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It’s fair to say that crypto has brought us many surprises over the last year. Many expected DeFi to go mainstream in 2021, and while major corporations and institutions started to take an interest in Ethereum and the DeFi ecosystem running on top of it, there’s little doubt that NFTs stole the spotlight.
In fact, while NFTs pervaded mainstream culture for the first time, many of the earliest DeFi protocols stalled and entered their own bear market even as other crypto assets soared to record highs. One factor behind this might be the rising gas fees on Ethereum, as well as traders seeking exposure to ETH over application-level governance tokens. Nonetheless, while many DeFi tokens traded sideways, the total value locked in the industry surpassed $100 billion on Ethereum and $250 billion across the broader ecosystem.
Arguably, the most notable DeFi development of the year was the explosion of activity on alternative layer one networks such as Solana, Avalanche and Terra. These networks have shown strength against Ethereum and proved that crypto is heading toward a multi-chain future featuring several smart contract platforms. As we head into 2022, other smart contract networks such as Fantom and NEAR have also started to see traction.
Alternative layer one platforms have often used generous incentives and liquidity mining rewards to attract builders and users. However, the real test of their viability will come if the market experiences another serious downturn. Many new bridges and networks are offering compatibility with the Ethereum virtual machine, so we expect to see another explosion of DeFi activity across multiple networks this year.
The Curve wars and DeFi 2.0
DeFi is currently in the midst of a transformational shift as a result of the so-called ‘Curve wars’ involving the DeFi ecosystem and one of the earliest and most used protocols, Curve Finance. In DeFi, liquidity is everything, and the Curve wars are proving this while showcasing the power of composability.
For several months now, the Curve wars have seen protocols such as Yearn Finance and Convex Finance competing for attention by offering generous rewards to users who stake Curve’s CRV token in their protocols. When users lock up CRV in Curve, they receive veCRV. Holding veCRV gives them voting power according to how long they lock their tokens for. This is powerful because voters can make decisions on the number of rewards allocated to each pool on Curve.
Several protocols are ramping up the competition for liquidity, buying as many CRV tokens as possible, and giving rewards to those who stake them. Liquidity is everything in DeFi, and projects have realized that they must incentivize users to stick with them by offering high rewards. Convex now holds 47% of the supply of veCRV.
The Curve wars have intensified recently amid growing interest in the DeFi 2.0 movement. Other newer protocols such as Dopex Finance, Tokemak and Olympus DAO have also emerged, offering a variety of unique ways to capture and keep liquidity. In 2022, the Curve wars and the unexpected burst of innovation in DeFi 2.0 projects look set to define and possibly transform the DeFi ecosystem.
Where do DeFi blue chips on Ethereum stand?
We expect alternative layer one networks and DeFi 2.0 to continue their growth trajectories in 2022. This presents questions about the position DeFi blue chips like Compound, Uniswap and Maker DeFi 1.0 classics that launched on Ethereum find themselves in. Most blue chip tokens are currently down over 50% off their highs, and there are many potential reasons for this. For one, most newer crypto users are priced out of DeFi on Ethereum due to its high gas fees. For ‘degens,’ the lucrative yields offered in DeFi 2.0 have meant the blue chips falling out of vogue. And the market is experiencing a general decline, with most major assets also way down from their highs.
DeFi also suffered this past year due to the rise in hacks and major exploits. As a recent Chainalysis report revealed, crypto crime revenue totaled $14 billion in 2021 almost all of it coming from the DeFi space. Ethereum and EVM-compatible chains such as Polygon and Binance Smart Chain hosted some of the year’s most impactful hacks. This signals that the industry needs to start building a culture of using insurance and smart contract auditors.
2021 has proved that the market believes in a multi-chain future. However, the reality is that holding assets across multiple networks presents challenges for even the most experienced crypto users. Bridges can be clunky and carry security risks, as proven by the vast number of attacks on bridges. And as Vitalik Buterin has pointed out, bridges carry increasing security weaknesses as they increase in prominence. Cross-chain interactions are still difficult across networks like Solana, Ethereum and other EVM chains, which should leave space for ‘layer zero’ interoperability-focused chains like Cosmos and Polkadot to thrive.
Key trends for 2022
A major development for DeFi in 2022 will be the emergence of layer two solutions like ZK-Rollups. Growing adoption could kickstart a repeat of 2020’s ‘DeFi summer,’ when traders flocked to Ethereum protocols to farm yields on their assets for the first time. We believe layer twos will see widespread use in 2022 but DeFi is also likely to flourish on other networks. It will be interesting to see how the growth of DAOs impacts the space as finance becomes increasingly decentralized, given the core value proposition of DeFi is censorship resistance derived from its decentralization. Only time will tell, but one thing is for sure DeFi is here to stay, and it should continue to grow fast.
While cross-chain interoperability still feels somewhat far, there is a gap in the market for protocols and projects that intend to bring the vision of a multi-chain world closer to reality. In the meantime, the DeFi ecosystem largely exists within Ethereum and other smaller segregated networks.
We also expect to see innovation explode at the front end this year. If 2021 was the year of mainstream NFT adoption, teams should now be focusing on onboarding new adopters into the abundance of opportunities in DeFi. The most successful applications among new adopters will focus on creating fast, seamless and low-cost use cases that make using the technology feel simple. Last year showed us that, while the interest in crypto is here to stay, there are still many rails that will need to be built before we are ready for mass adoption.
Summing up
2021 was a year to promote and onboard newcomers. In 2022, we need to continue this trend while making sure that those freshly hitting the industry succeed (at whatever level) in their goals within it. In terms of an adoption curve pun intended we may have seen the very beginning of visionaries (rather than hardcore nerds and gold-rushers) entering the industry.
We are now faced with the task of proving blockchain-based technology and systems are superior in practice, not just in theory. Only through better, objective results will we manage to attract the pragmatists and convince the skeptics of the world.
Brian Pasfield is the CTO at Fringe Finance with almost 10 years of expertise in blockchain, cryptocurrency, fintech and DeFi. He has delivered technically-complex projects that have leveraged his engineering background and keen understanding of the industry trends and philosophies. Brian has also worked with industry blockchain bodies to lobby for legislation and government policy changes.
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