Author: 0xPain.sui
Compiled by: Deep Tide TechFlow
Conclusion: The DeFi market is recovering and remains active.
What happened to DeFi?
Despite being affected by token price fluctuations, the total locked value (TVL) of DeFi is currently about 60% of its historical peak, but its daily trading volume has recovered to previous peak levels, around $5 billion to $15 billion. This indicates that the activity in the DeFi market is warming up.
According to the data on daily active addresses, as of the end of September 2024, DeFi occupies an important position in the entire crypto market. It should be noted that this data may be influenced by bot activities.
From the income data, the yields of DeFi projects reached new highs in the second and third quarters of 2024, far exceeding the levels during the DeFi summer of 2021.
Therefore, it can be concluded that DeFi has always been an important component of the crypto market. However, the market's focus is currently shifting to other areas, such as meme coins and AI, leading to a recent decrease in attention towards DeFi.
Three Major Opportunities for DeFi's Potential Explosion
1: Interest rates are declining
During the bull markets of 2016-2018 and 2020-2022, DeFi experienced its golden age, coinciding with the Federal Reserve's significant interest rate cuts (close to zero). Thus, DeFi benefited in two ways:
When the attractiveness of traditional investment tools (such as treasury bonds) declines, funds typically flow into high-yield investments like DeFi.
The inflow of external capital will drive investment in risk assets such as crypto tokens, increasing the demand for returns when holding these assets.
By the end of 2023, even in a high-interest-rate environment, DeFi continues to grow. Therefore, as interest rates decline, DeFi is expected to experience explosive growth.
2: Inflows from real-world assets (RWA), centralized exchanges (CEX), and Bitcoin
2.1 RWA
RWA market value data source: Binance Research
As of the end of August 2024, the market value of the RWA sector has exceeded $12 billion, more than doubling compared to the same period in 2023. Among them:
Private credit accounts for about 75%, or $9 billion. This figure is only 0.9% of the traditional private credit market, indicating a huge market potential. Platforms supporting this sector include @centrifuge, @maplefinance, and @goldfinch_fi.
Tokenized government bonds account for 17%, with a market value exceeding $2.2 billion, with related platforms including Ondo, @Securitize (in collaboration with BlackRock's BUIDL fund), @FTI_Global, @Hashnote_Labs, and @OpenEden_Labs.
Private credit refers to loans provided to SMEs by non-bank financial institutions.
Recognizing the potential of this market, @MorphoLabs has taken action by collaborating with Coinbase's KYC verification system to support the lending pairs of Centrifuge Anemoy's Liquid Treasury Fund (LTF), Midas short-term US government bonds (mTBILL), and Hashnote US Yield Coin (USYC). Therefore, integrating these asset types into DeFi seems to be a trend in the near future.
2.2: Centralized Exchanges (CEX)
Capital flows are also shifting from centralized exchanges (CEX) to decentralized exchanges (DEX) through derivatives and spot trading. According to data from The Block, since the end of 2023, DEX has significantly increased its market share in both areas, with spot trading reaching a new high of over 15%.
From a broader perspective, centralized exchanges are also bringing off-chain users onto the chain through initiatives like launching Appchain L2, such as Base launched by Coinbase and Ink by Kraken...
2.3: Bitcoin
The integration of BTC and DeFi is receiving high attention from major institutions, especially after @coinbase launched cbBTC due to concerns over WBTC's security. In just one month, cbBTC's market value reached $500 million, primarily used for DeFi protocols on Ethereum and Base. If this trend continues, billions of dollars in BTC may flow into DeFi in the future.
As of the end of October 2024, the total market value of WBTC and cbBTC accounts for only about 1/1300 of Bitcoin's total market value, indicating that this largest crypto asset still has a large amount of untapped liquidity.
3: The old era of DeFi models has almost proven its market fit
Fees and incentive mechanisms. Data Source: Artemis
DeFi has always been an important area of the crypto market, and over time, its models have gradually shown compatibility with the market. This can be seen from the continued demand for usage, even as incentives such as token rewards are decreasing. This is particularly evident in some major projects, such as Aave (lending), Uniswap (decentralized exchange), and Lido (liquid staking), where their fees remain at a high level, while the price and quantity of tokens used to incentivize users have been steadily declining since 2021.
Compared to other trends in the crypto market, we can observe:
NFT: Trading volume is currently at a low point, with no signs of recovery following the boom of 2021-2022 (this period coincided with the growth of DeFi).
