Last June, this blog explored the top five emerging trends in the decentralized finance (DeFi) sector. DeFi was then in its relative infancy. An exciting new movement, it had just reached the milestone of $1 billion in total value locked (TVL)—the amount of crypto funds deposited by users to decentralized applications (dapps). TVL would hit $2 billion by month’s end and increase to over $15 billion by the end of 2020.1https://defipulse.com/ Today, as the movement shows no signs of slowing down, several key trends have become fixed while others are worth watching as the space continues to develop throughout the year. Let’s take a look at what they are and why they matter.
DeFi Is Growing: Follow the Developments Shaping the Movement in 2021
1. Scaling Solutions Become Priorities
The popularity of DeFi dapps is straining the Ethereum network, causing transaction, or gas, fees to rise. As of this writing, simple token transfers can cost several dollars, while complex smart contract transactions such as opening a Vault can cost hundreds of dollars or more. Ethereum 2.0 will ultimately address the persistent gas problem and other issues, and allow the network to scale to a level that can support mainstream adoption. But the upgrade is rolling out in phases (the first phase, Phase 0, launched on December 1, 2020) and will take years to complete.
In the meantime, developers are creating stopgap and complementary solutions that allow the launch of high-scale dapps before the complete release of Ethereum 2.0.
One approach is to move certain tokens and operations to child chains on the Ethereum network. An example of this is Matic Network,2https://matic.network/ now part of the broader Polygon suite of scaling solutions. Because Matic transactions occur on sidechains, they are fast and inexpensive.
Another technology allows developers to bundle transactions off-chain and submit them to the main blockchain in batches.3https://docs.ethhub.io/ethereum-roadmap/layer-2-scaling/optimistic_rollups/ Those bundles, called Rollups (also offered by Polygon), could enable Ethereum to support a 200-fold increase in transactions.
2. Users Embrace AMM-based DEXes
Automated Market Makers (AMMs) provide a completely new model for decentralized exchanges (DEXes), using liquidity pools and pricing set by an algorithm rooted in supply and demand instead of conventional order books.4https://academy.binance.com/en/articles/what-is-an-automated-market-maker-amm Effectively, users trade with a smart contract-based liquidity pool rather than directly with other users. It’s an elegant and user-friendly solution to trustless crypto trading that avoids the problems and complexity of moving traditional exchanges’ systems onto the blockchain.
AMMs exemplify how DeFi platform developers are adapting to the unique demands of the space and presenting users with opportunities that are unlike anything they’ve seen in the traditional finance sector. Uniswap, which popularized the AMM approach, is a favored DEX in the crypto space, along with Curve, Sushiswap, and Balancer. In fact, those four exchanges together represent nearly $13 billion TVL.5https://defipulse.com/ The largest order book-based DEX attracts just a fraction of the trading volume of the most popular AMMs.
3. Stablecoins: DeFi’s Killer Assets?
Described by Ethereum co-founder Vitalik Buterin as simultaneously the most valuable and most boring things to come out of DeFi,6https://twitter.com/VitalikButerin/status/1306599248356548609, stablecoins offer users vital means of storing and transferring value on the blockchain without exposing them to the volatility for which crypto is notorious. Importantly, stablecoins are also powerful tools for enabling the efficient allocation of capital to DeFi yield farming opportunities.
4. NFTs: A Most Exciting Crypto Trend
Non-fungible tokens (NFTs) are indivisible blockchain tokens that represent a unique real-world or digital item. They’re quickly gaining popularity, as they prove authenticity and ownership of digital art, collectibles, in-game items, and even parcels of virtual land. NFT marketplaces, such as SuperRare, Nifty Gateway, Rarible, and others, enable people to buy and sell all kinds of collectibles using ETH and, increasingly, stablecoins.
Not only are NFTs a valuable niche in the crypto world in their own right, with over $180 million in total sales7https://nonfungible.com/market/history as of this writing, but there’s now a DeFi use case for them: Protocols such as NFTfi and Rocket allow NFTs to be used as collateral for peer-to-peer loans, enabling holders to treat their digital collectibles like any other asset to be monetized.
5. Cross-chain Collateral Gains Ground
As the demand for collateral to deploy in DeFi dapps increases, new ways of bringing liquidity into the sector are also coming online. A major development in this area is the growth of Bitcoin on Ethereum (via ERC20 tokens that are backed 1:1 by BTC). Two examples of this are Wrapped Bitcoin (WBTC),8https://wbtc.network/ which uses BTC held in custody by the token issuer (like USDC for Bitcoin), and Ren Protocol, which adopts a trustless model for tokenizing Bitcoin and other cryptocurrencies for use on Ethereum. As the largest and most valuable cryptocurrency, Bitcoin represents a huge amount of potential liquidity for DeFi. For example, over 125,000 BTC worth almost $6 billion currently exist as WBTC, while the value of assets locked in the Ren Protocol has gone from zero to almost $1 billion in six months.
What Else is Unfolding in DeFi?
While the five developments above are the most watched, users are also beginning to focus on a few others, including:
- CBDCs. Over the last five years, central banks and governments have been exploring the benefits of blockchain technology with the aim to launch their own Central Bank Digital Currencies. The first versions of these CBDCs are now being trialed, most notably in China. Several other countries are preparing to follow.
- Insurance. Decentralized insurance apps have the potential to bring transparency and efficiency to this multi-trillion dollar industry. Cover for various pitfalls in the DeFi space, from smart contract exploits to exchange hacks, is a small but rapidly-growing use case.
- The rise of true DAOs. Implemented properly, decentralized finance protocols can be more secure, transparent, and efficient than traditional, centralized financial systems. As the DeFi space evolves and awareness of genuine decentralized operations increase, more projects are progressing toward becoming true DAOs (decentralized autonomous organizations).
DeFi’s Time to Shine
The growth of DeFi in 2020 points to an exciting sector with great promise. Today, it’s becoming more and more clear that DeFi could quickly shape the future of finance. Dapps are on pace to have another remarkable year thanks to new trends bolstered by the power of stablecoins, the increase in adoption of NFTs, and new scaling and liquidity options.
Learn more about the role the Maker Protocol plays in helping power DeFi applications.