The past year has been a crazy journey for the blockchain industry. Between the crippling effects of the COVID-19 pandemic in various sectors and Bitcoin’s marathon bull run, the year was great for some and disastrous for many.
Decentralized finance is the epicenter of the blockchain hype today. From the rise of the decentralized mainstream exchanges to the overwhelming demand for cash drawdowns, DeFi has not only stirred up a lot of dust, it has put billions of dollars on blockchains.
On June 15, DeFi platform Compound began distributing its COMP token to users and handing control of the protocol over to employees. By August 15, wrapped Bitcoin (WBTC) valued at over $ 1 billion had been sold, allowing even Bitcoin holders to access the world of Ethereum-based DeFi applications.
Now some DEXs even compete with centralized exchanges, and the term “vampire mining” will always remind us of blockchain, rather than pale blood-sucking creatures with pickaxes and hard hats. But while DeFi lit the fireworks last year, it was Bitcoin (BTC) that made everyone stop and stare. Its unprecedented surge to nearly $ 40,000 makes it one of the most profitable and fastest growing assets in history.
But was DeFi at least partially responsible for it? Earlier stages of Bitcoin’s rise correlated negatively with DeFi, and many even speculated that this was due to the transfer of funds from DeFi platforms to Bitcoin. The total value of digital assets tied to smart contracts has quadrupled in the past two years. Much of this growth, however, has occurred in recent months and has been driven by the appreciation of already invested assets rather than an increase in new investment.
Just as many claim that DeFi has had a significant impact on BTC and blockchain technology, Bitcoin also affects DeFi. Blockchain may be the new, exciting financial technology of the coming decade, but it is Bitcoin that brings brand equity. That’s only part of the equation, but is it really substantial?
Duel or duet?
With the total volume of trade with DEXes increasing significantly over the past year, some have attributed Bitcoin’s recent growth to the increased use of DeFi platforms. According to Robert Leshner, CEO of Compound, “Bitcoin’s surge to $ 40,000 coincided with a surge in WBTC activity.” The Compound Protocol is also the top holder of WBTC. Over $ 1.2 billion in BTC is used as collateral for loaning stable coins and other assets.
One of the most commonly reported metrics in the DeFi space is the Total Locked Score (TVL). It represents the value of digital assets locked into DeFi smart contract platforms and has grown from a few hundred million a few years ago to over $ 26 billion today. This is largely due to the recent rise in the value of large capitalization assets like Bitcoin and Ether (ETH).
According to Scott Stuart, co-founder and chief product officer of blockchain developer Kava Labs, the rise in Bitcoin value is an incredibly positive sign for the DeFi space: “DeFi requires a healthy amount of collateral to be used in products. The more valuable BTC is, the more collateral and thus the use in DeFi. “
There has been a lot of hype and misinformation around the TVL metric in blockchain circles. While it isn’t the most accurate representation of what DeFi networks are worth right now, it does show how many people are willing to take risks for them. Despite the fact that regulatory requirements like customer identification could break most popular DeFi applications sooner or later, they only seem to grow.
However, not everyone sees regulation as a threat. “It’s a lost battle for regulators,” said Stuart, adding, “Even if you can squeeze a product or platform, it will likely turn up elsewhere – it’s open source software.”
This is comparable to the unregulated transfer of peer-to-peer files on the Internet. Strict parents create devious children. However, the results of a government restriction of the Know Your Customer review in DeFi could also lead to more compliant applications. Although this is probably restrictive, decentralized financing outside the legal limits cannot grow sustainably. Bitcoin regulation is already complicated, and DeFi is sure to make things a lot more difficult. So the correlation here seems to be more obvious.
Old ideas, new energy
In the past year, DeFi made Ethereum the most widely used blockchain, making the cumulative transaction fees higher than Bitcoin’s. This is often a strong sign of a network’s ability to generate higher returns, and the updated Ethereum 2.0 promises even better performance and cheaper transactions. With the transition to Eth2, DeFi could see another significant surge in usage. Despite impressive growth over the past year, DeFi’s market cap is still barely 2% of its total crypto market cap.
The amount of Bitcoin used in DeFi is approaching 0.9% of total BTC supply, with nearly $ 300 million in WBTC trading alone on a daily basis. This is probably a good thing as DeFi is being discussed not just for its profitability, but rather for its ability to improve financial systems. The brief negative correlation between Bitcoin and DeFi in 2020 could be due to merchants migrating funds from DeFi, but both have grown by leaps and bounds since then.
Bitcoin and decentralized finance have a very symbiotic relationship in which they encourage mutual growth. More Bitcoin in DeFi brings more platforms that offer value, and with a seemingly endless stream of new DeFi projects constantly emerging, they are generating hype and creating innovative use cases for cryptocurrencies as a whole.
The challenges ahead
“The biggest challenge for new DeFi projects is code security and testing,” said Leshner, adding, “The reviewers are stretched thin and most developers are writing Solidity for the first time.” Blockchain is still incredibly young and even though millions of people worldwide own cryptocurrencies, it still only scratches the surface of mainstream adoption.
While some think the current income frenzy is unsustainable, others believe it could be the start of many new things. Stuart stated that DeFi loan and loan rates are likely to normalize and the platforms will make efforts to attract long-tail users with better user interfaces and cheaper network fees.
The trends affecting DeFi inevitably affect Bitcoin as well, but the two appear to be growing independently. Aside from the current inability to scale, there are many other issues that Bitcoin needs to address before it goes mainstream. For one, as a safe haven, Bitcoin’s liquidity can be compromised as Bitcoin may gain importance on DeFi platforms in the coming years.
When Bitcoin was founded, the vision of a decentralized financial system could not be realized without the existing and continuously developed decentralized infrastructure. After over a decade, DeFi is finally making strides to bring us one step closer to that vision.
Ultimately, Bitcoin is a digital asset that will never go out of style. The first mover advantage is real here, and newbies to space are more likely to test the water using BTC than an obscure DeFi token. With global exposure to cryptocurrencies, the demand for services for decentralized assets is also increasing. People can visit Bitcoin, but they stay for DeFi.