Telegram games (such as the Citizen project under Binance Launchpool): Daily active users (DAU) only increased around important dates related to airdrops, and the project failed to maintain a stable number of active users over a longer period.
SocialFi: After facing developmental difficulties, Friendtech has officially relinquished control of the protocol, and the user count and NFT prices of Lens Protocol have both seen significant declines...
Two Major Challenges for DeFi
1: Interest rate instability and liquidity fragmentation
As previously mentioned, lowering the Federal Reserve's interest rates is a necessary condition for attracting traditional funds (including individuals and institutions) into DeFi in search of returns. However, the yields of DeFi are not stable and are often affected by market conditions. For example:
The mechanism of MakerDAO relies on whether the price of USDS is above or below $1 to adjust savings rates.
The interest rates when providing liquidity on Uniswap or other decentralized exchanges depend on the level of trading activity.
Interest rates on lending platforms like Aave are influenced by the curves set by the DAO governance system and the utilization rate of the liquidity pools.
Moreover, DeFi protocols also face the issue of liquidity fragmentation across different blockchains, leading to increased interest rate volatility and reduced capital efficiency, especially as hundreds or even thousands of chains will go live in the future.
The unified liquidity layer concept of Aave V4. Source: Aave
To address this issue, well-known DeFi projects have proposed some unified liquidity solutions, such as the cross-chain liquidity layer developed by Aave and the Superchain initiative participated by Uniswap. However, these solutions have not yet been implemented.
2: New models have yet to show results
2.1: Modular DeFi
DeFi may return in a modular form rather than relying on liquidity mining. This shift may be led by the three giants: Uniswap, Aave, and MakerDAO (now known as Sky). @SkyEcosystem recently rebranded as Sky Money and continues to advance its endgame strategy. @Uniswap's V4 is planned for release in the fourth quarter of this year, adopting a new model called Hooks, allowing users to develop their own automated market makers (AMM) on the Uniswap platform. @aave's V4 is also set to be released in early Q2 2025.
Recently, only a few smaller protocols have completed the development of new models, such as Morpho and Euler. Morpho allows curators to utilize the liquidity of Morpho Vaults to design lending markets. @eulerfinance launched v2 with the Ethereum Vault Connector (EVC), establishing connections between lending pools on Euler.
At this stage of DeFi development, a common trend is the expansion of collateral asset types, which opens up new application scenarios to reach and serve new user groups.
However, based on the activities of Morpho Labs, the company that initiated this trend, we have not seen an increase in loans. → Therefore, DeFi may shift towards a modular model, but the effectiveness of this approach will take time to validate.
2.2: Re-staking
Although re-staking was only launched at the beginning of 2024, its total locked value (TVL) has already reached $15 billion, accounting for 5% of ETH's market value, with about $10 billion concentrated on Ethereum's @eigenlayer. However, the use of re-staking as a security economic layer's AVS is almost zero. This poses long-term challenges, as apart from the project tokens, stakers have no stable source of income, and if this situation continues, TVL may significantly decline.
2.3: BTCFi
BTCFi TVL. Source: Coinmarketcap BTCFi Report
In addition to bringing BTC into the DeFi ecosystem through WBTC or cbBTC, the idea of creating an independent ecosystem for Bitcoin has also formed and is primarily developing on sidechains like Stacks and Merlin. Although this concept has existed since 2021 (with the launch of the Stacks mainnet), its TVL remains relatively small, at only about $1 billion. This may be because these projects:
It does not reflect the unique characteristics of Bitcoin L1, such as Ordinals or Runes, but resembles a copy of Ethereum.
They are not fully regarded as 'native' projects because they only use BTC as an asset and lack close ties with Bitcoin L1.
DeFi has always been an important growth area in the crypto market. Over time, the old DeFi models have proven their market adaptability. In the near future, funds from traditional markets, real-world assets (RWA), centralized exchanges (CEX), and Bitcoin may flow into DeFi, potentially further driving the development of this sector.
Currently, the development of new models in DeFi still seems unclear and limited in effectiveness, primarily relying on old models, which somewhat suppresses the momentum for growth. However, we can still look forward to solutions in future phases, such as modular DeFi, cross-chain liquidity, and even fee-switching mechanisms for major DeFi protocols. Once capital flow is activated and new models demonstrate market demand, DeFi is expected to experience unprecedented growth.
