, otherwise known as DEXs, which uses automated market makers to conduct swaps and asset exchanges. Uniswap paved the way for other AMMs like PancakeSwap, SushiSwap, QuickSwap, Curve Finance etc. Within the last 12 months, DEXs have facilitated more than $685 billion with $563 billion YTD.
According to data from Dune Analytics, even after the reduced traction in cryptocurrency activities and, by extension, DeFi activities also, the daily trade volume in DEXs as of 1st July is $3.52 billion. With DEXs volume already rivalling their centralised exchange counterparts and surpassing it (Uniswap surpassed Coinbase in daily volume trade in September 2020), DEXs volume could triple by 2025.
DeFi banks will power the mainstream financial sector through stable APYs
Big DeFi protocols are fast becoming the rails for traditional finance. Compound Finance recently announced that it is rolling out Compound Treasury, a product targeting the conventional financial sector but with the stability of a steady 4% APY on USDC savings. Why is this significant? If there’s anything we know, the macro outlook for the mainstream financial sector is characterised by rising inflation rates, yet interest rates on saving remain abysmal. In fact, financial institutions now offer negative interest rates for operating a savings account with them. And at the current 0.5% interest on USD, Compound Treasury is willing to guarantee a perpetual 4% APY on USDC savings.
Like liquidity mining became a mainstay for DeFi projects after Compound Finance proved it to be a successful way of bootstrapping DeFi projects, Compound Treasury could spark another movement proving to be the perfect bridge between mainstream finance and the more volatile DeFi sector. Five years from now, more liquidity could easily find its way into DeFi through products like Compound Treasury.
Nation-states borrowing from massive DeFi pools with monetary policies determined through on-chain voting
The previous section discussed massive liquidity flowing into DeFi with stable APY from big DeFi banks acting as the impetus for the massive exodus. Global monetary and financial regional bodies like the IMF, World Bank etc., are known to offer developmental-focused loans but with stringent conditions which may somehow be antithetical to the cultural growth of the requesting nations. Although most DeFi lending protocols currently practice negative leverage, which requires that the collateral asset for any loan be greater than the funds being borrowed, uncollateralised loans are fast becoming a thing in DeFi. With a functional DeFi credit rating system in place, even nations can leverage the growing TVLs on protocols and, by extension, have the terms of that loan determined through on-chain governance, as we see in most DeFi protocols.
Deeper interconnectedness of DeFi across chains
Already, there are DeFi applications like Plasma, Yearn, Frontier etc., offering a one-stop destination to invest, store, and manage any DeFi token with ease. These kinds of platforms demonstrate the needs most DeFi users advocate, which revolves around portfolio management, liquidity pools, lending & borrowing, DEX & swap aggregator, cross-chain asset swap, all from a single dashboard.
The fact that most DeFi applications are composable with one another opens up further opportunity to connect with themselves regardless of their native chain.
Another factor fuelling the interconnectedness of DeFi projects is the inherent problem of Ethereum as base layer either not fast enough, or spiking transaction fees. We’ve therefore seen challenger chains like Polkadot, Binance Smart Chain, Solana, Avalanche, Algorand etc., and for the first time, it is looking like Ethereum’s market dominance in the DeFi sector may be threatened. Irrespective of the competing chains, the trend suggests DeFi will not live and thrive on a single chain. Innovative ways of cross-chain DeFi communications is growing and becoming rather prevalent. From liquidity mirroring to asset bridging and even the rise of Layer 2, the future of DeFi are chains becoming more interwoven with themselves such that no single chain will appear to have insane market dominance.
To conclude, DeFi activities are still in its infant stages especially when compared with the volume traditional finance clears on a daily basis. Within the next five years, DEXs will grow large enough that more crypto asset trading will be happening on them as compared to conventional centralised exchanges. DeFi will also transform to become the rails that will prop up mainstream finance as many of the latter will troop into the sector in search of attractive APYs with some form of stability. And with increasing liquidity flowing in from mainstream finance, even nation states may start borrowing from the massive DeFi banks having the terms of their loans dictated by governance token holders. Finally, the future of DeFi is not on any particular chain like Ethereum, Polkadot, BSC, Solana etc. Rather, most DeFi applications irrespective of their parent chain will be deeply interconnected with themselves.