- DeFi had a horrible year in 2022 as the total value locked across the sector declined from a high of $181.21 to a low of $38.2 billion.
- Despite the market downturn, the number of unique users interacting with DeFi increased by more than 1.8 million users in 2022 and has increased by another 600,000 users in the first four months of 2023.
- Ethereum staking and liquid staking platforms like Lido Finance are the most popular DeFi trend currently, as they allow users to earn a yield while still being able to utilize the value held in their staked tokens in the open market.
- Non-fungible tokens are poised to usher in a new era for digital assets and DeFi as the tokenization of real-world assets has the potential to lead to trillions in value being added to the ecosystem in the future of cryptocurrency.
Decentralized finance (DeFi) has been one of the most transformative developments in the world of cryptocurrency as it has helped pique the interest of institutional investors around the world looking to take part in the shift from traditional, centralized financial systems to peer-to-peer finance. So let’s discuss what the future holds - will crypto bounce back? And what are other digital asset predictions for the second half of 2023?
Ever since it burst onto the scene in 2020’s “Summer of DeFi,” the nascent sector – which is powered by smart contracts – has introduced a bevy of new industries in the digital asset ecosystem including lending and borrowing platforms, staking, yield farming, prediction markets, margin trading, payments products, and insurance.
Leading the way in the early days was Uniswap, the first simplified decentralized exchange (DEX) that allowed users to access newly released tokens without the need for centralized exchanges like Binance or Coinbase. DEXes continue to be one of the driving forces in DeFi in terms of total value locked (TVL) and the number of dApps, followed by lending protocols, collateralized debt positions, bridge protocols, and staking providers.
2022 and 2023 saw the rise of a newly dominant sector in DeFi – liquid staking platforms – as the transition of Ethereum from proof-of-work to proof-of-stake, and the extended period where staked Ether was locked on the Beacon Chain, necessitated the creation of liquid staking derivatives. Data from DeFi Llama shows that Lido DAO, a liquid staking platform that supports Ethereum, Solana, Polygon, Polkadot and Kusama, currently ranks number one in total value locked (TVL) with $11.42 billion currently staked on the platform.
DeFi was also instrumental in kicking off the bull market of 2021 as the sector saw a surge in interest that propelled the total value locked across the digital asset industry to $123.5 billion by May. The ability for digital asset holders to put their tokens to use while earning a yield became “the killer app” that the community was looking for and eventually pushed the total TVL to a record high $181.21 billion by December 2, according to data from Defi Llama.
The industry single-handedly helped usher in a new era for the global financial system, rebuilding it from first principles with more security, transparency, and interoperability in a matter of months. This DeFi trend helped instigate a flood of institutional capital into the space as all manner of infrastructure – from digital asset custodians to compliance and data analytics – looked to get established in the rapidly growing asset class.
Unfortunately, the tremendous growth in valuations witnessed in 2021 met its polar opposite in 2022 as everything that could go wrong for the asset class did, with some of the largest and most dependable platforms and exchanges initiating contagion events that plunged values across the cryptocurrency market to their pre-2021 levels. So, will the crypto market bounce back?
DeFi in 2022
As 2022 kicked off, the mood across the cryptocurrency ecosystem was elevated as many in the industry expected the highs of 2021 to be quickly surpassed as Bitcoin climbed its way to the highly prized $100,000 price tag that had long been forecast by market analysts.
After the DeFi TVL pulled back to a low of $129 billion, the metric once again began climbing higher and looked poised to overtake its previous high after climbing to $165.9 billion by April. But new all-time highs were not meant to be, as cracks in the bull market facade began to appear and inquisitive techno-sleuths began to pick apart some of the top protocols in the industry, including the stablecoin issuing platform Terra.
Total Value Locked: Source DeFiLlama
It was actually a large Bitcoin purchase by Terraform Labs – done in an effort to increase confidence in the reserves that backed TerraUSD (UST) – that piqued the interest of many and ultimately led to the protocol’s downfall.
By April, UST (now known as TerraClassicUSD - USTC) had become the third-ranked stablecoin by marketcap behind Tether (USDT) and USD Coin (USDC) and was the top-ranking algorithmic stablecoin. The fact that it was a decentralized stablecoin further bolstered its profile as DeFi protocols looking to be truly decentralized opted to integrate UST.
