Is DeFi dead?
The creation of decentralized finance (DeFi) has taken the crypto industry by storm.
This story stems from a hypothetical thought experiment by Reddit user u/vbuterin (now widely known as Ethereum co-founder Vitalik Buterin) in 2016. He came up with an idea at the time to run an on-chain decentralized exchange in the form of an automated market maker on the chain, similar to a prediction market. This subsequently drove the creation of a decentralized financial system on top of blockchain technology.
Since then, the DeFi industry has exploded into a thriving, multi-billion dollar ecosystem full of opportunities. At its peak in December 2021, DeFi had a whopping $247.96 billion in total value locked (TVL) thanks to multiple blockchain ecosystems and applications. However, the DeFi space has lost ground following macroeconomic uncertainty, geopolitical tensions, increased DeFi hacks and breaches, a general market downturn, and an increasingly pessimistic outlook due to recent events (Terra, 3AC, Celsius storms) great value. In June 2022, its TVL fell to a low of $67.46 billion.
Which begs the question: is DeFi dead?
Now, that’s a tough question to answer. Saying “no” is too hasty, and we see web3 maximalists who are “denied” a lot of time; saying “yes” is also too hasty, and it makes us underestimate the true vitality and robustness of this space, how much it has gone through to survive, and how much more it can grow and develop.
The best answer, then, is “between the two.” While DeFi is certainly not dying in any way, going down the same path that led to market cap collapse and loss of TVL won’t do the space any favors at all.
To be reborn, DeFi must build on the ashes of previous cycles. The way forward should always be guided by the lessons of the past, so this is where our overall focus is first.
A Brief History of DeFi
In the midst of the bitter cold of crypto winter, Uniswap, Maker Protocol, and Compound emerged from the first explorers to explore uncharted territory. These projects were created with a similar vision in mind to create a decentralized and trustless financial system that is censorship-resistant and economically inclusive, without compromising its capacity and efficiency.
With these three decentralized applications, the idea of a trustless digital asset exchange, stablecoins and crypto lending becomes a reality. According to DeFilllama, by June 2019, the protocols had amassed a staggering figure of nearly $500 million in TVL, a remarkable feat at the time.
Having said that, the idea of decentralized finance was not really something widely available at the time, with only a few smart contracts living on the Ethereum blockchain.
“DeFi” is a buzzword that is often thrown around as a glimpse into a promising future for the decentralized financial system. The huge shift towards building DeFi really started with the birth of Uniswap in November 2018.
The Birth of DeFi: On-Chain Automated Market Maker Uniswap
Building on Vitalik Buterin’s thought experiment on decentralized exchanges, Uniswap was launched as the first on-chain automated market maker protocol on Ethereum. Although Bancor first proposed the concept of liquidity pools, Uniswap popularized it to the masses with its famous “x * y = k” constant product pool formula.
The mission of Uniswap V1 is simple, providing users with an interface that allows them to seamlessly exchange ERC20 tokens on Ethereum. With its primary focus on decentralization, censorship resistance, and security, it effectively enables Uniswap to create a safe and secure way for users to trade their digital assets trustlessly without a centralized custodian.
The code of the Uniswap protocol is designed to be a public good that moves the industry forward, its code is completely open source, there are no special treatment for early investors, adopters or developers, and there are no governance tokens or platform fees.
The choice to fully open source the Uniswap protocol code has clearly resulted in many decentralized exchanges across multiple blockchain networks today.
Learn about Maker Protocol and DAI, the first decentralized stablecoin
The Maker Protocol platform enables anyone to generate DAI, the first decentralized collateralized stablecoin backed by crypto assets like ETH and BTC.
Since the market value of cryptocurrencies often experiences large fluctuations, the need for stablecoins is clear. However, the only market products at the time were centralized stablecoins backed by assets from centralized parties that faced custody and regulatory risks.
In a decentralized economy, the product market for DAI is clear, as it preserves the founding spirit of the crypto industry, censorship resistance, and decentralization.
Source: Maker Protocol
The protocol and its stablecoin have gone through several iterations since its inception.
On March 12, 2020, a day known as Black Thursday, the price of ETH experienced a massive drop and fell by more than 30% in 24 hours. This market volatility coupled with Ethereum’s rising gas fees has put enormous pressure on the protocol as many DAI vault owners have their vaults undercollateralized and liquidated.
At the same time, there were not enough liquidators bidding for liquidable collateral as arbitrageurs paused operations amid network congestion. This quickly led to stability issues as DAI was pegged to the US dollar and the price of MKR dropped significantly by over 50% on the same day.
To save DAI, the MakerDAO community proposed adding USDC, a centralized stablecoin backed by Coinbase’s Circle, as collateral for minting DAI, providing greater stability to the protocol and its DAI stablecoin.
While a controversial decision at the time, staking USDC proved to be a good move to stop the bleeding and effectively save the Maker protocol.
Aave (ETHLend) and Compound: Pushing the Boundaries of DeFi Lending
Launched in 2017, ETHLend is the first decentralized lending marketplace on Ethereum. The first of its kind, the platform matches individual lenders and borrowers looking to participate in mortgage positions in a safe and secure way.
To ensure its security and trustlessness, the platform utilizes smart contracts on Ethereum to store user funds and their collateral to facilitate peer-to-peer lending protocols. The platform opens up a range of DeFi features, allowing traders to add leverage or short crypto assets, while businesses and consumers can access cash flow and liquidity without selling the underlying collateral.
This is when Compound comes into view.
In September 2018, Compound launched its algorithmic and autonomous money market protocol on Ethereum, allowing anyone to frictionlessly earn interest or borrow crypto assets in a trustless manner without interacting with counterparties. What makes Compound stand out is its introduction of a Peer-to-contract design and dynamic lending and borrowing rates.
Lenders and borrowers only interact with the lending pool, not another user, which is a smart contract reserve containing the user pool assets. Each lending market automatically calculates supply and lending rates, which fluctuate in real time as market conditions adjust.
This allows Compound to effectively offer lenders and borrowers effective rates in response to market conditions.
Source: Compound Finance
Unlike traditional credit intermediaries where borrowers need to negotiate loan terms and borrowing rates, Compound has reimagined the service in a trustless and automated way, making loans accessible to all and allowing lenders to generate income from their crypto assets .
This pool-based model allows a loan position to be opened permanently while the borrower pays the borrowing rate and the lender earns interest on the assets it provides. This dynamic is balanced by the loan-to-value ratio (LTV) mechanism, which is a measure of the threshold for liquidation of loan positions.
Because the protocol is completely open source, Compound has played a major role in pioneering algorithmic on-chain money market protocol design in a decentralized economy.
