How Big is DeFi? A look at the Crypto Lending Market

DeFi lending remains significantly smaller than lending via digital asset platforms (for now)

Listen to the podcast recording here.

Like many in crypto we have been watching the growth of DeFi with great interest and enthusiasm.

The DeFi boom has been a major factor in the 2020 price outperformance of Ethereum (ETH), on which much of DeFi operates, over bitcoin (BTC). Year to date ETH is up nearly 200% compared to BTC’s +57%.

According to DeFi Pulse, the total market value of funds “locked” in various DeFi platforms and protocols is up ~7x since the start of June, having grown exponentially from approximately $1 billion to over $7 billion today.

But what exactly is DeFi?

DeFi is shorthand for “decentralized finance”. And that’s about where definitional consensus ends.

Decoding DeFi dissonance

Establishing generally agreed upon definitions and taxonomies has been a frequent challenge in the cryptocurrency space.

Bitcoin, for example, is still referred to by a plethora of different terms, including virtual currency, cryptocurrency, cryptoasset, digital currency, alternative currency, and so on.

DeFi has proven similarly difficult to define, categorize, and measure.

In defining DeFi some emphasize its automation. However, many financial processes outside of the world of DeFi are already highly automated (e.g. trade matching engines at traditional exchanges).

Emphasizing DeFi’s automation also implies the absence of human actors, or potential for human intervention, in the management of DeFi. While fully eliminating the possibility of human administrative management is the ultimate goal for many DeFi protocols and applications, this is not the state of play across much of DeFi today.

Descriptions of how DeFi cuts out the middleman are also problematic as it implies a substantial reduction or elimination of fees, not skyrocketing Ethereum transaction (gas) fees.

While no precise definition exists, DeFi has come to generally refer to smart contract-powered financial applications built atop Ethereum (ETH), such as decentralized exchanges (DEXs) like Uniswap, and crypto borrowing and lending protocols like Aave.¹

Lending has been DeFi’s biggest application to date

According to DeFi Pulse, the “lending” segment is the largest single segment of DeFi at $3.7 billion in size. This represents just over half of the total $7.1 billion in value currently locked in DeFi.²

The growth we’ve seen in DeFi lending and borrowing — often referred to as money market protocols — has been both impressive and not surprising to DeFi users.

Compound was one of the first such money market protocols. Its introduction of permissionless, real-time interest bearing crypto deposits, offering attractive yields compared to traditional banks, has proved compelling.

Money market protocol users do not need to complete a lengthy application, or go through a formal approval process, to begin earning interest on or borrowing cryptoassets. Instead, users simply access the protocol’s lending market via a compatible software wallet, deposit crypto, and immediately borrow or begin watching interest compound in real time.

It was the introduction this spring of the Compound governance token (COMP) that supercharged funds deposited on Compound and other money market protocols, kicking off the current “yield farming” and liquidity mining boom.

While it is unclear what longer-term impact distortions in lending and borrowing rates created by liquidity mining mean for money market protocols, the innovations unleashed have opened up exciting possibilities for greater financial inclusion and upgrading our financial infrastructure.

Segmenting the crypto lending market

Crypto borrowing and lending markets existed well before DeFi.

Alongside DeFi growth we have seen a significant rise in crypto borrowing and lending facilitated by digital asset lending platforms (DALPs), also sometimes referred to as over-the-counter (OTC) lending desks, such as Blockchain.com.³

Crypto OTC lending desks resemble more established lending and borrowing markets, sharing some similarities with more traditional Wall Street-style lending desks. These operations typically involve more human interaction in the coordination of loans than DeFi.⁴ DALPs also cater not just to institutions but also retail customers, and have typically integrated crypto trading.

While rates across DALPs and DeFi have fluctuated over the past 12–18 months, prior to the yield farming bonanza we often saw that DALP deposit yields were superior (USD stablecoin deposit APRs of 8% or more) to rates that could be earned on DeFi platforms such as Compound.⁵

Other factors, including concerns over potential smart contract software bugs, more predictable interest rates, and ease of use have often led many to prefer lending their yield generating cryptoassets to DALPs over DeFi.

DeFi lending is still smaller than DALP lending

Amid all the DeFi hype we thought it would be useful to compare the market size of DeFi lending with DALP lending.

