What is Decentralized Finance? From Inception to 2022 and Beyond
DeFi is a censorship-resistant finance system built on Ethereum. As a peer-to-peer crypto asset network, DeFi solutions enable trustless activities linked to legacy banking, debt, capital markets, leverage, storing wealth, investments, and more.
The Evolution of This Concept
While Bitcoin created an entirely decentralized worldwide payment system, Ethereum’s smart contracts provided the technology that powered the modern DeFi landscape. Hence, it would be technically correct to state that DeFi started back in December 2017, when the Ethereum-based protocol MakerDAO was launched. The developers of MakerDAO deployed the smart contracts for their collateral-backed stable coin (DAI) in 2017.
The concept started with the borrowing and lending of these stable coins and ways to trade efficiently without going through a centralized exchange (automated market makers like Uniswap and 1inch). Users could lock up cryptocurrency via a smart contract in exchange for DAI, pegged to the value of the US dollar. Almost 90% of the total USD value locked in DeFi projects can be attributed to MakerDAO. In early October 2019, MakerDAO’s token, DAI, was pegged to within 2% of 1 USD while other cryptocurrencies faced significant market volatility.
After the pioneering MakerDAO, Ether Delta came in 2017, the first application to allow the permissionless exchange of ERC20 tokens. Also in 2017, one of the biggest use cases for Ethereum, ICOs became prevalent. A few of the more remarkable DeFi projects from the ICO period were -
- Aave — Lending and borrowing.
- Synthetix — A liquidity protocol for derivatives.
- Ren — Protocol that facilitated entrance into inter-blockchain liquidity.
- Kyber network — An on-chain liquidity protocol.
- 0X — an open protocol that allows the peer-to-peer exchange of assets.
- Bancor — On-chain liquidity protocol.
During the ICO mania, one of the chief discoveries was the concept of users interacting with smart contracts carrying pooled funds instead of directly interacting with other users, thus creating a user-to-contract model that was more fitted for decentralized applications.
In November 2018, the first draft of Uniswap was uploaded to the main net of Ethereum. As opposed to Ether Delta, Uniswap was created on the idea of liquidity pool and automated market makers, which allowed for the previously discussed user-to-contract model to be leveraged.
In July 2019, Synthetix proposed the first-ever liquidity incentive program, a technique that later turned out to be one of the primary drivers of the DeFi boom of 2020. Also, Ethereum Mainnet witnessed multiple other DeFi projects launch their protocol between 2018 and 2019, including Compound.
How is DeFi Different from Traditional Finance?
The comparison between decentralized finance and traditional finance is a hotly debated topic. The two vary from each other in the following areas:
- Traditional finance is governed by licensed financial institutions that are trusted sources. With DeFi platforms, a public blockchain acts as the trusted source governing all operations.
- Since DeFi blockchain is more open and transparent, there is a lack of barriers to entry. Anyone with programming skills can build financial services on the public blockchain.
- In contrast, traditional finance systems need to obtain proper licenses and authorization from regulators leading to cumbersome barriers to entry. This has limited innovation and has made it improbable for the traditional finance system to adopt emerging trends.
What Exactly Happened in the 2020 DeFi Boom?
With exciting new protocols to improve cross-chain asset bridges, DeFi’s monumental rise dominated 2020 to become the hot new crypto trend of the year. DeFi crypto saw billions of dollars locked on various platforms either by investors drawing loans using smart contracts, leveraging decentralized exchanges, or staking tokens to earn interest across multiple ecosystems. DeFi showed the crypto world that technical innovation was possible, and new projects could still bootstrap liquidity, funding, and engagement in novel ways.
The major stimulant for the DeFi boom was Comp token’s liquidity mining initiative kicked off by Compound’s governance token, COMP, as a new mechanism for luring assets. The idea of rewarding DeFi users for lending and borrowing for extra incentives in the form of Comp tokens resulted in the supply and borrow APYs for different tokens going up dramatically.
This also enabled the evolution of yield farming, wherein users were incentivized to transition between borrowing and lending different tokens to realize the best possible yield. Following this, COMP witnessed an electrifying rise to become the sixth-largest decentralized finance protocol with the most value staked in DeFi. COMP also was the first to briefly topple MakerDAO as the industry leader.
As the final showdown of the DeFi summer, Uniswap launched its token, Uni. All of the previous Uniswap users and liquidity providers were incentivized with a back-dated airdrop worth over 1 thousand dollars. Moreover, Uniswap launched its liquidity mining program spanning over four different liquidity pools and attracted more than 2 billion dollars in liquidity.
During the DeFi boom, every critical DeFi metric dramatically improved. The monthly volume of Uniswap alone rose from 169 million dollars in April 2020 to over 15 billion dollars in September 2020.
If you look at the total value that has been locked in smart contracts, it’s remarkably over 30 billion dollars. If you go all the way back to 2017 and the start of 2018, it was less than 100 million in terms of value.
The Future of DeFi
If we are to join the crypto market revolution, superior protocols are needed to continue the upward trajectory. One exploration route is aggregators; DeFi trackers such as Shunya compare trading prices across chains to provide you with meaningful, aggregated, personalized insights.
About Shunya
Shunya is an investor-focused DeFi deep analytics platform. Our goal is to simplify DeFi experience and help investors grow with informed decisions.
We’re a team with a very diversified background in engineering, entrepreneurship & marketing. We love talking about web3, finances, food, health & pets.