Unfortunately for DeFi and the wider digital asset ecosystem, matters came to a head in early May when UST first lost its peg to the U.S. dollar and was never able to regain it. As its value slid lower, worried UST holders began selling the token en masse at lower and lower prices, initiating a downward spiral in its price that eventually saw the $1 asset plummet to a low of $0.00654.
This sparked chaos and an industry-wide contagion event that saw some of the biggest names in the ecosystem – including the highly touted Three Arrows Capital hedge fund and the cryptocurrency lending platforms Voyager Digital and Celsius – go belly up, leaving customers holding the bag and the future of crypto uncertain.
While the situation in the cryptocurrency market was already deteriorating by that point, with the total market capitalization sliding from a high of $2.924 trillion in November 2021 to $1.8 trillion in the opening days of May, the fallout caused by the Terra/Luna collapse saw another $1 trillion worth of value evaporate from the total market cap.
Prior to the downfall of Terra, the DeFi TVL stood at $146.03 billion, but as UST lost its peg, the TVL quickly plummeted to $80.45 billion and continued to limp lower from there. At the time of writing in early April, 2023, the DeFi TVL stands at $51.2 billion.
And it wasn’t just the Terra/Luna debacle that took its toll on the digital asset market, as all manner of bridge hacks and protocol exploits seemed to emerge on a weekly basis, pilfering the coffers of DeFi protocols and leading to a loss of trust in the ecosystem for many.
Reshaping of the DeFi Landscape
Following the Terra collapse, the makeup of the DeFi landscape was altered as digital asset holders withdrew their tokens that still maintained some value and wrote off tokens like Terra Classic (LUNC) and USTC, which were now essentially worthless.
As a result of this development, many of the protocols that ranked at the top in terms of TVL saw their rankings plunge while others that offered different services ascended.
One of the hardest hit protocols was Curve Finance (CRV), a decentralized exchange for stablecoins that uses an automated market maker (AMM) to manage liquidity. Due to having UST integrated into its stablecoin pools, Curve had to scramble to reduce its exposure to the failing platform and refocus on other stablecoins that it provided liquidity for.
Unfortunately for Curve, faith in the stablecoin market was shaken as even USDT and USDC experienced brief de-pegging episodes, and the once dominant DeFi platform that saw a TVL high of $24.15 billion in January of 2022 has seen its TVL nosedive to its current valuation of $4.72 billion.
And Curve was not alone in its struggles as many of the top DeFi lending protocols including AAVE and MakerDAO saw their TVLs fall from over $19 billion to their current valuations of $5.8 billion and $7.75 billion, respectively.
Despite the negative year for the digital asset ecosystem and DeFi in particular, data from Dune Analytics showed that the number of unique wallets that interacted with a DeFi protocol in 2022 increased from 4,760,399 at the end of 2021 to 6,650,801 by Jan. 1, 2023, an increase of 1,890,402.
Total DeFi Users over Time: Source Dune Analytics
The hot start the cryptocurrency market has seen in 2023 has seen that number continue to rise, surpassing 7,250,000 unique wallets as of April 11, an increase of nearly 600,000 wallets in a little over four months, which points to a promising future for the digital asset market.
The centralized exchange platform FTX also deserves an honorable mention here as its collapse in November further exacerbated the weakness caused by Terra’s demise and led to additional declines in the valuations of DeFi protocols and tokens.
But with every catastrophe comes opportunity, and many of the protocols that rose in stature over the course of 2022 had one thing in common: Ethereum. As the cryptocurrency industry’s faith in DeFi waned, proponents embraced the simplicity and security offered by on-chain staking.
Staked ETH and Validators: Source Dune Analytics
This gave rise to platforms like Lido DAO (LDO), a liquid staking provider that allows token holders to earn staking rewards while simultaneously being able to access the value held in their tokens to earn a yield in DeFi. While there were a few instances in 2022 where concerns about staked Ether (stETH) losing its peg to Ether caused brief pullbacks in the price of ETH, overall, the various staked Ether tokens have performed as expected and remain popular options for ETH in DeFi.
