DeFi renaissance! Arthur, the founder of investment institution DeFiance, uses five key points to help you understand why DeFi has more than 6 times of room for growth in the future.
DeFi experienced a DeFi Summer wave in 2020 and 2021, driven by high expectations, with many believing it would revolutionize traditional finance (TradFi). However, like most new technologies, the initial hype led to disappointment as the infrastructure was not yet mature, leading to a downturn in 2022.
Like any revolutionary movement, DeFi has become more resilient over time, successfully navigating the "trough of disillusionment" and beginning to ascend the "slope of enlightenment". Gartner's Hype Cycle is an effective framework to visualize this journey, and DeFi is now showing signs of recovery.
After two years of adjustment, key indicators such as Total Value Locked (TVL) are gradually recovering, as shown in the chart below. While some of the improvement is due to rising cryptocurrency prices, trading volumes on DeFi platforms have also increased significantly, approaching 2022 levels, demonstrating that this recovery is genuine.
In fact, some core DeFi projects, such as Aave, have even surpassed their 2022 peaks in multiple metrics. For example, Aave's quarterly revenue has exceeded Q4 2021, which was considered the peak of the previous bull market.
This indicates that DeFi is maturing and entering a new phase of productive development, preparing for long-term scalability.
2. The Impact of the New Interest Rate Cycle Will Make the DeFi Market More Attractive to Players
The recovery of DeFi is driven not only by internal factors but also by changes in the external economic environment. With global interest rate fluctuations, risk assets like cryptocurrencies (including DeFi) have become more attractive to investors seeking higher returns.
As the Federal Reserve raised interest rates by 50 basis points in September, a new low-interest rate environment is forming, similar to the environments that drove cryptocurrency bull markets in 2017 and 2020, as shown in the chart below. Bitcoin (and cryptocurrency) bull markets are shown in green during low-interest rate periods, while bear markets are typically marked in red during periods of rising interest rates.
DeFi benefits from the low-interest rate environment in two key ways:
1. Lowering the opportunity cost of capital - As returns on Treasury bills and traditional savings accounts decrease due to falling interest rates, investors may turn to DeFi protocols to generate higher yields through liquidity mining, staking, and providing liquidity.
2. Lower borrowing costs - Reduced financing costs encourage DeFi users to borrow and deploy capital for productive purposes, driving overall ecosystem activity.
While interest rates are unlikely to return to near-zero levels of the past, the opportunity cost of participating in DeFi will be significantly reduced. Even moderate rate cuts can have a substantial impact, as the leverage effect amplifies the gap between interest rates and yields.
Furthermore, we expect the new interest rate cycle to be an important driver of stablecoin growth, as it significantly lowers the capital cost for TradFi funds to seek yields in DeFi.
In the previous cycle, the Federal Reserve's benchmark interest rate (FFR) had an inverse relationship with stablecoin supply growth, as shown in the chart below. As interest rates decline again, stablecoin supply is expected to increase, providing more capital to accelerate DeFi development.
3. DeFi Remains the Largest Product-Market Fit (PMF) in the Crypto Market
The crypto market has seen various attempts to combine applications, such as Non-Fungible Tokens (NFTs), the metaverse, games, and social media. However, based on most objective metrics, these areas have not yet truly found product-market fit (PMF).
The following case illustrates that even with the brief boost from the Bitcoin Ordinals hype in 2024, NFT daily trading volume is still declining.
As for the metaverse and games, there are currently no breakthrough Web3 games that have gained widespread global popularity. The daily active users (DAU) of two early Web3 metaverse projects, Decentraland and The Sandbox, are only in the thousands, far behind Roblox's 80 million. While the DAU data of TRON games is impressive, whether users will continue playing after the lack of ecosystem incentives remains a variable.
In contrast, DeFi has proven its product-market fit. Core DeFi areas like lending and borrowing have grown over 100% in the past year, demonstrating market appeal. At the same time, some new billion-dollar-scale verticals, such as Eigenlayer and Ethena, have seen explosive growth in less than a year, showcasing DeFi's composability and permissionless nature, as various teams continue to stack new financial Lego bricks to unlock more use cases.
Although regulatory barriers have long hindered DeFi's potential to disrupt traditional finance (TradFi), its inherent advantages are evident, such as:
Cross-border transactions and remittances with an average cost of 6% and 3-5 business days processing time.
Cumbersome backend systems and limited operating hours of stock exchanges, resulting in low efficiency.
Here is the English translation:
Tokenization of physical assets (such as real estate) can unlock liquidity and use them as collateral in DeFi, increasing composability and capital efficiency.
DeFi can operate 24/7 at low cost, with ample liquidity and without intermediaries, making it a more efficient alternative. The technology exists, but the challenge lies in whether regulators will allow DeFi to disrupt the global $10 trillion financial industry, which has long relied on inefficient operations.
