The decentralized finance movement was a ticking time bomb waiting to detonate when it finally exploded in 2020. From automated market makers to the industry’s current obsession with liquidity mining, DeFi has grown leaps and bounds over the last year.
Most decentralized finance applications are deployed on the Ethereum blockchain, bringing billions of dollars onto the network and pushing it to its maximum operational threshold. While the capabilities of the underlying network may seem like the only thing holding DeFi back, Ethereum isn’t slacking either.
As Ethereum 2.0 gears up for its transition, there’s a lot in store for 2021. Both DeFi and Ether (ETH) have been doing exceptionally well, with the native Ethereum token recently retracing its all-time high and even reaching a $2,000 valuation.
While some vocal community members believe this pump is the result of a bubble similar to the initial coin offering boom of 2017, there are many reasons to think this isn’t the case.
DeFi has brought a breath of fresh air to the cryptocurrency space, spawning countless new tokens that have revolutionized decentralized lending and borrowing services. The short-lived Yam Finance, which attempted to simplify the yield farming experience and transform blockchain governance into a practical model, quickly became one of the fastest-growing platforms in the DeFi space.
Projects like Uniswap even resurrected the concept of decentralized exchanges using an automated market maker model. This allows the system to price trades without relying on liquidity from a counterparty. Instead of using order books, the AMM prices assets using the ratio of tokens in a liquidity pool to determine supply and demand.
Uniswap’s surge in use has been fueling the DeFi engine for quite some time, with daily trading volume rising from around $1 million to $1 billion between July 2020 and September 2020. Without being tied down by order books, Uniswap can execute orders on-chain, meaning transactions are made and settled on the network directly, and this has become one of Ethereum’s most prominent features.
This has driven the number of smart contract calls on Ethereum to skyrocket, reaching new all-time highs and creating a token economy that is increasingly being managed by code. However, while DeFi’s trustless ecosystem has brought greater efficiency levels and more automation opportunities, it’s still far more complicated than traditional offerings have become.
This is a major problem that DeFi needs to address before it can attain more mainstream adoption. The act of buying and selling cryptocurrencies already needs work from a consumer’s perspective, but in its current state, DeFi is still very much “function over form.” Outfits like Yearn.finance have brought algorithmically managed portfolios to DeFi, but there’s still a lot of work to be done.
“Yield farming is not sustainable, but it is helping to bootstrap the industry in the short term and attract developers,” said Rune Christensen, founder of veteran DeFi platform MakerDAO, in a conversation with Cointelegraph, adding:
“Once the markets cool down, the next stage for DeFi will be integration with traditional finance and the tokenization of real-world assets so they can be used in DeFi protocols on-chain.”
He also mentioned that DeFi is currently fully reliant on the Ethereum platform, especially because it’s dependable on composability between current DeFi applications and ETH as a primary source of collateral and stability. However, there may be other issues in the way of DeFi’s growth.
This is a sentiment shared by many members of the community. According to Illia Polosukhin, CEO of Near Protocol — a blockchain that allows for the creation of decentralized applications and is interoperable with Ethereum — DeFi might just keep growing on Ethereum.
“Most of the applications are built to work with and around current limitations and they would be…