ETHLend took its lessons from Compound and moved away from its decentralized peer-to-peer lending design, eventually rebranding its platform as the now-famous Aave protocol.
Like Compound, Aave’s infrastructure is built on top of its pool-based vault. However, Aave takes DeFi lending services a step further by introducing innovative features such as flash loans, interest rate swaps, and liquidity provider (LP) tokenization.
The protocol has since undergone two upgrades and is now Aave V3.
Source: Aave V1
While they may not have realized it at the time, Uniswap, MakerDAO, Aave, and Compound were laying the groundwork for the arrival of the entire DeFi industry and paving the way for many of the other household names we know today.
In fact, 2020 and 2021 are years of leaps and bounds for this nascent industry, as many say they are starting to push the boundaries of DeFi beyond what was originally envisioned a few years ago.
The birth of yield farming
COMP governance token
On February 27, 2020, Compound founder Robert Leshner announced the launch of the new COMP token as a way to introduce a new community-led governance system that will replace Compound’s centralized management.
This change effectively allows COMP token holders to propose, debate and implement changes to Compound without relying on or requiring the project team. COMP tokens allow token holders to delegate their voting power to any ERC-20 address they choose; essentially allowing others to vote on their behalf.
Source: Compound Finance
The COMP token is the first “governance token” that enables anyone to own a stake in Compound and have an active say in the protocol’s future plans. By design, COMP tokens are distributed directly to its most important stakeholders, such as the users of the protocol.
This token distribution design empowers and incentivizes the protocol community to jointly manage the future of the protocol through good governance. Before you know it, this new design caused a huge shift that changed the crypto industry forever.
Although originally intended for community governance, the distribution of COMP tokens marks a whole new paradigm shift as traders are able to speculate on the future value of the Compound protocol.
In fact, users started using Compound for the sole purpose of farming their tokens, hence the popularization of the term “yield farming”.
Shortly after the token generation event in June 2020, the COMP token surged to a high of $336.22, an increase of 399.51% from 4 days ago. This price increase propelled the COMP token into the top 20 cryptocurrencies by market cap.
From a technology standpoint, this shift from centralized governance to community governance has led to all kinds of new innovations — from decentralized governance to new ways to attract liquidity to the protocol. While already popular at the time, the most active users of the Compound protocol greatly benefited from the extremely high APY in the form of COMP tokens.
This approach will prove to be very successful as it attracts many new users to the protocol. The protocol’s pool is so popular that APY changes rapidly by a few percent every minute. To the point where users actively seeking the highest yields try to automate the process of exchanging assets to the highest APY pool.
Andre Cronje (AC) of Yearn Finance
Next up is Yearn Finance, the first yield farming aggregator in DeFi, launched on July 17, 2020 by Fantom developer Andre Cronje (AC). To optimize returns from yield farming opportunities, Yearn Finance acts as a shared vault where anyone can deposit their crypto assets.
Its vaults are pools of funds that can automatically deploy funds into the best strategies to bring the highest returns to its depositors. In addition to generating the highest yields, these vaults benefit users by socializing gas costs, automating yield generation and rebalancing processes, and automatically transferring capital as new opportunities arise.
Source: Yearn Finance
At the time, there were several ways to generate yield on their crypto assets. The most common ways include earning transaction fees by providing liquidity to asset pairs on Uniswap or Curve Finance, or simply earning interest on lending by providing assets to lending platforms like Compound or Aave.
That all changed when the incentivized liquidity wars began and Compound was the first to turn on liquidity incentives with its COMP token. At the time each DeFi protocol would introduce its own governance token and provide token distribution to users of its protocol.
This complicates yield farming as yield becomes more profitable. For example, a user provides DAI to Compound and deposits cDAI (a token representing the right to receive DAI from Compound) into Balancer to earn COMP on DAI and BAL on cDAI.
On top of that, the strategy will generate DAI borrowing interest and transaction fees from the Balancer pool. Yearn Finance will simplify this process and turn it into a one-stop solution for passive investors.
Following in Compound’s footsteps, Yearn Finance launched its own YFI governance token. More specifically, however, Andre Cronje announced that the fair value of YFI is $0, since there is no token sale and all YFI tokens will be earned by platform users.
Nonetheless, some argue that a token’s value should be greater than or equal to the protocol’s TVL.
If the concept of comparing market cap to TVL is applied, it is seriously undervalued given the services YFI was offering at the time. Combined with its highly lucrative gains, the protocol has seen a significant increase in TVL, leading to astronomical price increases.
From a starting point of $0, Yearn’s governance token, YFI, reached highs of over $43,000 just 2 months after its launch.
YAM and the Food Token Wave
Yield farming has created a crazy liquidity mining boom, prompting a large number of ordinary users to chase the highest yields. However, no one can predict what will happen next.
What started as a fusion between cryptocurrencies and accessible financial products quickly morphed into a memecoin-themed yield farming subculture.
Source: Yam Finance
As a monetary experiment, Yam Finance has explored various DeFi concepts from the beginning, such as elastic supply of tokens, protocol vault governance, fair token distribution mechanism, and full on-chain governance. The protocol’s governance token, named after Sweet Potato (YAM), is evenly distributed among eight staking pools (COMP, LEND, LINK, MKR, SNX, wETH, YFI, and ETH/AMPL LP) to cover the entire DeFi community.
In less than 48 hours, the yield farming protocol garnered more than $600 million in TVL on its highly lucrative yields, which subsequently sparked a DeFi food token farming frenzy. One by one, out of thin air, you’ll see “delicious” names like Pickle Finance, Cream Finance, Beefy.Finance, Kimchi, BurgerSwap, Tendies, and more.
One would see this as a sign of euphoria at the height of the bull market, but degens are degens after all, and they’re just imitating them anyway. Unfortunately, a critical bug was discovered in YAM’s tokens, which resulted in an over-issue of tokens and an eventual drop in token price, resulting in over $500 million in lost wealth.
Likewise, many other copycat and fork projects of Yam Finance suffered a similar fate.
SushiSwap: Uniswap Derivatives
At this banquet table of Yam forks, runaways, and questionable delicacies, there is one protocol that is making waves in the DeFi community. SushiSwap is a simple derivative of Uniswap, launched in August 2020, allowing users to stake their Uniswap LP tokens on the SushiSwap platform to earn SUSHI governance tokens.
However, SushiSwap creator Chef Nomi went a step further, revealing plans to exchange these Uniswap LP tokens for new LP tokens that will be transferred to SushiSwap. This new technology, widely known as the “vampire attack,” enables SushiSwap to direct its own liquidity pool by extracting massive amounts of liquidity from Uniswap.
