Neither the author, Tim Fries, nor this website, The Tokenist, provide financial advice. Please consult our website policy prior to making financial decisions.
After a period of explosive DeFi growth, unbanked crypto lending is entering a more stable period of maturation. The initial surge of yield farming and skyrocketing governance tokens has receded, leaving DeFi to deal with the upcoming challenges.
DeFi Reaches New Peak Within One Week
Decentralized Finance (DeFi) is an exemplar of all things associated with the crypto space: rapid growth, speculation, overhype, huge gains for first adopters. It was all too easy to compare DeFi to an ICO bubble, with its abysmal record of being 80% scams. Nonetheless, such comparisons are merely superficial, better serving as a cautionary tale.
After all, DeFi is not about pioneering a new category of projects existing only inside the confines of a whitepaper, as had happened with many ICOs. Instead, DeFi offers working platforms that mimic financial products previously exclusive to banks. Linking your crypto wallet to such a platform in order to lend money with high-interest rates, also known as yield farming, was a huge success.
During that initial period of novelty exuberance, many governance tokens were overhyped, and some hacking shenanigans occurred. However, overall, things settled as expected. Here is the quick recap:
In a matter of one month, from June 1 to July 2, 2020, DeFi TVL (total value locked) doubled. It went from $1.054 billion to $2.038 billion, presaging the upward trend.
At the end of summer, on September 18, 2020, DeFi TVL surpassed the ten billion mark, at $10.552 billion.
Most recently, in just one week, DeFi TVL went up over one billion, from November 4, at $11.137 billion, to the new highest peak on November 9, at $12.753 billion.
What Challenges Does DeFi Continue to Face?
1. Ethereum vs. Bitcoin Blockchains
It appears that after the $10 billion milestone, DeFi activity began to stagnate. We can attribute this stagnation to DeFi’s first hard obstacle – an outdated Ethereum network causing congestion and high transaction fees. The majority of top DeFi platforms are using the Ethereum blockchain:
All the way down, at 24th market share with only $16.2 million, sits Lightning Network on a Bitcoin blockchain. Considering that Bitcoin (BTC) is by far the largest cryptocurrency, 5.6x larger than Ethereum, this leaves DeFi with a crippling start on top of an already congested Ethereum network. Outside of the Lightning Network, using tokenized bitcoins in the form of Wrapped Bitcoin (WBTC) is the only way to employ your bitcoins without cashing them out.
This is why we have seen over $1 billion worth of WBTCs deployed on DeFi’s Ethereum platforms. Clearly, the demand is high for native Bitcoin DeFi platforms. Unfortunately, building native smart contracts on the Bitcoin blockchain is a daunting task. Ethereum was designed with smart contracts in mind, while Bitcoin’s scripting language is quite limited in comparison.
2. Smart Contract Logic on Top of Bitcoin Blockchain
Bitcoin’s logic-scripting limit itself was one of the major reasons why Bitcoin rose to dominance, as it keeps the blockchain more secure. Other alternatives to bringing more Bitcoin users into the DeFi space come in the form of sidechains, which add a smart contract layer on top of Bitcoin’s blockchain:
This approach is certainly more elegant than using WBTCs, but it is another layer that people have to seek out. Which brings us to the crux of the issue. People view Ethereum as an active, flexible platform, while Bitcoin is viewed as a passive asset – a store of value that may even surpass gold.
3. DeFi Features Outside the DeFi Ecosystem
In addition to Ethereum’s congestion issues and not tapping into Bitcoin to the full extent, the DeFi space may also undergo stagnation due to competition. Circle, with its $2.86 billion USDC market cap, has recently announced it will expand the features of its business accounts.
Circle Business Account launched on March 10, 2020, with the aim to proliferate its USDC stablecoin across platforms. Thanks to APIs, you could use it as a USDC wallet, link to e-commerce marketplaces, link to traditional payment methods, and seamlessly accept USD payments as USDC.
Stablecoins such as USDC have grown immensely this year thanks in large part to DeFi, but this leaves them serving other platforms. Circle aims to remedy that with the November 5 announcement of high-yield accounts. The new yields should range between 8.5% to 10.75% APY (annual percentage yield). To further entice people to stay on Circle’s CeFi instead of DeFi, the upgraded accounts will be paid weekly instead of monthly or yearly.
Moving forward, we will likely see many CeFi platforms adopting DeFi interest yields, but offering extra peace of mind through guarantees associated with established brands.
Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim served as a Senior Associate on the investment team at RW Baird's US Private Equity division, and is also the co-founder of Protective Technologies Capital, an investment firms specializing in sensing, protection and control solutions.