In mid-February 2020, the total value locked within the Decentralized Finance (DeFi) application initially exceeded $ 1 billion. Supported by the summer of DeFi in 2020, it will reach $ 200 billion in less than a year and another 10 months, doubling to $ 20 billion. Given the pace of growth so far, it seems not strange to imagine that the DeFi market will reach $ 1 trillion within the next year or two.
This monumental growth can be attributed to one factor: liquidity. In retrospect, DeFi expansion can be defined in three eras, each representing another important development that removes barriers to liquidity and makes the market more attractive and efficient for participants.
DeFi 1.0 — Chicken or the egg first solves the problem
The DeFi protocol existed before 2020, but was somewhat plagued by the “chicken or the egg” issue when it came to liquidity. In theory, someone could provide liquidity to a loan or swap pool. Still, there is not enough incentive for liquidity providers until there is a critical mass of liquidity to attract traders and borrowers who pay fees and interest.
Compounds first solved this problem when they introduced the concept of agricultural protocol tokens in 2020. In addition to interest from borrowers, Compound lenders can also earn COMP token rewards, providing incentives from the moment they deposit funds.
It proved to be a DeFi summer starter pistol. Sushi Swap’s “Vampire Attack” against Uniswap provided additional inspiration to the founders of the project. The founders of the project used their own tokens to encourage liquidity on the chain and started the frenzy of harvest farming in earnest.
Related: Liquidity mining is booming — will it continue or will it go bankrupt?
DeFi 2.0 — Improving capital efficiency
So it was DeFi 1.0, an era that cost about $ 1 to $ 20 billion. During periods of further growth of up to $ 200 billion, DeFi 2.0 has resulted in improved capital efficiency. We have seen the growth of Curve, which refines Uniswap’s Auto Market Maker (AMM) model for stable assets and offers a more focused trading pair with less slippage.
Curve has also introduced innovations such as the voting escrowed tokenomic model that motivate liquidity providers to lock their funds in the long run to further increase liquidity credibility and reduce slippage.
Uniswap v3 has also further improved capital efficiency with a customizable liquidity position. Beyond Ethereum, the multi-chain DeFi ecosystem has begun to flourish on other platforms such as BSC, Avalanche and Polygon.
So how do you take DeFi to the next stage of growth and reach over $ 1 trillion? I believe there are four important developments.
DEX will be a hybrid
The AMM model, which proved to be very successful on DeFi, is inevitable after it became clear that Ethereum’s slow and high rates couldn’t provide enough orderbook models to survive on the chain. Has evolved into.
Related: Auto market maker is dead
However, the presence of DeFi on fast, low-cost blockchains means that the number of decentralized exchanges (DEX) using the orderbook model is likely to increase. Shorter settlement times reduce the risk of slippage, but the lower the fees, the more negligible the exchange of purchase orders will be for market makers.
There are some examples of decentralized exchanges using central limit purchase orders that have already emerged. To show some examples, serum constructed with Solana, Dexalot from Avalanche, Polkadex from Polkadot. The presence of an orderbook exchange has the potential to facilitate onboarding for institutional and professional investors by enabling limit orders and enabling a more accessible trading experience.
Cross-chain configuration possibility
The proliferation of DeFi protocols on non-Ethereum blockchains has severely fragmented liquidity into various ecosystems. To some extent, developers have tried to overcome this with bridges between blockchains, but recent hacks such as Solana’s wormhole bridge hack have raised concerns.
Nonetheless, a secure cross-chain configuration is needed to unleash DeFi’s fragmented liquidity and attract more investment. There are some positive signs. For example, Binance recently made a strategic investment in Symbiosis, a cross-chain liquidity protocol. Similarly, the cross-chain liquidity network Saw Chain was launched last year and has recently gained a rapid foundation for value locks, suggesting a clear desire for cross-chain liquidity.
Blockchain and DeFi begin merging with financial markets
Now that crypto is becoming a globally recognized financial asset, it’s only a matter of time before the boundaries between blockchain and DeFi begin to blur. This can move in two directions. First, by chaining liquidity from an established global financial system, and second, by the adoption of crypto-related decentralized financial products by institutions.
Currently, several crypto projects are launching institutional grade products, and many more are underway. There is already a MetaMask Institutional wallet, and Aave and Alkemi operate a Know Your Customer (KYC) pool for institutions.
Meanwhile, Sam Bankman-Fried has a flag to bring the financial system on-chain. In March, he spoke at the Florida Futures Industry Association, suggesting to US regulators that financial market risk management could be automated using practices developed for the crypto market. The tone of the FT work that covers the story is far from the negative and derogatory attitude that traditional financial press had towards cryptocurrencies and blockchain, and is now full of conspiracy.
Anyone can guess when DeFi reaches the $ 1 trillion milestone. But those of us who are looking at the current pace of growth, investment and innovation are reasonably convinced that we will get there early rather than late.
This article does not contain any investment advice or recommendations. All investment and transaction movements carry risks and readers need to do their own research when making decisions.
The views, ideas and opinions expressed herein are for the author only and do not necessarily reflect or express the views or opinions of Cointelegraph.
Jimmy Inn Co-founder of iZUMi Finance. Prior to entering the world of DeFi, he was a researcher at the North American Blockchain Association and a community member of the World Economic Forum. His PhD was supervised by the University of California, Berkeley and the University of Hong Kong, Max Shen. Jimmy seeks increased liquidity in both cryptography and spirit.