Since Uniswap had no governance token at the time, SushiSwap’s approach proved to be very effective. Uniswap liquidity providers chase the highest yield opportunities for their LP tokens as they can earn SUSHI tokens.
On the day LP tokens migrated to SushiSwap, the protocol quickly gained over $1 billion in TVL from Uniswap’s liquidity pool. Uniswap, on the other hand, experienced a massive exodus of TVL in equal proportions, with the protocol’s TVL rapidly falling from a high of over $1.6 billion to $534.24 million.
Source: DeFiLlama (TVL, first image = SushiSwap, second image = Uniswap)
Near the designated liquidity migration date in September 2020, the price of SUSHI plunged by more than 70% in a single day, as its creator Chef Nomi drained the SushiSwap protocol’s development fund, swapping it for a then-valued approx. 37,400 ETH for $14 million.
Chef Nomi has faced tremendous pressure and backlash as her actions have been publicly seen as a betrayal of the SushiSwap community. In response to community demand, Nomi handed SushiSwap’s smart contract private keys to FTX CEO Sam Bankman-Fried, who postponed the liquidity migration until September 9, 2020.
Shortly after successfully transferring more than $800 million in liquidity from Uniswap, Nomi voluntarily returned the ETH he had cashed out to the community out of guilt, and later publicly apologized for his actions. A week later, FTX’s Bankman-Fried returned the SushiSwap protocol to its community after implementing multi-signature to prevent a single bad actor from taking full control of the protocol.
Despite the drama, SushiSwap’s aggressive liquidity mining incentives and launch methods have inspired many future projects as it becomes increasingly difficult to fight for TVL in the growing DeFi ecosystem.
Ethereum Scalability and the L1 Arms Race
The ensuing blockchain scaling issues
The 2020 DeFi summer is coming to an end, and into 2021, Ethereum’s DeFi ecosystem is thriving, with countless decentralized applications deployed on the mainnet.
The price of ETH surged to new highs, from $150 in May 2021 to a peak of $4,100 a year later. On-chain activity continued to accelerate as users explored Ethereum’s DeFi ecosystem, and Ethereum gas fees started to get higher, sometimes costing over $30 in ETH for a simple swap transaction on Uniswap.
Beyond that, the non-fungible token (NFT) market is starting to heat up and gain traction as OpenSea and CryptoPunks steal the show in terms of volume and price action. Every day, OpenSea consistently ranks among the projects with the highest ETH gas consumption on Etherscan.
Source: Etherscan (average transaction fees on Ethereum)
According to Ethereum’s creator Vitalik Buterin, every blockchain should strive to achieve three key properties: decentralization, security, and scalability. However, while sticking to simple technology, a blockchain project can only achieve two of the three, hence what he calls the “blockchain scalability trilemma”.
At the time, it was clear that Ethereum needed to scale. However, layer 2 scaling solutions such as Optimistic rollup and ZK rollup are not ready and still in development.
At some point, after it became relatively inaccessible and expensive for ordinary retail users, funds began to move from Ethereum to greener pastures like Binance Smart Chain, Polygon, Solana, Avalanche, Fantom, and Terra, driving alternatives Layer 1 blockchain narratives enter the full turbo era.
Source: Vitalik Buterin
The Layer 1 Blockchain Arms Race
The foundations of each Layer 1 blockchain ecosystem have announced their own liquidity mining incentives and builder grant programs to attract developers and users.
Binance kicked off the frenzy when it announced a $100 million support fund for DeFi projects on Binance Smart Chain (BSC). Although its impact on price action was not immediate, in February 2021, on-chain activity on the BSC chain began to gain traction as the price of BNB surged from $40 to a peak of $686 in just 4 months.
Developers coming to this new ecosystem quickly realized they didn’t need to reinvent the wheel. As Ethereum has already had many successful applications finding a product market for them, developers forked and renamed them on BSC to quickly gain market share in TVL and new ecosystems in hopes of $100 million in incentives Take a piece of the cake.
Strangely, the most successful application (in terms of market share) happens to be the Uniswap fork and the delicious food farm, the famous PancakeSwap. While not exactly copy-paste, PancakeSwap has cemented itself as the core decentralized exchange (DEX) on BSC with additional features like staking-as-a-service, yield farming, Launchpad, and prediction markets.
The claim that Ethereum cannot scale is strong enough that every major layer 1 ecosystem has experienced its own heyday as liquidity mining incentives are thrown off during a typical bull run.
Similar to what happened on BSC, developers will replicate the same strategy of launching DeFi applications as fast as possible to gain maximum market share and TVL to qualify for ecosystem grants. While non-Ethereum Virtual Machine (EVM) chains like Solana and Terra cannot fork Ethereum applications due to codebase differences, many new protocols build on the design architecture of existing DeFi solutions.
As most young ecosystems lack key DeFi primitives such as decentralized exchanges, lending marketplaces, yield aggregators, stablecoins, and cross-chain bridges, there are plenty of opportunities to exploit.
This trend continues during 2021-2022 as DeFi degens jump from ecosystem to ecosystem to earn liquidity mining rewards. Crypto Twitter often refers to this as “L1 Rotation” and even coined the term “SoLunAvax” when referring to Solana, Terra and Avalanche Tier 1 rotation games.
As Ethereum DeFi’s TVL market share is gradually being eroded by new ecosystems offering cheaper fees, faster transaction finality, and an overall more user-friendly experience, Uniswap, Aave, and Curve Finance, among others Many applications of the first generation of DeFi were forced to extend their reach into the newer blockchain ecosystem.
Ultimately, this narrative shift further validates the multi-chain future thesis. Sovereign Layer 1 blockchains are more interconnected than ever through the creation and expansion of cross-chain applications and asset bridges.
However, referring to the concept of the scalability trilemma mentioned earlier by Vitalik Buterin, these newer layer 1 blockchains are not without their own problems and growing pains, as varying degrees of speed and scalability are sacrificed decentralization and security.
Having said that, the birth of multiple DeFi ecosystems means that a lot of load is offloaded from Ethereum’s mainnet, inevitably reducing network congestion.
Interoperability: The Future of Multichain
With the rise of young blockchains, it is clear that these ecosystems are starting to become more isolated. While already a nascent industry, DeFi protocols operating in newer blockchain ecosystems have had considerable difficulty gaining liquidity and user adoption. Interoperability is a key part of the future of blockchain technology and an essential part of DeFi infrastructure.
As the number of projects and use cases increases, so does the need for interoperability between blockchains. Interoperability will enable multi-chain ecosystems, where different chains can communicate with each other, and from an economic and technical point of view, they can collaborate and share data in real-time.
