Is DeFi Ready for Prime Time?

DeFi protocols have seen their usage swell as investors flee centralized crypto exchanges. 

The top ten decentralized exchanges by on-chain value have all seen their trading volumes jump by over 30% this month. And a Kaiko research note found DEX tokens saw their prices the least affected by FTX’s fall, even as bitcoin and other layer-1s test new lows.

For some, it looks like DeFi is ready for its big break, as venture capitalists descend on DAOs and centralized crypto faces deep reputational damage. But others urge caution. Will Harborne, CEO of rhino.fi, noted the boost in DeFi usage comes at the cost of crypto usage in general.

“We’ve had our most active volumes and number of users in the last few weeks, basically because people are withdrawing from centralized changes and topping up their accounts, but we’ve also had some of our lowest numbers of new users,” Harborne said. 

Harborne sees DeFi seeing major sustained growth in a two to three year window. This sentiment is common in crypto’s post-FTX reality — that DeFi is the inevitable destination once crypto grows out of its adolescence.

The struggle for credibility

“After the events of 2022, decentralized protocols will likely enjoy a bump in credibility, while centralized players getting too creative with their books will feel more regulatory heat — and will probably take a dent or two in terms of user confidence” Max Thake, co-founder of peaq, said in an emailed statement.

The term DeFi typically refers to two kinds of protocols: DEXs and lending platforms. DEXs, such as Uniswap or Curve, let users trade crypto with automated market makers that match buyers with sellers using smart contracts. Lending platforms, like Aave or Compound, let users lend and borrow crypto while either paying or receiving interest. Assets are mixed together in liquidity pools, and an algorithm automatically liquidates accounts if their collateral falls below a certain level. Many DeFi protocols are governed by DAOs.

The common thread is that computer code, instead of people, governs DeFi, so protocols can’t do things like secretly lend out customer deposits.

“DeFi is the answer,” Harborne said. “People will be able to fully onboard into DeFi and only use DeFi and avoid these things.”

Still, DeFi isn’t a silver bullet to crypto’s woes. While DeFi customers don’t need to worry about nefarious executives, they do risk falling victim to a hack, which has looted more than $300 billion from DeFi coffers this year. And, liquidity isn’t guaranteed — Aave froze some assets this week after a vulnerability in one of its lending markets was exploited, leaving the protocol with $1.7 million in bad debt.

DeFi protocols seem less prone to wholesale collapse in the mold of Mt. Gox or FTX. Even Terra, which got as close to bankruptcy as any in DeFi, relaunched and is still kicking. But JPMorgan, which executed its first DeFi trade earlier this month, doesn’t think DeFi can claim the mantle from centralized exchanges.

“DeFi protocols rely heavily on centralized exchanges to be able to function,” the bank wrote in a crypto report last week, before giving a laundry list of concerns about DeFi: Centralized exchanges boast quicker price discovery, protocols have lost billions to hacks this year, cascading automated liquidations could create systemic risks, and the overcollateralization common in DeFi is inefficient.

Crypto investors fleeing to lending protocols won’t find much yield, either. Aave and Compound, the two preeminent lending pools, both list yield under 3%. US Treasury yields currently sit north of 3.5%.

Representatives for Aave and Compound did not return requests for comment.

Harborne said yield is a measure of capital’s perceived value, and percentages should increase as DeFi does more to prove its usefulness. And as for the rest of DeFi’s issues?

“DeFi isn’t quite yet ready to onboard everyone,” Harborne said. “[But] all these things can and are and will be solved.”

---

Start your day with top crypto insights from David Canellis and Katherine Ross. Subscribe to the Empire newsletter.

Explore the growing intersection between crypto, macroeconomics, policy and finance with Ben Strack, Casey Wagner and Felix Jauvin. Subscribe to the Forward Guidance newsletter.

Get alpha directly in your inbox with the 0xResearch newsletter — market highlights, charts, degen trade ideas, governance updates, and more.

The Lightspeed newsletter is all things Solana, in your inbox, every day. Subscribe to daily Solana news from Jack Kubinec and Jeff Albus.