DeFi Growth and the Road Ahead

Decentralized Finance (DeFi) is one of the most popular developments in the crypto-asset space, which recreates traditional financial systems in a decentralized, open, autonomous, and permissionless way. Despite a harsh bear market, DeFi has proven resilient and has been incredible to witness throughout 2022.

The DeFi market saw the TVL (total value locked) rise from $687 million to over $14 billion by the end of 2022. Volume on DEXs in January was up 27% from a month earlier, at $56B. This marks the first increase in monthly volume since May 2022, excluding the spike in November following the FTX fallout.

DeFi – What exactly is it?

DeFi is the umbrella term for the collection of financial products and services that rely on smart contracts and blockchains. The DeFi applications are decentralized, operating on a peer-to-peer (P2P) basis. However, the extent to which they achieve decentralization can vary. It is also called “money legos” due to its modular and composable nature. Every individual “Lego brick” within the DeFi application represents a unique financial offering that users can combine according to their preferences. By merging multiple of these Lego-brick products and services, a new DeFi app can be created that is more robust or tailored to meet the specific requirements of each user.

The emergence of the DeFi market has gained attention from policymakers due to the rise of applications utilizing distributed ledger technologies. Instead of depending on centralized entities for trust, DeFi markets operate as community-based networks aiming to automate the elements that foster trust in centralized institutions. They strive to function globally and without borders, providing financial services while bypassing the need for intermediaries or centralized procedures.

The building blocks of DeFi

  • Stablecoins – Stablecoins are very significant for borrowing purposes. The user doesn’t require to borrow the cryptocurrency that fluctuates in cost. The user should borrow a stablecoin and then utilize it in the way they like. This also makes the borrowing process easier.
  • Governance – Governance is an important aspect of executing the decentralized protocol. All developments in the protocol are based on the results of the voting. Voting can be performed by holders of the protocol’s governance tokens.
  • Automated Market Makers (AMMs) – The traditional exchanges are based on Order books. If the user requires to trade a cryptocurrency, they will require a subsequent buyer or seller. AMM substitutes that. It allows users to develop liquidity pools of 2 tokens. Trading can take place within the pool so created.
  • Bridges – DeFi enables cross-functionality across different blockchains, allowing users to transfer tokens from one blockchain to another. This is made possible through bridges, which consist of smart contracts. These smart contracts lock the user’s native token and provide them with a 1:1 pegged token on the target blockchain.

DeFi Key Statistics 2023

Currently, global interest is growing in the digital economy, with a particular focus on blockchain technology. DeFi offers exciting possibilities, such as the fact that it comprises several highly interoperable applications and protocols. As an emerging technology, it has the potential to disrupt the entire financial sector in the future.
The Ethereum ecosystem continues to dominate the DeFi space, accounting for 58% of all liquidity within the sector. In terms of notable incidents, the largest DeFi exploit of 2022 was the Ronin bridge exploit, which occurred in March. This exploit resulted in losses of 173,600 ETH and 25.5 million USDC, valued at over $625 million at the time.
Despite the decline in Total Value Locked (TVL) and the significant scale of these hacks, financial analyses remain optimistic about the sector. According to a Market report, the worldwide blockchain market size is expected to reach $67.4 billion by 2026. This forecast takes into account various factors, including a surge in venture capital funding, wider acceptance of blockchain for payment systems, and the integration of blockchain solutions in domains such as cybersecurity and banking.

Top DeFi predictions for 2023

  1. Centralized Exchange Failure – In 2022, numerous centralized exchanges (CEXs), including FTX under Sam Bankman-Fried, experienced failures. This led to a lengthy process for users to retrieve their assets, resulting in a growing suspicion towards these platforms due to their lack of transparency and control.
    On the other hand, decentralized exchanges (DEXs) offer users transparent operations and complete control, although they often require more diligence from the average user due to their complexity. Instead of granting access to funds to a centralized corporation, DEXs provide users with full visibility of how their funds are stored on the platform. As a result, 2023 can be a breakthrough year for DEXs, with the possibility of more innovative functionalities being introduced to these platforms and applications.
  2. Decentralized Finance – An increasing number of investors have begun to understand the distinction between DeFi and its traditional centralized counterpart. An illustrative instance of this is when creditors were able to reclaim their assets solely through the use of smart contracts. This scenario occurred when Celsius and Alameda Research repaid their loans to gain access to the collateral they had provided in order to borrow dollars.
  3. Institutional Integration – Investors increasingly recognize the potential of utilizing smart contracts, leading to a likely increase in the integration of DeFi with CeFi. A notable example of this is JP Morgan, which has made significant advancements in its blockchain-based initiatives through its dedicated entity, Onyx.
  4. Decentralized Identity – As CeFi continues to explore ways to incorporate blockchain-based methods, DeFi will also play a pivotal role in the advancement of digital identities. In 2022, several tools emerged that explored the interaction between social networks, decentralized identities, and reputations. Projects like ENS, soulbound tokens, Lens, and POAPs were instrumental in this exploration.

The advantages of DeFi

DeFi have the potential to transform the financial sector by providing a more open, transparent, and accessible financial system for everyone.

  1. Decentralization: DeFi eliminates the need for intermediaries, allowing users to directly access financial services without relying on third-party institutions. This results in lower fees, faster transaction times, and greater control over one’s assets.
  2. Transparency: DeFi transactions are documented on a public blockchain, establishing a transparent and unchangeable ledger of all financial activities. This transparent recording of transactions instills trust in the system and allows anyone to audit financial transactions.
  3. Security: DeFi relies on smart contracts and cryptography to ensure the security of the transactions. In smart contracts, the terms of the agreement are automatically enforced when certain conditions are met, ensuring funds are only released when the conditions are met.
  4. Accessibility: DeFi is open to anyone with an internet connection, regardless of location or financial status. This enables users to access financial services they may not have been able to access otherwise.

Summing up

DeFi TVL decreased by 76% throughout 2022, however, it is expected to expand with a CAGR of 42.5% from 2022 to 2030. Since 2020, the DeFi TVL has increased by 6,900%. Decentralized exchanges saw more than $850 billion in trading volume in 2022 from more than 5.6 million unique wallet addresses.

DeFi passive income depends on the staking and single-sided exposure in 2022. There are many sectors within DeFi that already have a product-market fit. These will continue growing, such as DEXes for derivatives and spot trading, stablecoins, and liquidity staking protocols. In 2023, as the block space becomes more valuable, many users will want to stake their Ethereum tokens to earn revenues produced on-chain while experiencing the benefits and composability of DeFi.

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