Many companies and teams have achieved this by creating solutions that allow one blockchain to communicate with another blockchain directly or indirectly through third parties. At a high level, interoperable solutions can be divided into two distinct categories: (a) patched solutions built retrospectively on non-interoperable ecosystems, and (b) natively interoperable solutions.
To elaborate further, retroactively patched solutions built on non-interoperable ecosystems refer to interoperable solutions built on top of existing chains that were not built for interoperability. These can be further refined into solutions such as centralized exchanges and cross-chain asset bridges.
Centralized exchanges are the most commonly used type of crypto exchange, as they can be considered the “traditional” way of trading cryptocurrencies. In centralized exchanges, users deposit funds into accounts controlled by the exchange. The exchange then tracks all trades in the central order book and holds the funds in escrow until an on-chain transaction is required.
While enabling a fast and easy user experience for transacting between different cryptocurrencies regardless of the blockchain network, this form of off-chain interoperability adds layers of complexity as these platforms are heavily regulated. For centralized exchanges serving customers, exchanges must comply with each country’s own laws and jurisdictions, most of the time requiring customers to verify their personal identity through a know-your-customer (KYC) process, and then to allow users to withdraw their assets on-chain and regain custody of their funds.
Inadvertently, this exposes users to counterparty and credit risk, as exchanges can withhold user funds at any given time in the event of liquidity issues or even bankruptcy.
Source: Dmitriy Berenzon, September 8, 2021
In terms of on-chain interoperability, the diagram above depicts how blockchains will be connected to each other as of September 2021. Based on the core principles of decentralization, cross-chain asset bridges such as Wrapped BTC, Multichain (formerly AnySwap), and Portal (formerly Wormhole Bridge) have opted for a more permissionless approach. These solutions are built on a similar design architecture, enabling users to transfer their crypto assets from one chain to another in a trustless manner.
Cross-chain asset bridges typically operate on a “lock and mint” mechanism, where assets on the source chain are locked in the bridge’s smart contract vault, and redeemable “encapsulated” versions of native assets are minted on the target chain.
The rationale for this design is that native assets from one chain cannot exist natively on other sovereign blockchains, so these newly minted encapsulated assets linked to the value on the target chain can be burned in reverse and redeemed on the source chain Equivalent native asset.
While still the most commonly used form of interoperability, with over $12 billion in TVL, cross-chain asset bridges have been a prime target for many hacks and exploits due to the large amount of funds locked in them.
In the past two years alone, more than $1.85 billion in pool funds have been siphoned off by hackers from a handful of incidents such as the Ronin Network and Wormhole bridge hacks, losing $624 million and $326 million, respectively.
Source: Rekt News – Hacking Rankings
While most cross-chain bridges generally operate in a similar fashion, there are variations of each design, some of which are structurally more centralized than others and have additional flaws such as censorship risk and poor liquidity. Despite these differences, Halborn’s blockchain security experts found that most blockchain bridge hacks target a few specific attack vectors that are typically designed to result in the release of tokens on a blockchain, while There is no corresponding deposit on another blockchain. In recent history, exploits have mainly been carried out in the following ways:
1. False recharge events:
Cross-chain bridges often keep an eye on deposit events on one blockchain in order to start a transfer to another. If an attacker can create a deposit event without making a valid deposit or making a deposit with a worthless token, the attacker can withdraw funds from the bridge on the other end.
2. Fake deposits:
Each deposit is verified by the cross-chain bridge before approving the transfer. This verification process can be deceived if an attacker can make a fake deposit to verify that it is a real one. Such was the case with the Wormhole incident, where hackers exploited weaknesses in digital signature verification to steal $326 million.
3. Validator takes over:
Depending on how the bridge is set up, a group of validators on some cross-chain bridges vote to approve or disapprove a particular transfer. If an attacker controls a majority of these validators, they can authorize fictitious and harmful transfers. In the Ronin Network exploit, the attacker took control of 5 of the bridge’s 9 validators, allowing them to withdraw funds from the bridge’s smart contract.
Despite extensive code auditing and security measures by bridge operators, the nature of cross-chain bridges creates a complex environment that exposes itself to numerous risks. Given the number of vulnerabilities faced by centralized exchanges and cross-chain asset bridges described above, it is clear that building a multi-chain future requires natively interoperable solutions.
Source: Connext – Arjun Bhuptani
While many teams have recently risen to the challenge and sought more innovative approaches, building interoperability solutions is not an easy task. Similar to Vitalik Buterin’s scalability trilemma; there is the interoperability trilemma. As described by Connext founder Arjun Bhuptani, interoperability protocols can only have two of the following three properties, often sacrificing one or more in pursuit of others:
- Trustless means having the same level of security as the underlying blockchain.
- Scalability refers to being able to easily integrate into any blockchain.
- Generalizability refers to the ability to process more complex cross-chain data.
At the time of this writing, many new native interop solutions have chosen to use more sophisticated approaches to attempt to achieve all three properties above. Projects like THORChain choose to build their own decentralized liquidity network to act as a full-chain decentralized exchange (DEX), thereby transferring the risk of decoupling to various liquidity pool providers; interoperability centers such as Cosmos and Polkadot take the lead The concept of homogeneous “networks of networks” is proposed as they act as the underlying layer 0 of an interoperable network of multiple layer 1 blockchains.
However, recent interoperability designs seem to be the most promising because of their elegant and scalable approach. Compared to traditional bridge designs, cross-chain communication protocols such as LayerZero, Axelar Network, and Router protocols go far beyond encapsulated assets and centralized systems, reducing many moving parts and attacks through the idea of relaying generic and complex data vector. A mix of nodes, relays and oracles to establish fast, cost-effective and decentralized inter-blockchain communication without compromising security.
While not as widely adopted as their predecessors, these new solutions, built with interoperability in mind, appear to be a promising advance towards building a multi-chain future and solving the interoperability trilemma.
chaotic waters and the way forward
Since then, however, as we head into 2022, with some unfortunate events, things have started to go wrong for the cryptocurrency market as a whole.
First, all countries have problems with rising inflation due to the Covid-19 pandemic that has plagued them for the past 2-3 years. Geopolitically, the Russian-Ukrainian war that broke out in February this year also caused a lot of tension and concern. All of this culminated in massive macroeconomic instability as the Fed finally turned to raising interest rates to fight inflation, sparking fears of an impending recession.
So, unsurprisingly, markets around the world have suffered sharp declines. The S&P 500 fell sharply, as did the broader crypto market, and the DeFi market took a considerable hit.
The bad news doesn’t stop there. Murphy’s Law states that anything that can go wrong will eventually go wrong, and at the worst possible time. This adage could not be better used in the crypto market.
