The Renaissance of Decentralized Finance: Making DeFi Great Again

Article author: Arthur Cheong, Eugene Yap; Article translation: Block unicorn

The European Renaissance, which began in the 14th century, ignited a renaissance in art, culture, and thought that completely transformed modern civilization.

Today, we are witnessing a similar awakening in the crypto space - the renaissance of decentralized finance (DeFi). Like the Renaissance in history, this movement is breaking down barriers and reshaping our understanding of money and finance.Powered by blockchain and smart contracts, DeFi democratizes financial services, allowing people around the world to access a trustless economic system without traditional financial intermediaries. It has the potential to completely reshape finance.

Just as the European Renaissance thrived on technological advances and social change, the driving force behind the DeFi renaissance comes from a few key factors that are helping it move beyond its early challenges and enter a whole new phase of growth and innovation.

1. DeFi is emerging from the trough of disillusionment

DeFi experienced a surge in 2020 and 2021, when people had high hopes that it would completely disrupt traditional finance (TradFi). However, like most emerging technologies, early hype led to disappointment as the infrastructure was not yet perfect, leading to a downturn in 2022.

However, like any revolutionary movement, DeFi has become more resilient, successfully crossing the "trough of disillusionment" and starting to climb the "slope of enlightenment". The Gartner Hype Cycle is an effective framework that can well illustrate this journey, and DeFi is currently showing signs of recovery.

After two years of adjustment, key indicators such as total locked value (TVL) are rebounding, as shown in the figure below. While some of the improvement in indicators is due to rising crypto asset prices, the volume of transactions on DeFi platforms has also increased significantly, almost returning to 2022 levels, proving that this recovery is real.

In fact, some foundational DeFi projects, such as Aave, have even exceeded their 2022 peaks on multiple indicators. For example, Aave's quarterly revenue has exceeded the level of the fourth quarter of 2021 - a period considered to be the peak of the last bull run.

This shows that DeFi is maturing, entering a new stage of productivity, and preparing for long-term scalability.

2. The new interest rate cycle will make DeFi returns more attractive

The recovery of DeFi is not only driven by internal factors, but external economic changes have also played a key role. With changes in global interest rates, high-risk assets such as crypto assets, including DeFi, have become more attractive to investors seeking higher returns.

With the Federal Reserve implementing a 50 basis point rate cut in September, the market is preparing for what could be a period of low interest rates, similar to the environment that fueled the crypto bull markets of 2017 and 2020, as shown in the chart below. Bitcoin (and crypto) bull markets are shown in the green area, which typically occur in low interest rate environments, while bear markets are shown in the red area, which typically occur during periods of surging interest rates.

DeFi benefits from a low interest rate environment in two key ways:

1. Lower opportunity cost of capital - As Treasury bonds and traditional savings accounts offer lower returns due to falling interest rates, investors may turn to DeFi protocols to earn higher returns through yield farming, staking, and liquidity provision.

2. Lower lending costs - Financing costs become lower, encouraging DeFi users to borrow and use funds for productive purposes, thereby driving activity throughout the ecosystem.

While interest rates may not drop to near-zero levels seen in past cycles, the opportunity cost of participating in DeFi will be significantly reduced. Even a modest drop in interest rates is still enough to have a significant impact, as the difference between interest rates and returns can be amplified through leverage.

In addition, we expect the new interest rate cycle to be an important factor in driving stablecoin growth, as it significantly reduces the capital cost for traditional finance (TradFi) funds to enter DeFi in search of returns. In the previous cycle, the Federal Funds Rate (FFR) had an inverse relationship with stablecoin supply growth, as shown in the figure below. As interest rates fall again, stablecoin supply is expected to grow, providing more funds for the accelerated development of DeFi.

3. Finance: The Biggest Product-Market Fit for Cryptocurrencies

The crypto space has tried a variety of application scenarios, such as NFT, Metaverse, games, and social networking. However, by most objective metrics, they have not really found product-market fit (PMF).

For example, despite a brief recovery in 2024 due to Bitcoin Ordinals, NFT daily trading volume continues to decline.

As for the metaverse and games, there are no breakthrough Web3 games that are widely accepted by global fans. The two OG-level Web3 metaverse projects Decentraland and Sandbox have difficulty breaking through even a few thousand daily active users, while Roblox has as many as 80 million daily active users. While TON Games has an impressive number of daily active users, it is unclear how many people will continue to stay on TON Games once the economic incentives are gone.

In contrast, DeFi has proven its product-market fit. The growth of core DeFi categories such as liquid staking and lending has expanded by more than 100% year-on-year, which is a testament to its strong appeal. Meanwhile, entirely new, multi-billion dollar categories such as heavy staking (Eigenlayer) and basis trading (Ethena) are emerging, with almost zero total locked value (TVL) a year ago. This explosive growth demonstrates the composability and permissionless nature of DeFi, where new financial “LEGOs” can be stacked on top of each other to unlock new use cases.

Regulatory barriers have long limited DeFi’s potential to disrupt traditional finance (TradFi), but its inherent advantages are clear. For example:

• Cross-border transaction and remittance fees average 6%, and transfers take 3 to 5 business days.

• Stock exchanges have bloated back-end systems and limited operating hours, making them inefficient.

