Editor's Note: This article comes fromDecentralized financial community (ID: China_DeFi), reprinted by Odaily with authorization.

Editor's Note: This article comes from

Decentralized financial community (ID: China_DeFi)

Decentralized financial community (ID: China_DeFi)

, reprinted by Odaily with authorization.

2020 is a big year for DeFi. The industry has been the engine behind the cryptocurrency renaissance, seeing bitcoin top $24,000 and a market capitalization of $680 billion. Decentralized applications are finally starting to see sustained use, and the industry has taken a huge step toward realizing its macro vision for the Web3 economy.

Ethereum has once again led the way, and while soaring fees have hurt the gaming industry, DeFi has become the cornerstone of its ecosystem. During the year, however, rival blockchains have started to attract attention. As the market becomes more lucrative and composability unleashes new frontiers, competition among public blockchains will likely only intensify.

2020 is the year that cryptocurrencies prove to institutional and retail players that the blockchain vision is not a pipe dream.

Liquidity is king

Before 2020, DeFi was stuck in a negative feedback loop: dapps needed liquidity to provide low-slip/deep market services, but if there was no liquidity in the first place, it could not attract enough users (and funds), and then they switched Instead, choose a centralized alternative.

This year, however, the team discovered ways to incentivize users to move their capital, sparking a liquidity mining boom. The protocol will effectively pay participants to provide liquidity and use its services. Synthetix is ​​arguably the first to successfully implement it, but unlike many of its kind, the dapp has a native token.

This in turn incentivizes other protocols to consider launching their own tokens in order to benefit from the model. When Compound started distributing its COMP tokens, it set off a chain reaction. Teams with projects now and those building on the sidelines, seeing how quickly Compound has captured the market's attention and grown its user base and liquidity, subsequently want to join in.

Since then, every other day a new project has emerged, receiving token rewards for bringing liquidity and usage to its platform. DeFi began to grow rapidly, attracting industry attention and capital.

With liquidity, users are now able to enjoy the benefits of DeFi such as: wallet control, accessibility (no KYC), wider listing options and composability. By removing key barriers, projects are able to replace a negative feedback loop with a positive one: Fluidity begets fluidity.

In this case, issuing governance tokens (which allow token holders to vote to control the project) makes a lot of sense. The team will decentralize the platform by relinquishing control to the community, and token owners will benefit from ownership of the protocol.

Source: https://public.flourish.studio/visualisation/4748078/

Source: https://public.flourish.studio/visualisation/4748171/

While initially, some teams were more focused on the token’s governance utility, the market quickly realized that the token had at least one potential revenue stream. Since many DeFi projects are fee-based, revenue generated by the protocol may be distributed to users. This can give the token some quantifiable value. Curve becomes the first project to do so.

Issues with the centralization of governance tokens have taken some of the luster off the plan. However, governance models, distribution mechanisms, and incentive models are all evolving.

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gourmet food

Source: https://public.flourish.studio/visualisation/4740971/

One of the cores of the blockchain industry is that everything should be open source. This means that everything can be forked. When the market realizes that the main driver of liquidity is not necessarily utility or brand power, but mining incentives, offshoots of established projects start popping up left and right, offering the hope of getting rich quick from the yield.

To attract attention, they chose food-related names, which quickly became a food-meme after YAM and PASTA. The DeFi buffet offers everything from fruits and vegetables to sushi.

Source: https://public.flourish.studio/visualisation/4662726/

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Many of these projects did not last very long, but for miners active throughout the ecosystem, the output they provided was often high enough to compensate for the risk of some of these projects going wrong.

Still others become so prominent that they can even compete with the old core for dominance. For example, SushiSwap famously “crippled” Uniswap’s liquidity before Uniswap issued its own governance token, UNI. When Uniswap’s mining project expired, SushiSwap once again attracted a lot of liquidity.

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For now, the industry still maintains a friendly community atmosphere, but these incidents may herald a liquidity war to come.

One metric rules them all

With liquidity becoming the main driver of growth, Total Value Locked (TVL) is the leading metric for the industry. This stat measures the amount of capital (usually in USD) locked in a given dapp.

As TVL rankings began to emerge, TVL became a marketing tool for a project that could rapidly increase its liquidity. A high TVL instills confidence (sometimes falsely) that the item is reliable because others believe in it and are using it.

Part of the popularity of the original TVL was its simplicity, but it was that simplicity that made it so deceptive. First, the growth of the computing dollar introduces price-driven volatility. TVL may change not because assets are locked or withdrawn, but because the price of the locked asset has changed.

At different times of the year, it has sparked both excessive optimism and unwarranted panic. TVL is often in the headlines, not always revealing the true nature of market dynamics.

To remove the price impact, DappRadar has developed Adjusted TVL (aTVL), which more accurately depicts asset flows.

Still, fundamental TVL seems to be the most cited metric in DeFi, and it can blur reality from time to time.

Source: yearn.finance

stack deepening

With liquidity approaching useful levels, developers are now free to experiment and extend functionality. These efforts fall broadly into three areas: composability, new features, and retail.

One of the main advantages of DeFi is the ease with which protocols integrate with each other. The team began to integrate the multi-project incentive model, and the developers began to develop and optimize the liquidity mining platform.

