The decentralized financial movement was a ticking time bomb waiting to explode when it exploded in 2020. From automated market makers to the industry’s current obsession with draining liquidity, DeFi has made leaps and bounds over the past year.
Most of the decentralized financial applications are hosted on the Ethereum blockchain, bringing billions of dollars into the network and pushing it to its maximum operating threshold. While the capabilities of the underlying network appear to be the only thing holding DeFi back, Ethereum is not waning either.
As Ethereum 2.0 prepares for the transition, a lot is ahead of us in 2021. Both DeFi and Ether (ETH) did exceptionally well. The native Ethereum token recently retraced its all-time high, even hitting a valuation of $ 2,000.
While some members of the vocal community believe this pump is the result of a bubble similar to the initial boom in coin supply in 2017, there are plenty of reasons to believe it isn’t.
DeFi has breathed fresh air into the cryptocurrency space and spawned countless new tokens that have revolutionized decentralized credit and credit services. The short-lived Yam Finance, which sought to simplify the income farming experience and turn blockchain governance into a practical model, quickly became one of the fastest growing platforms in the DeFi space.
Projects like Uniswap have even revived the concept of decentralized exchange using an automated market maker model. This enables the system to rate trades without relying on the liquidity of a counterparty. Instead of using order books, the AMM values assets based on the ratio of tokens in a liquidity pool to determine supply and demand.
The increase in the use of Uniswap has been driving the DeFi engine for quite some time. Daily trading volume rose from around $ 1 million to $ 1 billion between July 2020 and September 2020. Uniswap can execute orders in the chain without being tied to order books. This means that transactions are made and processed directly in the network. This has become one of the most important features of Ethereum.
This has boosted the number of smart contract calls on Ethereum, hit new highs and created a token economy that is increasingly being managed by code. Although DeFi’s trusted ecosystem has resulted in higher levels of efficiency and more automation options, it’s still far more complicated than traditional offerings.
This is a big problem that DeFi needs to address before it can gain more mainstream adoption. Buying and selling cryptocurrencies already requires work from the consumer’s point of view, but in its current state, DeFi is still very much “function over form”. Outfits like Yearn.finance have brought algorithmically managed portfolios to DeFi, but there is still a lot to be done.
“Yield farming is not sustainable, but it helps to strengthen the industry in the short term and attract developers,” said Rune Christensen, founder of the experienced DeFi platform MakerDAO, in an interview with Cointelegraph, adding:
“Once the markets cool, the next stage for DeFi will be to integrate with traditional funding and tokenize real assets so that they can be used in DeFi protocols in the chain.”
He also mentioned that DeFi is currently completely dependent on the Ethereum platform, especially because it relies on composability between current DeFi applications and ETH as the main source of collateral and stability. However, there may be other issues that stand in the way of DeFi’s growth.
This is a feeling shared by many members of the community. According to Illia Polosukhin, CEO of Near Protocol – a blockchain that enables the creation of decentralized applications and is interoperable with Ethereum – DeFi could continue to grow on Ethereum.
“Most applications are designed to work with and around current constraints, and they would be only moderately successful in other chains,” he said. “It’s not just the apps themselves, it’s the entire ecosystem of users, assets, other applications, and integrations.” However, there may be other issues that stand in the way of DeFi’s growth.
These topics include the introduction of Eth2 and its potential impact on decentralized funding. MakerDAO’s founder claimed that with fewer new DeFi apps, it is likely to have less of an impact than expected. “Layer 2 scalability solutions with high security bridges will likely enable a more retail-focused DeFi,” he said.
The introduction of more complexity is a burden on the end user, especially with the harsh user interface / user experience systems that seem to be prevalent throughout the room. However, this would allow DeFi Smart Contracts to automatically interact and conduct transactions on multiple platforms without human assistance.
Ethereum currently benefits from the composability of applications and higher liquidity than any other blockchain with a smart contract function. However, dismantling can open the floodgates for DeFi apps to move platforms.
The possible effects of Ethereum 2.0 on DeFi are still unclear. Ideally, the platforms should offer scalability, composability and liquidity. However, this is not an easy task, especially as many decentralized applications migrate to layer two solutions and application-specific chains. According to Kevin Davis, Chief Technology Officer of the Kava DeFi platform:
“It will be a few more years before Eth 2.0 is a major player in the DeFi space. So at the moment we can only wait and see. The biggest bottleneck is the lack of skilled developers and mature developer ecosystems and tools. We’re just getting started and very few individuals / teams / companies have made it near the edge of the productivity curve. “
Wrap things up
Wrapped assets also make up a significant part of the DeFi area. Wrapped Bitcoin (WBTC) brings the original cryptocurrency Bitcoin (BTC) to intelligent contract platforms. Wrapped Bitcoin is an ERC-20 token supported by Bitcoin. At the time of writing, Ethereum is valued at around $ 6 billion in circulation.
While most DeFi tokens are based on the ERC-20 standard – a framework for designing tokens on Ethereum – this is not the case with ETH. Since this framework was only created after the ETH, the token does not technically correspond to the ERC-20 standard. With Wrapped Ether (WETH) it can now also be used effectively as a regular token on DeFi platforms.
With packaged assets, Ethereum can provide liquidity for any tokenized asset on a variety of platforms and bring hundreds of millions of dollars to the network. The rise in smart contract calls and the total number of transactions have taken ETH gas fees to new levels, with high gas prices becoming quite typical. Polosukhin said to Cointelegraph:
“A more scalable infrastructure can keep developers from thinking about it. Developers can build faster, more complex applications if they don’t have to deal with the same problems that a network with limited capacity would have.”
During a token launch, this can be disastrous as hordes of users flood the network to get their hands on it ASAP. This causes miners to prioritize transactions with higher fees, which then increases transaction costs as people in the queue try to get to the top of the line.
While high transaction fees could damage the space, miners with more incentives ultimately secure the network better. From this perspective, the increase in miners fees could also be seen as a sign that Ethereum is becoming more secure. However, this makes the barrier to entry higher than some would like it to be. Small investments make small profits, and with similar fees for $ 100 and $ 100,000 transactions, users transferring large amounts have an undeniable advantage.
That being said, Ethereum is turning away from the proof-of-work model, which encourages miners through block rewards and miner fees, and instead opts for a proof-of-stake model on the updated Eth2 network. In addition, the median average weekly transfer value of Ethereum has steadily increased, which is a strong signal that the network is shifting towards less inexperienced investors.
Beyond the promise of Ethereum 2.0, scaling the “world computer” has been a constant effort in recent years. The recently launched Optimistic Ethereum Testnet is a second tier scaling solution project that offers instant transactions at a much lower cost. In addition, this can be implemented using the current Ethereum infrastructure, and popular DeFi projects such as Synthetix, Uniswap and Chainlink have signed up as early adopters.
DeFi and Ethereum are a disjointed pair, and while their progress and evolution have been in parallel, they are both growing steadily yet independently of each other. With solutions such as the Optimistic Testnet and the upcoming switch to Proof-of-Stake, the Ethereum platform appears to be ready for even more DeFi measures in 2021.
According to MakerDAO’s Christensen, the biggest bottleneck in the development of new DeFi applications is “the lack of clarity about how securely one can interact with legal and real-world political and financial systems in order to gain real economic relevance”.
With the increasing market capitalization of ETH and the DeFi industry, new projects are opened faster than ever before. DeFi has become a thriving arena for innovation and development in the blockchain space, and with the growth against insurmountable opportunities last year, there will be far more windows for growth in the times to come.