• Real World Assets (RWAs), such as real estate, can unlock liquidity through tokenization and be composable in DeFi, such as for use as collateral.

DeFi’s ability to operate 24/7, with low costs, high liquidity, and without the need for intermediaries, makes it a more efficient alternative. The technology is there, the challenge is whether regulators will allow DeFi to disrupt a $10 trillion global financial industry that relies on inefficiencies.

To show how DeFi outperforms TradFi in terms of efficiency, let’s compare the costs of running the services. Here’s a breakdown of the costs, based on a study by the International Monetary Fund (IMF):

• Labor costs: Labor costs for DeFi are almost 0%, while for TradFi they are 2%-3%. For example, DeFi loans are processed automatically without human intervention, while TradFi requires manual review and paperwork.

• Operational costs: DeFi’s operating costs are only 0.1%, while TradFi ranges from 2%-4%. DeFi does not require large offices or intermediaries, smart contracts process transactions, and blockchain provides verification.

Overall, the marginal costs of traditional finance reach 6%-8% in developed economies and 10%-14% in emerging markets, and these costs are ultimately passed on to end users. DeFi eliminates these inefficiencies, it’s that simple.

In addition, there has been little innovation in the financial technology (Fintech) sector in the past 15 years, which echoes Blockchain Capital’s research findings. While we’ve made huge strides in areas like AI and global internet access, Fintech is still stuck on outdated systems, like the 50-year-old SWIFT system that all banks use, which typically takes 1 to 4 business days to complete a transfer.

Most Fintech advances, like digital payments, fractional shares, and APIs, are focused on improving the user experience rather than addressing the core inefficiencies of traditional finance (TradFi). For example, Robinhood and Plaid provide convenient solutions for people to buy stocks, but they still rely on old financial infrastructure. The real problem is that Fintech is simply connecting to outdated systems to make better use of them, rather than creating something entirely new. While these changes help, they don’t solve the deep problems that plague TradFi.

DeFi is different, it was designed to be completely digital from the beginning. Rather than working around old financial systems, DeFi embeds financial services directly into the internet.In DeFi, things like fractional shares, overcollateralized loans, and global payments are not innovations, but basic features. This marks a fundamental shift from small improvements to a complete overhaul of how finance works.

By adopting DeFi, we can move beyond minor tweaks and begin to unlock huge new economic opportunities, improve financial access, and create wealth in places that traditional finance often overlooks. It’s about reinventing the financial system to work better in a digitized world.

Looking ahead, the 2024 U.S. election could bring a clear direction for regulation. The Trump administration could introduce crypto-friendly regulation, while the Harris administration, which has recently warmed to the industry, could also maintain a positive stance. Regardless of the political outcome, the momentum behind DeFi is undeniable.

DeFi is just getting started, and the future of finance is decentralized and will unfold on-chain.

4. Improved UI/UX, Infrastructure, and Security

DeFi’s early interfaces were complex and technically difficult, which confused and alienated many users. However, over the past few years, UX, infrastructure, and security have all improved significantly, making DeFi more user-friendly for mainstream users.

One of the most significant improvements is in wallet infrastructure. In the past, managing seed phrases and private keys was a major hurdle, but new smart wallets and embedded wallets have greatly simplified the process, making it more secure. Features such as social recovery, biometric authentication, and password-less login now make it easy for users to manage their funds without the complexity of traditional Web3 wallets.

There have also been improvements in security, with more thorough audits before smart contracts are deployed becoming standard. Platforms like ImmuneFi incentivize ethical hackers to find vulnerabilities and security issues through bug bounties, ensuring that they are addressed before they can be exploited. These advances in wallet infrastructure and security have made DeFi safer and more efficient for all users, which is also reflected in the significant reduction in DeFi hacking incidents over the past year.

With these improvements, DeFi becomes more user-friendly for mainstream users, including institutional adoption, driving its continued growth.

Make DeFi Great Again

Just as the European Renaissance reshaped society, DeFi is poised to revolutionize the financial sector. The potential for innovation in DeFi is huge, and we are just beginning to see its impact. As more and more users and investors accept DeFi, the future of global finance will gradually shift to on-chain, making the financial system more efficient, open, and accessible to everyone.

DeFi has the power to eliminate inefficiencies, break down barriers, and create new opportunities for financial inclusion. It is more than just a fad, but a fundamental shift in the way the world interacts with money. From global payments to democratized access to financial services, DeFi offers a future for everyone to participate in the financial system.

Currently, the total market capitalization of all DeFi protocols is approximately $33 billion, accounting for only about 1.4% of the total cryptocurrency market capitalization of $2.3 trillion.

Data as of October 13, 2024

The growth and success of DeFi has been overlooked by most people in the near term due to the challenging market environment and industry conditions. However, this situation will change as DeFi protocols continue to grow at an astonishing rate and return the value of this growth to token holders (for example, Aave’s recently proposed token economics change).

Market participants will further recognize the fundamentals and potential of DeFi and reallocate their capital accordingly.

We expect DeFi assets to grow from 1.4% to 10% of total crypto market cap over the next two years as DeFi continues to grow and the market realizes its newfound appeal and renewed potential.

Make DeFi Great Again.