May 20, 2022 · 6 min read
What's Next for DeFI?
With markets looking uncertain, DeFi could be in for big changes...
2021 was an explosive year for the DeFi sector. Nansen estimated that the sector’s 2021 growth compared to 2020 was a 1,120% increase by TVL. Ethereum and marketplaces such as OpenSea enabled NFTs to achieve new heights of popularity and utility. Decentralised exchanges like Uniswap and lending protocols like Aave helped crypto assets remain liquid while providing high yield earning opportunities.
(Info from DeFi Pulse. Updated 16/05/22)
Recently however, markets have been less optimistic. DeFi Pulse reports that over the past three months alone, almost $30B has been removed from crypto’s DeFi sector. DeFi TVL now stands at around $58B - down significantly from its all time high of $110B in November 2021. Some protocols have seen greater decline than others. In light of the downfall of Terra’s UST stablecoin and LUNA token, both DeFi users and developers are now wondering what the future will bring for DeFi. And while the future is never certain, some trends are indicative of where the sector might be headed through 2022 and beyond.
One of the most (theoretically) profitable DeFi use cases, yield earning protocols seem unlikely to shrink in 2022. New forks of yield earning pools such as Pickle Finance’s fork of Yearn will continue to be developed allowing DeFi users to earn with their stagnant assets. Interest in yield earning platforms however seems to have followed recent bear market trends. Yearn Finance for example has seen a 50% decrease in TVL on the month - now sitting at $1.3B. This implies that users are pulling funds back into their wallets from what are perceived to be ‘high risk, high reward’ platforms to ‘weather the storm’.
Info from DeFi Pulse (Updated 17/05/22)
Despite this, new yield earning projects might be born out of the crypto winter. From an innovation perspective, 2022 might bring an increased appetite for yield earning from illiquid assets. Magic Internet Money’s ability to have users stake illiquid ‘ibTKNs’ (interest bearing tokens) might become more prevalent, in addition to NFT staking opportunities. Despite current conditions, DeFi innovation is driven by earning opportunity - and as one of its most profitable use cases, continued interest in yield farming will emerge on the other side.
With the collapse of UST, other stablecoin projects have been experiencing increased volumes (but still remain lower than usual due to market bearish-ness). MakerDAO’s DAI in particular has been performing well in the face of sell-offs. The protocol’s governance token MKR has in fact grown by more than 50% over the past week. Terra’s UST was essentially maintained solely through the ability to burn LUNA to mint UST, (as well as a small treasury of BTC). MakerDAO’s DAI however mints the token using a wide range of collateral - rather than the burning of a native token, effectively distributing the risk across a wider range of assets.
In the future, stablecoin projects will likely heed Terra’s warning and closely examine both how their token is backed and the mechanism through which they maintain price parity. LUNA’s collapse has shown that token burning is undeniably an efficient method of minting stablecoins, but compromises stability and puts users at risk. This might result in the yield earning potential of stablecoin collateralisation being smaller, but will help stabilise the sector.
Info from The Block (Updated 17/05/22)
Investors have undoubtedly been spooked by current conditions with $7B being withdrawn from Tether’s market cap since last week, but stablecoin volumes are remaining consistently high during the current bear market - showing their utility to the DeFi sector. They address the issue of volatility which is one of the main points of resistance for crypto investment. Because of this, stablecoins seem to be one of the safest bets in terms of growth as we progress through the year.
A substantial amount of the growth seen by the DeFi space over the last few years can be attributed to the emergence of mainstream NFT artwork collections such as Bored Ape Yacht Club and Crypto Punks. Such collections also suffered from recent market downturns. With most popular collections valued in ETH, it is to be expected that as the value of ETH decreases - so too does the value of certain tokens.
Info from CoinGecko (Updated 19/05/22)
What is more concerning however is that NFT floor prices are slipping too. BAYC’s floor price peaked at 153 ETH just under 3 weeks ago on May 1st. Over the past two weeks however, it has fallen by around 25% to roughly 95 ETH - indicating investor-hesitation for NFTs specifically (as opposed to crypto in general). When considered in the light of its 127% growth over the past 6 months however, it is difficult to feel too concerned. Predicting the trajectory of these valuations can be troublesome. What does seem likely however is that NFT collections on other chains such as Solana, Avalanche and BSC (Binance Smart Chain) will continue to expand to rival Ethereum as the ‘home’ of NFTs.
The NFT space has become so large over the past year that it now inversely impacts the world of fungible tokens. The popularity of Yuga Labs’ Ape Coin (APE) may indicate that other high-value collections may seek to create similar fungible tokens to represent NFT communities. Yuga Labs have already hinted that they are in the process of developing their own blockchain to facilitate APE and the Bored Ape community - after the shortcomings of their ‘Otherdeeds’ NFT mint. If this is successful, we may be at the beginning of popular collections launching their own networks to support themselves. Ethereum may have created the space, but 2022 may be the year that native chains become the norm.
Beyond artwork collections, NFTs as a utility seems poised to expand - and is a more tangible use case compared to collectables. New utilities such as non escrow staking (NFT staking without the need to be placed in an escrow contract) will provide new yield earning opportunities. It also seems likely that the use of NFT technology for authentication or ‘proof-of-access’ will be increasingly adopted. When combined with mobile apps and payment services, this could become one of the most significant developments for the DeFi space over the coming year.
Written by Rob Henderson for Novum Insights
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