History Can Teach Us What's Next for DeFi
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Three-plus months into 2021, and the DeFi craze shows no signs of slowing. Quite the opposite. Since January, DeFi has tripled in total value locked, rising from $15 billion to $45 billion. What’s more, it has plenty of potential to keep growing.
Of course, the narrative shifts depending on which way the wind is blowing. In the summer of 2020, as so-called “degen finance” started to make its presence felt, some corners of the cryptocurrency community started issuing portentous warnings about the historical parallels with the ICO era.
To be fair, it came on the back of the Yam Finance debacle, which underwent a spectacularly short but dramatic boom-and-bust within 24 hours in August after one of the founders admitted they’d found a fatal flaw in a smart contract. This happened at the same time as the “food finance” trend started to hit its stride.
Cycles are a known phenomenon, especially in financial markets, so drawing parallels with the past is understandable. But while the ICO boom has left a scar in the collective memory of the cryptocurrency community, we don’t need to rush to assume that DeFi is making the same mistakes. After all, there are plenty of similarities to be drawn between DeFi and the rise of cryptocurrencies.
The Bitcoin Blueprint
Let’s consider the history of Bitcoin. Until around 2014 or 2015, Bitcoin barely registered with anyone who wasn’t part of the niche cypherpunk movement. By 2017, the term “Bitcoin” became better known, but it was still relatively obscure.
Once the ICO craze hit and money started pouring into the space, Bitcoin reached its first all-time high. But even that wasn’t enough to maintain the price, because that generation of investors were mainly individuals looking for short-term gains. But the boom attracted plenty of innovators willing to take a chance that cryptocurrencies would eventually become accepted as a legitimate asset class. In 2020, Bitcoin finally got the kind of mainstream momentum that offered more sustainable price increases. Now, institutions are flocking in.
The term DeFi itself didn’t gain traction until late 2019, but it had been around in various formats for several years before. Maker was one of the earliest entrants, along with Uniswap V1 and Bancor. But in early 2020, DeFi underwent its first major growth phase fueled by flash loans. Over the summer, the appetite for governance tokens gave rise to further expansion.
Centralized entities move in
Currently, we increasingly see centralized entities taking an interest in DeFi, which became evident when exchanges such as Binance started offering staking and lending services. Although they’re centralized, the concepts are clearly borrowed from DeFi. However, centralized services have also started to integrate with DeFi projects and protocols, in some cases even rolling out their own. For instance, Binance has been a trailblazer among centralized crypto firms, last year launching its own smart contract platform — the Binance Smart Chain — that’s rapidly become a hub for DeFi projects seeking to escape an increasingly beleaguered Ethereum. In February, PancakeSwap became the first billion-dollar project on the Binance Smart Chain.
Other firms have taken a different approach. In March, centralized exchange Huobi and DeFi lending platform Kava announced a major integration release. Users can now stake Huobi’s Bitcoin-pegged HBTC on Kava to earn an 8% yield until March 2022. Kava CEO Brian Kerr is evidently embracing the idea of CeFi integrations, stating that the partnership has the potential to bring millions of new users to Kava’s platform.
Kava already has some form when it comes to integrating with centralized platforms. Binance’s BNB and BUSD were among the first assets to become listed on Kava as collateral for minting the project’s native stablecoin, USDX. With the much anticipated Kava 5.1 upgrade to the Kava infrastructure, users can now lend and borrow Bitcoin to earn a +45% APY return. The frequency and speed of such integrations of Kava by financial institutions demonstrates the pent-up demand by users for DeFi products and services.
A bright future ahead
So what next? We’ll likely start to see more DeFi and CeFi integrations emerge. For instance, Trace Network is an intriguing new project merging DeFi with NFTs and real-world use cases in retail and trade finance. NFTs offer the ability to provide an immutable, unique proof of ownership for luxury products, such as designer handbags or high-end watches. The DeFi element provides the ability to break down financial barriers and open up new liquidity channels between partner firms.
Elsewhere, some DeFi initiatives are taking steps to bridge the regulatory gap. The Chicago DeFi Alliance emerged due to a collaboration between prominent Chicago trading firms and members of the DeFi community, including representatives from Compound, Kyber Network, and Aave. The latter also became the first DeFi protocol to obtain an e-money license from the UK Financial Conduct Authority last summer.
All of this has echos of Bitcoin’s rise to the mainstream. From obscure platforms used by a tiny minority to an explosion in popularity, following by increasing interest from first-movers willing to take a chance. If the cycle holds firm, the next wave will be inflow from firms outside of the cryptocurrency space. This will be followed by a full-on integration of DeFi into existing financial infrastructure, similar to what’s currently happening with Bitcoin. History often repeats itself, and if that happens with DeFi, then there’s never been a better time to get in on the ground.