As market participants have just embraced the aforementioned macroeconomic catalysts, the proverbial final nail in the coffin has been drilled into the cryptocurrency market from within. One of the most popular darlings in the field at the time, UST, unfortunately suffered a decoupling. This led to a run on the Anchor bank, and then Terra inevitably collapsed due to hyperinflation, along with a massive $60 billion sinking. Terra’s debacle had serious implications for the entire space.
From here, Three Arrows Capital (3 AC), one of the biggest players in the industry at the time, suffered a sudden thunderstorm. Large CeFi lenders like Celsius, BlockFi, Babel, and Voyager also collapsed as the Terra and 3 AC crashes spread. Further exacerbating the market situation, stETH started trading below ETH due to all the forced selling as CeFi lenders were forced to repay DeFi lending protocols like MakerDAO and Aave to unlock their collateral.
As the total market capitalization of cryptocurrencies plummets, we also see the total market capitalization of DeFi plummet by 75% in Q2 2022 as TVL begins to rapidly exit the ecosystem. Although the total market value of DeFi has recovered somewhat since then, the road to a full recovery is still long and arduous.
Where are we going from here?
The collapse of Terra, while unfortunate, helps uncover the fragility of the algorithmic stablecoin model and the need for more sustainable token economics in the larger DeFi ecosystem. This points the way forward for DeFi.
The act of printing stablecoins out of thin air works wonders while it lasts, but alas – it’s by no means sustainable.
As a very solemn reminder of the above, Terra collapsed in just a few days the moment UST lost its peg, followed by a price drop from $1 during the May 9-14, 2022 death spiral to $0.12.
Clearly, something has to change drastically. The DeFi ecosystem should not rely on super-hire capital to prop up. This is simply not wise if we want a DeFi ecosystem that is vibrant, strong, and most importantly – sustainable in cycles. If sustainability does not exist, the DeFi ecosystem will never become substantial in any meaningful way either.
In Spartan Labs Research’s view, we see a clear path for DeFi to emerge from the ashes of the past, at least in the short to medium term.
Warning: “Rebirth” does not equal prosperity; the two are necessarily mutually exclusive. As such, neither Spartan Labs nor CoinMarketCap claim that DeFi will experience a boom in the coming months. Rather, in our view, these are just a few steps the ecosystem should take to move forward from the lessons of the past.
In order for the DeFi ecosystem to revive from the relative slump it is currently stuck in, and to truly learn from the lessons of the past, three major pivots and progress must be made.
First, all given DeFi protocols must prioritize their own sustainable cash flow generation to a greater extent. Over the past year or two, most DeFi projects (largely due to the euphoria generated by the bull cycle) have been very openly focused on the user acquisition/TVL onboarding aspects of their roadmaps and operations. However, after the bull cycle, we are now starting to realize that this may not be the best strategy for the long-term sustainability and overall longevity of DeFi protocols. This is what we’ll elucidate further in the next section.
Next, the token economics models that dominate the DeFi space must also evolve to adapt to changing times. Rather than relying on hiring capital, the protocol must learn (through its token economics strategy) to attract the appropriate user base that aligns with their respective long-term goals and visions.
Finally, we also believe that the rise of synthetic assets will drive the DeFi space forward and largely sustain it for many years to come. After all, the derivatives space is largely untapped when it comes to DeFi and web3. With the rise of synthetic assets, perhaps the potential of this DeFi sub-vertical can be maximized to the extent that it really should be.
Shift to sustainable cash flow generation protocols
Witnessing the full-blown collapse of LUNA and UST, both of which were (at the time) top 10 by market cap, slammed down in a matter of days has seriously shaken the confidence of the entire market.
The lingering fear, uncertainty, and doubt in the market (to this day) has sparked a dramatic shift in narratives about what an ideal DeFi protocol should look like. Investors are no longer blindly craving the benefits and features of Ponzi schemes that promise ridiculously high returns if they work.
Instead, investors are starting to set their sights on true stability and sustainability to ensure that their token investments can withstand the volatile market conditions that define the crypto/DeFi markets, while still delivering impressive returns that may outperform traditional markets.
So while DeFi in 2021 and early 2022 is largely determined by ridiculously high APRs (think Olympus DAO, Wonderland) and the rise and fall of liquidity mining incentives, both of which are specifically aimed at Large-scale users – Many people now realize that the real key (for users and builders) lies in the user retention strategy, which is lacking in both of the above models.
For builders, it’s not time to just bring a lot of users to your platform and protocol. While important, it shouldn’t be the only thing a project prioritizes. What happens after the user is acquired is also very important because that’s basically why the user is brought in in the first place. The key question now becomes: how do projects and protocols retain their already established users? How do they create a sticky form and moat around said users?
It’s not time for users to just be lofty promises of high returns and yields without financial data to provide them with a substantive representation. Lately, it has been proven that project owners can all too easily (and often) break said lofty promises once anything is far off. There are projects now proving that the returns and benefits they tout are possible and sustainable because of their existing operations, and users should definitely be strict about this before considering any kind of investment in the aforementioned projects.
At this juncture, by the way: the ridiculously high APRs and liquidity mining incentives we mentioned above have been criticized by many inside and outside the cryptocurrency space as “Ponzi Economics.” While we do understand why they are being criticized like this, we humbly beg to be different. For all intents and purposes, the meaning of the word “Ponzi” masks fraudulent intent. Labeling all DeFi protocols that promise high yields as “Ponzi schemes” is unfair to those who intend to provide substantial value to users but fail to do so due to the hiring nature of the capital they attract. Granted, there must have been some built to scam (carpet), but it would be inappropriate to talk about it in such general terms.
Back to the point, the apparent shift in focus to user retention (through true value generation) has led to the rise of revenue-generating protocols, and for some like UNI and AAVE, this is the second time around.
It is clear that users are now looking to invest in substantial value, not promised value. This largely means an operation that generates and accrues expenses in a consistent and sustainable manner.
Below, we’ll explore several protocols that have already done so, and others should learn from and/or emulate their bets to become part of the larger DeFi ecosystem.
Uniswap (UNI), the king of fee generation
As the first AMM on Ethereum and the undisputed leader in fee generation, Uniswap has revolutionized the job of liquidity provision (LP) by allowing users to provide liquidity at custom price ranges across different fee tiers Way.
Taking into account the volatile market conditions, Uniswap is charging an average of $160K-$300K per day in 2022 (as of this writing), doing a very good job of generating various stable revenue streams.
The fees generated by the agreement are all paid to LP users, and the agreement fees are still set to zero.
AAVE, the largest cross-chain currency market
Next, another protocol that has generated some real material value through stable fee accrual is AAVE, the largest cross-chain money market with a TVL of $6.3 billion.