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Efforts to optimize Yearn culminated in Yearn, a project started by Andre Cronje who handed over its governance to the community through one of the most aggressive token distribution schemes to date.

As synergies emerge, projects start to consolidate at the aggregator and base protocol levels.

As part of this, flash loans are starting to play an important role. Users can borrow large amounts of funds through this particular type of facility, as long as the loan is repaid in the same transaction, which reduces capital constraints for many dapp-to-dapp businesses.

Aave's entrusted loans further expand the stack, allowing for more flexibility in capital allocation.

With the growth of transaction volume, new market demands are highlighted. For example, teams started working on derivative products. CeFi has exchanges that provide futures and options markets, while DeFi has few options for hedging and controlling risks.

During this year, the emergence of Hegic, and projects such as Auctus and Deriswap laid the foundation for this type of market.

On the retail side, it becomes possible to provide users with a simple, friendly user experience that offers attractive yields but removes many of the complexities of DeFi. Projects such as Dharma and Idle utilize various DeFi protocols to provide users with regular income streams.

The emergence of liquidity has allowed the industry to grow both horizontally and vertically.

the price of growth

food-meme introduces a fast-start mode whereby projects go into production without going through a full review. This transfers the risk to the users of the application.

Source: https://public.flourish.studio/visualisation/3396454/

Additionally, many projects are initiated by pseudo-anonymous teams, which greatly reduces recourse in the event of malicious behavior or oversight.

Unsurprisingly, the industry has seen a plethora of costly breaches, hacks, and “rug pulls.” While the damage caused by different agreements varies, the threat of a major negative event continues to loom over the industry. Protocols that exploit composability only increase the danger of a domino effect event.

Furthermore, by offering flash loans, attackers have access to a large opportunity to exploit capital, which makes it profitable and cheap to execute.

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However, algorithmic events may not always be intentional. In fact, MakerDAO nearly collapsed in March due to an algorithmic event triggered by price volatility that unfortunately coincided with network congestion.

Source: https://public.flourish.studio/visualisation/4741633/, yinsure and Nexus Mutual

This further increases the risk of a potential domino effect.

Source: Etherscan.io Gas Price

The industry has attempted to address this with a growing number of decentralized insurance solutions, but issues of testing and quality standards will need to be addressed in the future to avoid painful setbacks.

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Another key issue is transaction costs and congestion. As transaction activity on Ethereum increases, so do fees. This is tolerable for the big players, whose transaction volume makes any fees seem insignificant, but it drives away retail investors and decimates sectors such as gaming that depend on small transactions.

This puts layer 2 solutions like Plasma (Matic Network) and Rollups (StarkWare and Optimism) in the spotlight, but they still require integration, introduce complexity and reduce composability.

Source: https://public.flourish.studio/visualisation/4752301/

The sector and industry will need to address these issues, or continued growth will begin to undermine the structural integrity of the space.

While BTC and ETH maximalists continue to debate whose assets deserve to be considered digital currencies, stablecoins have been expanding their presence to fill the void.

Source: https://public.flourish.studio/visualisation/4741746/

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Stablecoins offer an opportunity for invoicing, trading and settlement with less volatility than any major cryptocurrency. This is why they have become the lifeblood of the DeFi ecosystem.

Still, like everything else in the industry, there are custody and DeFi solutions. As it stands, Tether USDT is far from the dominant stablecoin in the market. However, these solutions may eventually lose their appeal due to concerns over counterparty risk and the ability of centralized players to freeze assets by blacklisting wallets.

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However, as the stablecoin space becomes lucrative, businesses and government agencies alike are looking to enter. These projects include Diem (formerly Libra) and CBDC tokens that aim to reassert the dominance of traditional powerhouses.

Source: btconethereum.com

Network Effects and Competition

DeFi has allowed Ethereum to re-establish its dominance in the dapp space. The industry's gains attract other communities. The largest capital inflow is from Bitcoin. For those who don't want to sell, but still want their funds to work, wrapping BTC and putting it on Ethereum opens the door to many opportunities.

As more dapps start accepting BTC as a wrapper, its value on Ethereum and the number of centralized and decentralized bridges are skyrocketing. This, in turn, lured the rest of the community into Ethereum, with Zcash, Dash, Ethereum Classic, and Filecoin all launching wrapped versions of the original currency on Ethereum.

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Projects tried to follow the blueprint of Ethereum, so many MakerDAO, Uniswap, and Compound alternatives launched on rival networks.

Source: https://public.flourish.studio/visualisation/4025241/

Source: https://public.flourish.studio/visualisation/4750516/

Source: https://public.flourish.studio/visualisation/4750519/

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Source: Beacon Chart

looking to the future

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Source: NFTfi.com

looking to the future

As DeFi continues to develop and grow, it should foster growth in other areas. DeFi provides the infrastructure for transacting value, and it is now in place, which should help the value creation sector move forward.

The art and collectibles space has already started to integrate into the stack, with projects like Aavegotchi and NFTfi combining collectibles and decentralized finance. NFT artworks are attracting more and more funds at auctions, making it feel like it’s only a matter of time before these assets are accepted as collateral in DeFi.

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