VYSYN Ventures Weekly Insights #45
- DeFi TVL surpassed $50 billion
- New use cases like insurance, dApps, and betting applications are springing up within the DeFi ecosystem
- The continued growth of DeFi is having an impact on native tokens of the blockchains underpinning the ecosystem
- Regulation of the burgeoning area of DeFi remains rudimentary
- Regulations are expected to dynamically evolve as both DeFi and the wider cryptocurrency industry continue to mature
As more funds continue to flow into decentralized finance (DeFi), the market has posted a new all-time-high (ATH) in total value locked (TVL). For the first time, the TVL in DeFi protocols and applications has crossed the $50B mark. This is a reflection of the increased adoption of decentralized exchanges.
For many cryptocurrency enthusiasts, DeFi remains the most practical application of blockchain technology. The extremely restrictive banking sector has been a boon to DeFi popularity and has spurred adoption among repressed netizens.
In the latest VYSYN release, we highlight some of the recent DeFi developments that have driven greater adoption. We also consider the current challenges in the industry that may be holding the technology back.
A Trend That Began in 2020
The DeFi explosion of 2020 was centred around speculators allocating capital to earn interest. Others would take out loans by leveraging on smart contracts. The lion’s share of this activity took place on the Ethereum blockchain.
Many factors were linked to the explosion in DeFi. One such factor was the financial crunch that was caused by the Covid-19 pandemic. Amid excessive money printing by central banks, many speculators began to turn to alternative assets, with cryptocurrencies and DeFi experiencing a surge in interest.
In 2021, DeFi appears to be maturing with the emergence of more diverse use cases. Solutions around betting, dApps, insurance, and several others are springing up within the DeFi ecosystem. This is generating a new influx of users and capital, resulting in further growth of the industry.
Growing Protocols Are Contributing to Overall TVL
One of the popular trading protocols on DeFi, UniSwap, has grown to a market capitalization of over $15 billion. This value places it among the top ten cryptocurrencies by market capitalization.
The continued growth of DeFi assets is likely having a significant impact on the price performance of the blockchains underpinning these assets. Ethereum and Polkadot have both experienced significant growth this year.
The price of ETH, the native cryptocurrency of the Ethereum blockchain, currently trades at over $2,000 with a 192% YTD return.
Polkadot, a blockchain that has a burgeoning DeFi ecosystem, currently trades at $41, a 336% YTD price return.
The development of DeFi projects on these blockchains increases the demand for the native token of the network. While this is bullish for token dynamics, the high gas fees to process ETH transactions is another side effect.
Lending and DEXs Dominate DeFi Protocols
Of the top five DeFi projects in terms of TVL, three of them are lending platforms while the remainders are decentralized exchanges (DEXs). These two categories represent the majority of the earliest implementations of DeFi.
Lending platforms like Compound let users earn interest or borrow assets against collateral. Users can simply supply assets to the platform’s liquidity pool and earn interest on their assets. Likewise, borrowed assets can serve as collateral, allowing speculators to access enormous leverage.
On the other hand, DEXs like UniSwap replace order books with liquidity pools. They provide the opportunity for users to swap ETH with any ERC20 token in a decentralized ecosystem. The liquidity in DEXes is provided by users who earn a share of trading fees for the market that they create.
Other categories of DeFi projects include derivatives development, assets, and payment solutions. Applications like Cash Tech are aiming to introduce wallets that also encompass the broad features of the DeFi ecosystem. As it stands, DeFi applications outside of lending and DEXs remain in the early phases of implementation.
DeFi Faces Regulatory Challenges
One of the major challenges confronting DeFi development and mainstream adoption is regulation. Circumventing restrictions is one of the reasons that DeFi proliferated initially.
As the ecosystem continues to grow, states are naturally becoming concerned with how to avoid the use of such technologies to facilitate crimes like arms trafficking, terrorism financing, and tax evasion. As a result, most governments are in the process of developing regulatory frameworks that will govern digital asset activity like DeFi.
In Q4 2020, the Swiss parliament voted unanimously for a new DLT-law. The law aimed to enhance legal certainty surrounding DLT and remove obstacles to DLT application development.
Regulatory frameworks that protect DeFi investors are also not in place yet. Most of the settlement processes in DeFi remain within the bounds of the protocol and are settled by smart contracts. When it comes to cases such as exit scams and rug pulls, litigation processes are yet to become well-defined across various jurisdictions.
Dynamic DeFi Regulation
As the industry continues to evolve and develop, we expect to see improvements in the regulation and supervision of DeFi and the crypto space. A finalized regulatory framework may not be possible because of the evolving nature of the financial market.
DeFi and other related technologies have come to stay. The demand for DeFi products is rising, especially in areas like staking and services.
More users are entering the ecosystem, and that is driving an increase in both the price of DeFi assets and the underlying blockchains. With DeFi continuing to spread and expected improvements in both the Ethereum and Polkadot blockchain, we may see DeFi surpass the expectations of many.