While centralized currency markets like Celsius and Voyager eventually collapsed during this market downturn, AAVE has stood the test of time and remains fully functional. In fact, it’s even generating a steady ~$700-900K per day in 2022 (as of this writing).
GMX, a rising star
Recently, we have also seen the rise of several decentralized perpetual protocols. On the one hand, GMX is a fast-growing decentralized perpetual exchange built on Avalanche and Arbitrum. The deal attracts a lot of TVL in 2022, soaring from $108 million to $289 million. The dramatic increase in GMX’s TVL reflects the market’s desire for perpetual transactions on blockchains other than Ethereum without KYC.
GMX allows users to leverage up to 30x collateral by leveraging borrowed liquidity from other users in the form of GLP tokens, an index that measures tokens such as BTC, ETH, AVAX, and stablecoins.
70% of the fees generated by the protocol are shared with GLP holders, while the remaining 30% are shared with GMX stakers.
Synthetix (SNX), a revenue sharing agreement
Finally, a revenue/fee sharing protocol that has become very popular recently will be Synthetix (SNX). In some cases, Synthetix is a derivative liquidity protocol that allows users to create synthetic assets and trade perpetual futures. Synthetix is also one of the first DeFi protocols to use synthetic assets to bridge the gap between stablecoins, stock markets, and commodity markets.
More recently, protocols such as Kwenta, Lyra, Curve, and 1 Inch have built on Synthetix to take advantage of the deep liquidity of Synthetix debt pools and allow for efficient trading with reduced slippage. As these different protocols are transacted through Synthetix, Synthetix will incur fees, which will then be shared with SNX stakers.
As a result, SNX incurs a sharp increase in fees from $20,000-80,000 per day to $150,000-300,000 per day (as of this writing) in 2022.
The shift to sustainable token economics
From the above we can see that the ability to generate and sustain real substantial value through sustained revenue generation may now define this existing wave of new DeFi protocols as users begin to find the real weight behind the easy-to-manufacture lofty Commitment and APR. With DeFi market cap and total TVL shrinking as much as they have recently, those who stay will surely and rightly be infinitely harder to please, harder to retain, and more strict with their capital. Charismatic leaders will no longer cut it; in this new era, efficient operations must be the cornerstone of any successful DeFi protocol.
However, this is not enough. While this is the baseline standard that all DeFi protocols should meet to survive and thrive in this post-bull context, DeFi protocols should also do more to ensure they only attract the right users. Failure to do so will result in an influx of hiring capital, which, as mentioned earlier, could be drained if prices fall again. Protocol survival is intrinsically tied to the volatile price behavior of the crypto market, a fact that is not ideal for the longevity and maintenance of any given DeFi protocol and should be properly addressed in the future.
This is where the concept of token economics and game theory comes into play. As protocols move to substantive models of real value and revenue generation, they must also ensure that the users serving them will be largely aligned with their long-term goals and vision. Therefore, the token economics model of the entire DeFi protocol must be enhanced and augmented from the existing system to meet this demand.
In the early days of DeFi, as mentioned several times in this report, the protocol offered extremely high returns as a go-to-market strategy to bootstrap liquidity and gain market share in the ecosystem. High token release means these protocols face a race against time to use their market share to overcome the dilution rate of tokens flowing into the ecosystem.
This question sparked the first foray into sustainable token economics when Curve created the popular ve model widely used in many protocols today.
The original ve model is a simple but effective protocol method that reduces selling pressure while incentivizing long-term holders by increasing rewards. Curve allows users to lock their CRV for up to 4 years in exchange for a x2.5 boost in veCRV rewards. Therefore, the incentive lock of CRV helps to reduce the circulating supply of CRV and reward those who believe in the project for a long time and choose to lock for a long time.
The ve model also raises secondary implications for the DeFi scene when token bribes for voting rights demonstrate how protocols can monetize their governance rights.
The Convex protocol is designed to accumulate staked CRV on the protocol to improve its governance influence in the Curve ecosystem. This eventually led to the infamous Curve Wars, in which protocols raced to accumulate large amounts of CRV to influence governance proposals on Curve.
With the rise of the ve model, we’ve started to see steady progress in the various iterations that have emerged recently. In our opinion, this progress is unlikely to go away anytime soon, and newer protocols/builders will do well to learn from the best of these iterations.
For some (non-exhaustive) examples of the above iterations of the ve model, we’ll look at two protocols that perform relatively well in our own implementations.
Trader Joe (JOE)
On the one hand, Trader Joe is the largest AMM on Avalanche with $225.34 million in TVL. It launched veJOE, sJOE and rJOE in March 2022.
The Trader Joe team chose to break down the use cases for the JOE token into 3 separate components:
- veJOE – LP Rewards and Protocol Governance Improvements
- sJOE – Profit sharing of protocol fees
- rJOE – Allocation from launchpad token sale
By segmenting these use cases, Trader Joe tries to get users to focus on the aspects of the DEX that best suit their needs.
veJOE has also opted to do away with lengthy lockups and instead attempt to incentivize long-term staking through the promise of virtual points accumulation. Their premise is simple and clear: the longer you bet, the more virtual points you earn.
Having more virtual points allows users to earn additional rewards from the LPing TraderJoe platform. Users can unstake and trade their JOE tokens at any given point in time; they only need to give up their accumulated virtual points.
Next, Platypus.finance is an open liquidity and single-sided stablecoin AMM on Avalanche. It uses a univariate slippage function instead of an invariant curve and allows for single currency liquidity. Currently, it has amassed $191 million in TVL.
To further illustrate the token economics of Platypus, $PTP is a governance and utility token that LPs can earn by providing liquidity, while $vePTP is a reward boosting token earned by staking $PTP.
For the latter, users can stake PTP to get 0.014 vePTP per hour, of which it takes 10 months to reach the vePTP cap. This is a veJOE-like model where users will be rewarded proportional to their vePTP score.
When it comes to the vePTP model, there are also mechanisms that limit the influence of whales, which are best represented by this equation:
In detail, deposit weights and vePTP scores will always be square roots to limit the impact of whale farming of PTP tokens. This is a good attempt to achieve a more equitable distribution of PTP issuance to users, but can be easily circumvented by more savvy users.
Platypus also leveraged the Platypus Heroes NFT project to inject some gamification elements into the vePTP model. Here, the Platypus Heroes NFT will allow users to accumulate vePTP scores at a faster rate, while also giving them access to gated communities.
It will be interesting to see how these projects and more continue to build and innovate on veModel, and we certainly haven’t seen the last. As mentioned earlier, emerging protocols will learn well and build upon protocol models like JOE, PTP, etc.