Non-fungible tokens (NFTs) are also starting to have an outsized impact on DeFi trends as NFT staking platforms and the ability to tap into the equity held in popular NFTs are offering new and engaging yield opportunities for digital asset holders to take advantage of.
Predictions for the Second Half of 2023
As 2023 nears its midpoint, the bullish start to the year has many optimistic about the future of DeFi. With the potential to see some major improvements come to decentralized finance in the second half of the year that could lead to a resurgence in the promising sector – and to a market-wide price surge – deep divers are on the hunt, scouring whitepapers and social media groups for the next breakout platform.
Following the rough conditions experienced in 2022, platforms that have managed to survive have now been battle-tested, hardened, and seen improvements to their user experience (UX) that will lead to a smoother user experience and beneficial use cases.
The fast-moving blockchain sector is now home to many apps that rival the best that centralized finance has to offer, which will onboard new users throughout the year. The emergence of the worst banking crisis since 2008 has only served to speed up this process as global investors are now searching for safe places to store their wealth outside of the legacy banking system.
As the Ethereum network continues to experience upgrades, transaction times and gas costs will continue to decrease, making the DeFi experience more user-friendly.
Social media companies like Twitter and Reddit will also help play a part in fostering the adoption of cryptocurrencies and DeFi trends, as the integration of retail digital asset wallets will expose a new cohort of internet users to the possibilities that crypto offers.
Non-fungible tokens are playing a major role on this front as users are required to have a digital wallet in order to store their NFTs. The popular social media news aggregator Reddit is a prime example of this as nearly 3 million users created Ethereum-compatible wallets so that they could interact with the Reddit avatar NFT.
And with Elon Musk at the helm of Twitter, many feel as though it is only a matter of time before a digital wallet is integrated with the popular social media platform. The fact that the platform briefly saw the DOGE logo replace the Twitter blue bird logo as an April Fools Day joke only served to increase such speculation.
The potential for new digital asset wallet holders to interact with DeFi is massive. As of April 2023, out of the 227 million Ethereum addresses that have been created, only 7.25 million of those wallets – or roughly 3.2% – have interacted with DeFi. This suggests that there remains a large mass of untapped potential that is ripe for DeFi exposure in 2023.
And the integration of NFTs into DeFi has only scratched the surface, meaning that the intersection between NFTs and DeFi is posed to be a major trend in the second half of 2023. DeFi is the perfect environment for tapping into the billions in value currently held in the NFT market, and it's likely that the financialization of NFTs will really start to gain traction over the next year. This could help accelerate the tokenization of real-world assets as NFTs, which could then be leveraged in DeFi.
As more users engage with DeFi, the entire ecosystem could enter a positive feedback loop as more transactions take place on the Ethereum network, leading to the increased use of Ether, Ethereum-based assets, and L2 networks – which in turn helps to amplify the value proposition of the entire DeFi ecosystem and create new use cases ushering in a cryptocurrency market bounce back.
With DeFi beginning to evolve into what it is meant to be, institutional adoption could also see a rise as the growing infrastructure allows institutions to interact with DeFi applications while also accommodating regulatory compliance requirements.
Platforms like SOMA.finance are leading the way in this regard by offering users access to the best that DeFi has to offer while simultaneously including KYC and AML checks that help protect the community and ensure that nefarious parties are excluded.
It’s not a matter of “will digital assets recover” but “when will digital assets recover”? Following the bullish start to 2023, the stage is now set for the entire digital asset ecosystem to see a resurgence as the underperformers and shady platforms have faded from memory – clearing the way for strong, innovative, and system-changing protocols to rise up the ranks. It’s possible that the market could see a DeFi Summer 2.0 as a spreading banking contagion combined with rising institutional interest and the integration of tokenized assets bring a new level of use to DeFi and further eat into the market share that centralized finance controls.
Just as was seen in 2020 and the first quarter of 2021, DeFi-related tokens, projects, and TVL might strongly outperform all the other asset classes if global governments are forced to step in and rescue financial markets. Bitcoin was created in response to the Great Recession of 2008, after all, and this is the first time since its creation that the resilience of global markets has been seriously tested. And with the integration of real-world assets being thrown into the DeFi mix, it's only a matter of time before new record-high valuations are reached and decentralized finance is once again the hottest sector in crypto.