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The Current State of DeFi: A Growing Digital Financial Ecosystem

Julio Rubio
Aug 13, 2021 8:28:52 AM

Since August 2020, with over $120B locked into smart contracts, according to DefiLlama1, decentralized finance (DeFi) has become a major attraction in crypto and finance. Smart contracts open an entirely new market for both traditional as well as novel finance business models. DeFi is a digital financial ecosystem where each individual owns their assets, trades, lends and borrows at their choice without having to trust a third-party, among other things. - Author: Julio Rubio

In this article, we will give an account of the current state and the growth potential of DeFi and outline its real-world applications.

DeFi size has grown to 3.1M users

DeFi is not only a transformative technology but also a movement, where teams of developers, visionaries and entrepreneurs have come together to improve the existing finance ecosystem and to take it to the next level. DeFi has experienced incredible growth but how can we measure its adoption? A common approach would be to take a look at the number of unique addresses that have interacted with DeFi protocols. According to Dune Analytics2, there were less than 10,000 unique addresses that interacted with Ethereum based DeFi platforms in 2018. In 2019, participants increased by 100,000 and from 2020 to date, August 2021, participants have grown to an astonishing number of 3.1M, this being only the user base in the Ethereum blockchain. 

There are currently three main components in the DeFi ecosystem:

Decentralized exchanges

Decentralized exchanges have boomed over the last year. While lending markets have greater liquidity or value locked, decentralized exchanges have the biggest user share by far in the DeFi environment. As a clear example, comparing borrowing and lending platform Compound’s total users (unique addresses that have interacted with this protocol) against the total users of the once biggest decentralized exchange Uniswap, we can observe how Uniswap has more than 6 times the users that Compound has, 2.5M vs 319.000 according to Dune Analytics (see Figure 1). It is also remarkable that of the 3.5M users that have used DeFi, 2.8M which roughly equates to 81% have used Uniswap at least once in their DeFi journey, as shown in Figure I. In decentralized exchanges, participants can choose either to exchange their tokens or to provide liquidity to the exchange in order to earn a share of the trading fees and get rewarded for providing liquidity. The ability to act as a liquidity provider (LP) creates a positive feedback loop, where if the number of participants increases, the generated fees also increase, attracting more liquidity and therefore more participants.


Unique user interaction with Uniswap, Compound and DeFi in total

Figure 1: Unique user interaction with Uniswap, Compound and DeFi in total
Source: Dune Analytics

Borrowing and lending markets

Borrowing and lending protocols have blown up in this space, allowing borrowers to access fast and easy loans and lenders to access interest on their assets. On the one hand, lenders are incentivized to lend their tokens for very attractive APYs, allowing them to access an extra source of yield to their assets held. On the other hand, borrowers are incentivized to borrow since a credit score is not needed and the borrowed assets allow them to profit from arbitrage opportunities between decentralized exchanges. To mitigate lenders' risk of borrower default, borrowers have to lock up collateral into a smart contract in order to access the borrowed funds.

Maker was the first borrowing/lending protocol to start functioning in the DeFi space. It allowed lenders to earn interest when lending to other users. The Compound protocol appeared later, offering a wider range of tokens to lend and borrow, and then the Aave protocol started to compete directly with Compound, offering even more tokens and bigger margin possibilities. The Compound platform currently has served around 300k users, 15% of the total number of DeFi users.

Yield aggregators

These act like “funds” that automatically look for the best yield opportunities in the space, managing participants' capital with different strategies. Yearn Finance is the leader in this type of protocol, with a total value of $3.86B locked in the protocol to date, according to yearn.science3. Between June and July of this year, Yearn Finance surpassed the 5B in value locked as shown in Figure II. It is also important to mention that yield aggregators not only serve individual investors that are looking for yield, but also serve other DeFi projects.

TVL Yearn

Figure 2: Yearn.Finance value locked since inception
Data Source:  Yearn.Finance Newsletter #33

The important point here is that participants are rewarded for providing liquidity to decentralized exchanges, borrowing/lending markets and yield aggregators, this attracts more participants and increases liquidity, which explains how DeFi has grown so fast in the last few years.

Conclusion

In conclusion, DeFi has become one of the most dynamic sectors in the crypto realm in only a few months. There are still a lot of financial services to explore and to develop, for example the insurance world which is gradually being tested in DeFi to cover users against smart contract risks. These contract insurances are growing comparatively slowly within the crypto sector with the exception of platforms such as Nexus Mutual, InsurAce or Unlashed. The actual size of DeFi is difficult to assess but it can be approximated with metrics such as total value locked, liquidity, unique users, etc. All of them show an exponential growth over the last three years. Despite DeFi being in its infancy, with the amount of room for improvement and current rate of developments, DeFi is definitely the beginning of the future of finance.

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Remarks

About Sharpe Explorer

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Author

Julio Rubio already in high school felt amazed by the blockchain technology and its possibilities. With 4 years of experience in blockchain he developed a passion for it that completely involved him into the Blockchain ecosystem, participating in multiple DLT and Blockchain related projects. He now works for the Blockchain Founders Group as a blockchain consultant and at Sharpe Explorer as a product developer. You can contact him via mail (julio.rubio @sharpeexplorer.io) or via LinkedIn.

References

  1. DeFi total value locked - https://defillama.com
  2. Figure 1 - DeFi users over time - https://dune.xyz/rchen8/defi-users-over-time
  3. Figure 2 - Yearn.Finance total value locked - https://yearn.science

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