Sustainable DeFi Protocol Framework
Despite its pros and cons, the ve model (and its iterations) reveal the cornerstone framework needed for any given protocol that wants to be sustainable and consistent with generating value.
We summarize the above cornerstone framework into a concise table that projects can refer to when planning their operations:
- Supply – Lock-up to limit the release of circulating tokens to minimize selling pressure
- Demand – Introduce protocol-level demand by incentivizing large long-term stakers
- Revenue generation – the agreement can generate revenue to ensure the long-term viability of the business model
- Income distribution – share protocol revenue with long-term stakers, allowing holders to participate in the success of the protocol
- Simplicity – has a simple to understand token economics model to facilitate easy onboarding of users
- Supply and Demand Balance – Modeling Token Offerings Based on Expected Demand Growth Over Time
Expanding on the above, we can also draw 4 lessons from the composition of sustainability and moat protocols:
- Need to get rid of high APR and liquidity mining to bootstrap liquidity
- Positive circular flywheel needs attention in terms of protocol adoption
- Need to focus on building a core community that truly believes in the vision of the protocol (rather than hiring capital)
- Need to get rid of dilutive rewards. Alternatives are:
- Stablecoin rewards (TRI, JOE, SNX)
- Custody Rewards (GMX, SNX, ILV)
Taken together, this does not mean that the ve model (and its iterations) is necessarily the whole and final model for the next wave of DeFi innovation.
In fact, we think just the opposite. In a dynamic space like DeFi, there is never a one-size-fits-all model. This mentality will only fail any protocol that adopts it.
So, as times (and markets) change, so should the protocols and their respective token economics models. Protocol models should never remain static over time – a space in which passivity never pays off and active reflection and adaptation are always required.
In fact, we are already starting to see some protocols push this reflective change in their own way. We’ll explore some of these new models in the sections below.
Further Development of Token Economics
No Token Issuance Agreement
In some cases – how YFI structured their launch may constitute the best example of a tokenless release protocol. To clarify, revenue-generating tokens may choose to move to an emission-free model after the bootstrapping phase. In such a model, there should be a gradual shift away from the stuffed issuance of native tokens to cash flow rewards generated by protocol fees.
In this way, there will be a strong incentive for early adoption and a close eye on the sustainability of the revenue model. Additionally, the token (and the protocol by extension) will be more resistant to selling pressure due to the extremely scarce supply.
Of course, the protocol may also choose to adopt a very low issuance to account for the gradual growth of the protocol.
Dynamic Token Issuance
Finally, based on our belief that the DeFi space is an always-evolving space and that protocols will do well by actively adapting, we believe that token economics models will eventually evolve into ever-changing, robust and such models in A high level would involve shaping the token offering based on demand and profit, providing a minimum for said token.
In this way, dynamic issuance allows the protocol to be conservative and not overcommit to any particular issuance structure.
One issue here, however, is that teams may exploit the dynamic nature of releases for their own selfish and/or malicious means. To mitigate this, we might consider Soulbound NFTs — non-transferable NFTs that can essentially act as digital CVs — to ensure the trustworthiness of all relevant DAO governing members.
Additionally, increasing the duration limit ensures that the changes are gradual and not abrupt. This is probably something we’ll be thinking more about on a deeper level, so keep an eye out!
The rise of synthetic assets and derivatives
In addition to new token economics models, another sub-vertical that has recently emerged in the DeFi space (and will likely continue to emerge) is the synthetic asset and derivatives space, where synthetic assets are a tokenized derivative.
In traditional finance, cash flow from synthetic assets is primarily derived from the underlying assets replicated in the synthetic product itself. However, in DeFi, cash flow can also be generated from newly created synthetic assets as well as from underlying assets. For example, staking SNX tokens to sUSD allows users to both take advantage of SNX’s staking returns and use newly minted sUSD tokens to participate in yield-generating strategies in DeFi.
This increases capital efficiency and flexibility by allowing users to determine their desired parameters as the basis for synthetic assets.
These parameters include (very concisely):
- Collateral ratio
- Asset Type – Commodities, Indices, Stablecoins
- profit sharing
- Peg mechanism for synthetic assets (i.e. leveraged tokens from TracerDAO)
The ability for users to configure the above parameters will fully increase the capital efficiency within the ecosystem. The underlying asset will continue to appreciate in value, while the synthetic asset can be freely traded. Synthetic assets can also act as a form of leverage for users, which is a double-edged sword. However, if used carefully, capital efficiency can be greatly optimized.
More background on capital efficiency above, and while sticking with the SNX example, users often complain about a 400% collateralization ratio (c-ratio) because they often use the money market’s c-ratio as a comparison for capital efficiency.
This is where we have to make a distinction. For most money markets, users typically provide collateral for loans that they can trade in or generate yield on. For SNX, users will receive SNX rewards and protocol fees from staked SNX, while still being able to trade/generate revenue using sUSD Minted. The user also does not need to pay off the debt position until his/her c-ratio reaches 150%.
From this, if a user wants to get as much free capital as possible from the underlying collateral, then taking a loan in sUSD on the money market or on ETH collateral on SNX (130% c-ratio) would be considered more capital efficient .
If a user wishes to generate as much passive income as possible from a long-term position, SNX may still be considered more capital efficient as the position can be held until it reaches its 150% floor rate while still generating additional income from said position.
Returning to our main point in this section, synthetic assets will also allow the creation and trading of any unrelated asset. This is a form of hedging against the volatility of the cryptocurrency market and also provides investors with more diversified investment options.
Additionally, this has the potential to open familiar markets to non-web3-native traditional financial investors (even those in emerging economies and/or those who do not have access to the necessary financial services and tools to take advantage of these markets), with a lower composition The risks they can grab when they enter the web3 world.
In doing so, synthetic assets potentially democratize access to such services and tools around the world.
But that’s not all that synthetic assets can offer. We believe the future is very bright in this sub-vertical.
Below are two forms of innovation that we believe will gain traction in the space in the short to medium term.
Fixed Rate Bond Notes
Fixed rate bond notes will allow the protocol to use its treasury to offer fixed rate bonds to users in the form of synthetic tokens, where users will be able to over-collateralize the corresponding underlying assets to mint representative synthetic bonds.
The bond can only be redeemed at maturity at the floor price and the promised fixed rate, and is freely tradable on the open market to anyone willing to take the risk of the bond.
This will provide additional financing options for projects and will also help ensure everything remains transparent and on-chain.
In some cases, structured products are financial instruments whose performance is related to the underlying asset basket.
Most derivatives-based structured products allow investors to buy or sell an asset at a predetermined price or strike price. Additional conditions can be added to the product to ensure that the product is sufficiently attractive to both issuers and investors (i.e. the strike price is higher than the strike price).