Today, crypto lending for both DeFi and DALPs is largely dominated by a relatively small number of players.⁶ There are seven leading DALPs (in alphabetical order):

• Binance
• Bitfinex
• Blockchain.com
• BlockFi
• Celsius Network
• Genesis Capital
• Nexo

Using a mix of private and publicly available data we have established a lower bound estimate of total interest bearing crypto deposits at DALPs of $5.4 billion.⁷ This is ~$700 million, or 19%, greater than the total value locked in DeFi lending platforms according to DeFi Pulse.

While our $5.4 billion DALP figure is a lower bound figure, we estimate the actual total value on deposit at DALPs to be well over $6 billion, or 62% more in crypto value deposited on DALPs over DeFi.

Today, the combined DALP and DeFi total estimated crypto lending market size is $9.1 billion at the lower bound, and more likely at least $10 billion in size.

The future of crypto lending

For nearly a decade now software has been eating the world. It is tempting to think that DeFi lending protocols will soon surpass and perhaps even eliminate digital asset lending platforms. However, that is unlikely to happen in the near-term.

As expected, we have seen numerous DeFi smart contract hacks and bugs emerge in recent months, leading to loss of funds and other issues. Like any new and fast growing sector, DeFi is highly competitive and teams have understandably prioritized speed to market and live battle testing over time consuming and often expensive software code audits.

The “Black Thursday” March 12–13 crypto price plunge also highlighted some limitations around the ability to quickly re-collateralize DeFi loans during periods of network and market stress, leading to unwanted liquidations and lawsuits.

In short, DeFi buyers beware.

As we discussed recently with Camila Russo, author of a history of Ethereum titled The Infinite Machine, DeFi also often presents a much more difficult user interface challenge than many DALPs, which offer live technical support where you can communicate with a live person to receive step-by-step instructions. Given DeFi’s greater technical learning curve it is not surprising that money market protocols like Compound appear to only have ~10k total unique users.

In sum, it is fair to say that DeFi is still a Wild West. An exciting place to be no doubt, where minor fortunes could be struck, but not yet ready for everyone.

Overall, we view DALPs and DeFi as complementary, and we anticipate both will continue growing in size as individuals and institutions seek ways to earn meaningful yield on savings in a world of zero and negative interest rates and rising inflation.

Garrick Hileman is the head of research at Blockchain.com, the leading provider of cryptocurrency solutions and creator of the world’s most popular crypto Wallet and the Blockchain.com Exchange. You can read more of his analysis and research on Twitter @GarrickHileman and @Blockchain.

Important note:

The research provided herein is for your general information and use and is not intended to address your particular requirements. In particular, the information does not constitute any form of advice or recommendation by Blockchain.com and is not intended to be relied upon by users in making (or refraining from making) any investment decisions. Appropriate independent advice should be obtained before making any such decision.

Footnotes:

1. Arguably bitcoin and much of the universe of cryptocurrency networks that possess some degree of decentralization could fall under the heading of DeFi
2. For reference, according to DeFi Pulse the next largest DeFi category is decentralized exchanges (DEXs) at $1.9 billion in size.
3. OTC lending desks are also sometimes referred to by other names, including as “centralized finance (CeFi)”. However, as noted earlier, terms like “CeFi” and “DeFi” risk oversimplification and confusion. For example, many DeFi protocols like Maker feature centralized assets as backing collateral, such as USD Coin (USDC), a relatively centralized USD-backed stablecoin. Another term we have run across to describe the digital asset lending firms is “private lending”, which we also find somewhat confusing and less descriptive.
4. While the terms “trusted” and “trustless” are sometimes used to differentiate between digital asset lending platforms and DeFi, respectively, the reality is that some degree of trust is required across both. In the case of DeFi, administrative keys to smart contracts are often retained by founding teams for software upgrades or emergency protocol shutdown purposes, and some degree of trust in the soundness of the underlying smart contract code is also required of DeFi users.
5. It is important to note that many higher crypto DALP deposit rates were likely subsidized for user acquisition and growth reasons, and questions remain about the longer-term sustainability of high annual percentage rates offered at present on crypto deposits.
6. DeFi lending is even more concentrated than DALP lending, with just three platforms — Aave, Maker and Compound — representing 98% of the total market value locked in DeFi lending platforms.
7. These estimates are preliminary and the methodology will be described in more detail in a forthcoming research report.