Decentralized Finance (DeFi) is the hot topic of cryptocurrency and many believe it is the true calling of cryptocurrency and distributed ledger technology. The benefits of DeFi certainly fit the bill.
For the unaware, DeFi is a broad term that emcompasses any financial services that are facilitated in a decentralized manner by smart contracts, protocols and decentralized applications. Ethereum was the pioneer of DeFi and is currently leading the charge for DeFi adoption, but other DeFi services are consistently gaining ground.
DeFi is in a constant state of growth. The amount of money locked in DeFi has increased 32% since the start of 2020 and at the peak of the year more than $1.2 billion dollars were locked in DeFi. Currently ~$870 million is locked in DeFi with the vast majority of money allocated to lending services (~73%) and the majority of the remainder is locked in decentralized derivative services (~14.5%).
One glance at the graph showing the value locked in DeFi shows the consistent and strong growth that this niche is experiencing in terms of USD value. This is also the case when looking at the amount of ETH locked.
Not all sunshine and rainbows
The growth of DeFi over time is undeniable, but the upward trajectory admittedly hasn’t come without its share of problems. Growing pains are inevitable, especially with emerging technology.
The most notable event occurred recently during a huge cryptocurrency market drop, which is not-so-lovingly referred to as Black Thursday. In just one day Bitcoin and Ethereum lost nearly half of their value which had cascading effects on the crypto markets and also the DeFi ecosystem.
Maker has a 51% dominance in the DeFi space, which means more than 50% of the funds in DeFi are locked in Maker services. When the ETH price dropped there was a cascade of liquidations across DeFi protocols. The influx caused network congestion which only worsened the problem. Many transactions were failing. The MakerDAO system was required to carry out liquidation events but there were too many for the standard procedures to handle. Because of this many auctions were carried out which enabled individuals with stub orders to profit as they gained a lot of value for next to nothing. Of course, on the other end of these deals were a lot of people losing a lot of money because the system couldn’t cope with the load.
We also recently wrote about the bZx price oracle exploit where a malicious user was able to exploit flash loans to take a large leverage position and then manipulate a price oracle to falsely profit from their leverage position, making a profit of 1193 ETH.
Both of these examples had huge consequences for the DeFi space, but overall we still can see the growth as more money flows in. Not to mention the development improvements that have been made, or will be made, because of these issues. Following the MakerDAO incident one can expect DeFi applications to have better tooling, risk management and insurance procedures. In relation to the bZx exploit, DeFi developers have learnt the hard lesson of the importance of decentralized price feeds.
Overall, these setbacks are nothing to be ignored, but they haven’t killed the DeFi ecosystem. Anything but that, in fact. Necessity is the mother of invention and problems like these force DeFi products to improve.
What’s next for DeFi?
First and foremost, one would expect DeFi’s growth trajectory to continue. As the ecosystem innovates and improves it will naturally grow.
Binance Research conducted a thorough analysis into the state of DeFi with some great predictions for what might be coming throughout the rest of the year. The general trend is growth, with staking expected to largely increase. There is also an expectation to see competition increase in the space and the dominant forces like Maker to lose some of their market share based on both volumes and locked amounts. Binance Research also predicted a growth of Alt-DeFi, which is DeFi outside of Ethereum. One project that is well positioned to grow in this space is ProDefi.
ProDeFi is bringing a unique approach to the DeFi space, which after the hiccups this year could be warmly welcomed by the community. The goal of ProDefi is to bridge decentralized and centralized financial systems by creating offerings that are decentralized in some of their aspects but centralized in others.
People are interested in DeFi because of the transparency, lack of centralized control and the security of a decentralized architecture. With ProDefi, all of this is still available. However, as we’ve established, there are growing pains for DeFi which have had large financial consequences. With ProdeFi, the centralized side of the system provides a fail-safe layer which can provide a new level of customer protection.
There has been a distinct hesitation for institutional investors entering the space. We have only really seen interest from big players when they have the ability to invest using centralized services they already trust, which is why the crypto community was so excited about Bakkt, for example. The same is true for DeFi.
Large investors are justifiably hesitant at the moment because despite the benefits, there are likely still undiscovered risks such as the MakerDAO event discussed above. A service like ProDefi would be able to introduce prevention methods that would prevent these events from taking place and reassure large investors, potentially unlocking a lot more capital to enter the DeFi market. For example, Prodefi could leverage their slightly more centralised structure to actively prevent a situation such as the MakerDAO CDP event that we saw some weeks ago.