Such structured products also allow issuers to hedge risk in volatile market conditions and allow investors to take on risk at an appropriate premium. However, there is a caveat: Structured products should only cater to sophisticated investors who understand the complexities and nuances involved in such products.
Regulation and DeFi: what’s next?
For DeFi to be reborn, we cannot look inward. While improvements to token design and protocols are important, the space must also rethink external developments.
There have been several such external developments (and huge ones) in recent weeks. On August 7, 2022, the now-infamous privacy mixer Tornado Cash and more than 40 Ethereum and USDC wallets associated with it were sanctioned by the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC).
This represents a significant shift in OFAC’s approach to cases, where previous sanctions have typically targeted specific entities utilizing specific tools for malicious conduct, rather than the entire tool, or, in this case, directly to the source code.
The consequences of this were swift.
Popular decentralized exchange dYdX quickly blocked accounts that had any interaction with Tornado Cash, GitHub suspended Tornado Cash’s GitHub account, and Circle froze $70,000 worth of USDC on the mixing platform while banning any interaction with Tornado Cash The relevant address gets access to USDC.
On the other hand, Tether Holdings Limited, the company behind USDT, the world’s largest stablecoin by market capitalization, announced that they will not unilaterally blacklist or freeze addresses associated with Tornado Cash.
The Coin Center, a nonprofit research and advocacy center, also filed a legal challenge to OFAC’s ruling.
What does this mean for DeFi?
OFAC sanctions against Tornado Cash will have an impact on this space beyond what has already happened (as previously mentioned). There will be several factors to consider and think about.
The censorship resistance value of L1 must be protected and preserved
First, the value of L1 blockchains like Ethereum (the base layer of Tornado Cash) really came to the fore during this event. Tornado Cash’s source code is still very much alive today, even though OFAC has bashed it. To put this into perspective, according to Nansen data, on August 8, 2022 (post sanctions), Tornado Cash outflowed 13,800 ETH, which is a massive daily outflow of 1,400 ETH in increments just the day before (sanctions). forward). In other words, while Tornado Cash’s frontend may have been removed from its website, the backend code is still there, unstoppable and impossible to kill.
In the blockchain world, code is always king; it is censorship-resistant, and not even the whim of a large centralized entity like a government can be succumbed to. While there are illegal cases (we do not condone illegal money laundering for illicit gains in any way), this certainly has value in the privacy-poor world we live in today. The Tornado Cash incident largely demonstrates this.
This value is something we must protect and maintain at all costs, not only for the DeFi space, but for the wider Web3 space. We bring this up for a reason.
Twitter user @TheEylon made a very pertinent and thought-provoking post on Ethereum. In it, he discusses how the Ethereum validator community is ostensibly not decentralized enough to be truly censorship-resistant.
If @TheEylon’s hypothesis is correct and more than 66% of beacon chain validators will not sign blocks related to Tornado Cash (thus complying with OFAC regulations), how does Ethereum differ from any given centralized platform ? So, what is the point of blockchain in this context?
So if we even want to experience any kind of rebirth, decentralization/diversity of the validator community is definitely something that the industry as a whole has to carefully consider first.
The Necessity of Grassroots Legislative Intervention
While what happened was very unfortunate for the DeFi space, it was not as dire as many thought. In any given emerging industry, there will always be inflection points that help the industry mature, as long as they are handled properly.
We believe that the Web3 industry is currently at such an inflection point. How we move on from here is critical, and the resulting discussions and conversations must be so nuanced and effective. Looking at sanctions from another angle, this is an opportunity for the Web3 community to voice their concerns (regarding space legislation) and to fight for a space to define some parameters when it comes to legislation.
We now have a reference point, albeit a very extreme one, to use; we must strive to have a strong voice in this critical conversation that will likely shape the Web3 landscape for years to come.
At a very high level, OFAC sanctions already have a lot of nuance. On the one hand, it may be a sanction that hurts innocent parties more than sinister and malicious parties. This post-sanction dusting attack proves it.
Not only that, but the above also demonstrates how the aforementioned sanctions can be so excessive and all-encompassing that it has the potential to overwhelm the system while these cases (in this case, innocent recipients of ETH dust) can at least Said is trivial, making it ineffective against the real “bad guys”.
While the legal framework should always be broad enough to prevent loopholes or workarounds from being easily discovered, OFAC’s rulings are by no means perfect. As a community, we have the opportunity to have a conversation about this. If we can have a substantial one, then when it comes to the legislative and regulatory areas of Web3, we may well have the ability to shape our own future for years to come. This cannot be taken lightly.
Over-reliance on centralized entities
Finally, the Tornado Cash incident also revealed a strong need for the protocol not to rely too heavily on centralized entities to keep it alive and prosperous.
MakerDAO’s current situation perfectly encapsulates this in light of OFAC sanctions. In some cases, MakerDAO’s native stablecoin, DAI, is currently primarily backed by USDC. MakerDAO is a major DeFi protocol with an extremely significant (relative to DeFi’s total TVL) TVL of nearly $11 billion. As such, their (over) reliance on USDC, an asset that has proven to be so clearly within the reach and reach of government sanctions, should definitely be of concern to everyone in the space.
In fact, the founder of MakerDAO, Rune Christensen, has publicly discussed the possibility of stripping USDC from the DAI peg, a move apparently in response to USDC’s oversight of OFAC.
This is something beyond MakerDAO and DAI; objectively, the survival of decentralized communities, ecosystems and industries cannot be premised on centralized elements that are easily controlled and influenced by centralized entities.
Again, as already mentioned, we in no way condone bad actors who exploit Tornado Cash and/or any given decentralized protocol for undue gain. Just to get Web3 to achieve its purpose in the first place, that has to be admitted.
In our article, we trace the evolution of DeFi from a mere thought experiment to the vibrant and diverse ecosystem it is today.
While DeFi total market cap and TVL may be down sharply from the summer DeFi highs of 2020 (and to some extent, 2021), DeFi is definitely not dead by any means.
The trials and tribulations of the past few months are sure to shape and improve the DeFi space in the months and years to come, and we’ve seen some similarities in several of the protocols discussed in this report.
What people sometimes don’t remember is that DeFi isn’t a single entity, nor is it static, it’s the sum of many moving parts, constantly adapting and evolving dynamically.
What people also sometimes forget is that the concepts of Web3 and cryptocurrencies never really got a chance to fight in the first place. In the misunderstood eyes of many, we always died (and still are). Regardless, however, we’ve managed to get to this point in our collective journey, and there are more races to come.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/10000-word-article-how-does-defi-rise-from-the-ashes/
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