Since the launch of Bitcoin in 2008, several major trends have emerged within the blockchain industry that shifted the course of the entire ecosystem and the broader financial economy. Decentralized Finance (DeFi) is one of those trends.
The exponential growth of the DeFi market reflects the potential of digital currencies and decentralized platforms to offer an alternative to the paradigm of traditional finance that for decades has seen steady consolidation, stifling innovation and deemphasizing financial inclusion. DeFi is creating a foundational layer for permissionless, blockchain-based financial services within the emerging digital economy.
Life Before Decentralized Finance
Decentralized finance (DeFi) is pledging to transform the financial world by providing alternative financial solutions while empowering communities.
DeFi comprises all kinds of financial products and services built on blockchain infrastructure, typically governed by decentralized communities. These services can be traditional – such as borrowing and lending, payments, money issuance, insurance, trading, and asset management – as well as entirely new and innovative, such as automated market makers (AMMs), staking programs, and yield farming.
It has been argued that Bitcoin was the first DeFi use case since it was designed as a peer-to-peer (P2P), decentralized money system. Bitcoin, however, has emerged as a compelling store of value (SOV) more than a means of exchange as other blockchain networks have become more established.
Conversely, DeFi tokens and applications enable users to do more with their holdings than sending value from one address to another.
The term DeFi was coined in the summer of 2018 during a Telegram chat between Ethereum developers and entrepreneurs who wanted to name the movement of open financial applications built on Ethereum. Out of several options to call the emerging movement, DeFi seemed the best choice as it sounds like “defy.”
The Rapid Rise of DeFi
DeFi has grown at an impressive pace since the summer of 2020.
DeFi really took off in 2020 thanks to Compound. Compound launched its COMP governance token in May of that year, enabling users to earn COMP in exchange for providing liquidity to the platform. Compound is an Ethereum-based autonomous lending protocol where users can lend out their digital assets to earn interest or borrow against collateral.
Compound supports more digital currencies and provides a governance token for liquidity providers. Thanks to Compound, yield farming, the act of providing liquidity to maximize governance token rewards, became a buzzword inspiring other DeFi apps.
In general, the Total Value Locked (TVL) figure is one of the most important indicators to assess the overall growth rate of DeFi. TVL reflects the value of funds users have collectively locked into DeFi projects.
In June last year, TVL sat at about $1 billion worth of cryptocurrency deposited in DeFi applications. Today, the TVL figure exceeds the $60 billion mark, and it peaked at over $86 billion in mid-May, according to data from DeFi Pulse.
2021 has started off as another banner year for DeFi TVL, which has surged by 300% year-to-date. More and more retail investors and institutions are realizing the potential of DeFi as an investment opportunity as an ecosystem that can host financial services in a decentralized manner.
DeFi Thrives in 2021
Despite recent volatility and a notable pullback in May, DeFi has accelerated its expansion in the first half of 2021 overall.
Besides lending protocols such as Compound and Aave, other DeFi applications have also been expanding in 2021, including:
Decentralized exchanges (DEX) – According to Messari, trading volumes on DEX have surged by over 8,000% in the first quarter of 2021 compared to the same period last year. Curve Finance and Uniswap are currently the largest DEX by trading volume and TVL.
Derivatives – futures and options exchanges built on decentralized exchanges are the next big thing. Projects like Hegic, Perpetual Protocol, and Mirror Chain have been increasing in popularity across the DeFi community.
Asset management – Yearn.finance still dominates DeFi’s asset management sector. The TVL in Yearn surged from about $500 million at the beginning of the year to almost $4.5 billion as of today.
Stablecoins – Stablecoins have played a major role in DeFi, acting as a bridge between the emerging digital economy and traditional finance. USD Coin (USDC), the USD-backed digital currency launched by Circle and Coinbase in 2018, has been the fastest-growing stablecoin in both 2020 and 2021. In total, the aggregate market cap of stablecoins has surged from about $25 billion in January to over $109 billion as of June 2021.
Stablecoins Have Fueled DeFi Growth
Stablecoins are imperative for the DeFi space, and their rapid growth reflects in part the surging demand for DeFi applications. For example, many liquidity pools use stablecoins like USDC as the quoted currency to make trading more convenient and intuitive.
Besides DEX, DeFi lending platforms and other DeFi applications rely on stablecoins to mitigate volatility in crypto markets and attract more investors.
Circle’s USDC is the most dominant stablecoin used across DeFi projects. Recent data from FlipsideCrypto shows that USDC was DeFi leading stablecoin in terms of TVL, daily active accounts, as well as daily transactions in the first quarter of 2021.
Expansion of the DeFi industry is expected to continue to accelerate in coming years, and stablecoins will continue to play a leading role.