IMF research shows that DeFi's efficiency far exceeds that of TradFi, with the following comparison of service costs:
Labor cost: DeFi's labor cost is almost 0%, while TradFi's is around 2-3%. For example, DeFi loans are automated, while TradFi requires manual review and cumbersome paperwork.
Operating cost: DeFi is only 0.1%, while TradFi is 2-4%. DeFi processes transactions through smart contracts, with verification provided by the blockchain, without the need for large offices or intermediaries.
In high-income countries, TradFi's marginal costs reach 6-8%, and in emerging markets, 10-14%, ultimately borne by end-users. DeFi completely eliminates these inefficiencies.
Furthermore, the Fintech industry has seen limited innovation in the past 15 years, as Blockchain Capital's research has shown. Despite significant progress in AI and global internet penetration, Fintech remains rooted in legacy systems, such as the banking industry's use of the 50-year-old SWIFT system, where transfers still take 1-4 business days.
Most Fintech innovations, such as digital payments, fractional stock trading, and API trading, have focused on improving the user experience rather than addressing the core inefficiencies of traditional finance. For example, Robinhood and Plaid provide convenient stock trading solutions, but still rely on outdated financial infrastructure. The essence of Fintech is to leverage existing systems, not to create entirely new ones. While these changes have been beneficial, they cannot solve the deep-rooted problems plaguing traditional finance.
DeFi, on the other hand, is built from the ground up as a digital system, not operating around legacy systems, but directly embedding financial services into the internet. In DeFi, fractional ownership, overcollateralized lending, and global payments are not innovations, but basic functionalities.
This marks a shift from incremental improvements to a fundamental restructuring of the financial system, known as disruptive innovation.
Adopting DeFi will allow us to go beyond minor tweaks and unlock vast economic potential, improving financial accessibility and creating wealth in regions traditionally overlooked by traditional finance, implementing financial inclusion - a revolution to reshape the financial system for the digital age.
Looking ahead, the 2024 US presidential election may bring regulatory clarity. If Trump is elected, he may introduce crypto-friendly regulations; if the Biden administration maintains its friendly stance towards the industry, it may continue its positive approach. Regardless of the political outcome, the momentum of DeFi's development cannot be ignored.
DeFi is just getting started, and the future of finance will be decentralized and on-chain.
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4. Improvements in user interface/experience, infrastructure, and security are making DeFi more mainstream
The early development of DeFi was hindered by cumbersome interfaces and technical complexity, deterring mainstream users. However, in recent years, significant improvements in user experience, infrastructure, and security have made DeFi more accessible to the general public.
One of the most important advancements is the enhancement of wallet infrastructure. Managing seed phrases and private keys was a major obstacle, but new smart wallets and embedded wallets have greatly simplified this process while improving security. Features like social recovery, biometric authentication, and passwordless login now allow users to easily manage their funds, avoiding the cumbersome operations of traditional Web3 wallets.
Security has also been enhanced, with more rigorous smart contract audits becoming a standard procedure before deployment. Platforms like ImmuneFi encourage white hat hackers to find vulnerabilities and security issues through bug bounty programs, ensuring that flaws are patched before they can be exploited. These infrastructure and security improvements have made DeFi safer and more efficient for all users. The significant decline in DeFi hacking incidents over the past year is a testament to this progress.
With these advancements, DeFi is gradually moving towards mainstream adoption, including institutional adoption, further driving its growth.
Make DeFi Great Again
Just as the European Renaissance reshaped society, DeFi will revolutionize the financial sector. The innovative potential of DeFi is limitless, and we are only beginning to see its impact. As more users and investors embrace DeFi, the global financial system will gradually migrate on-chain, becoming more efficient, open, and accessible to everyone.
DeFi has the power to eliminate inefficiencies, break down barriers, and create new opportunities for financial inclusion. It is not just a passing trend, but a fundamental shift in the way we interact with money. From global payments to the democratization of financial services, DeFi offers a future financial system that is open to all.
Currently, the total value locked in all DeFi protocols is around $33 billion, accounting for only 1.4% of the entire crypto market capitalization ($2.3 trillion).
*Data as of October 13, 2024*
Despite the challenges of market conditions and industry environment, the growth and success of DeFi have been overlooked by the market recently. However, as DeFi protocols rapidly develop and deliver value to token holders, such as Aave's recent proposal to change its token economics, market participants will gradually recognize the fundamentals and potential of DeFi, and reallocate capital accordingly.We expect that as DeFi continues to grow and demonstrate its latest appeal and potential, its market capitalization will increase from 1.4% to 10% of the total crypto market capitalization within the next two years.
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Disclaimer: The content above is only the author's opinion which does not represent any position of Followin, and is not intended as, and shall not be understood or construed as, investment advice from Followin.
