Decentralized Finance (DeFi) has grown to become one of Ethereum’s main drivers of adoption. At the core of DeFi is the provisioning of a brand new, permissionless financial ecosystem without any central authority, available to everyone in the world.
2019 brought DeFi into the spotlight and while growth has been impressive, there are still significant challenges to realize DeFi’s true potential, which I’ve previously written about in a joint research report with Harmony.
Looking ahead to 2020, I’m optimistic things like scalability, consumer friendly interfaces and fiat on/off ramps will be solved. However, I believe we are still far from addressing other challenges like credit scoring, financial privacy, and most importantly, RISK.
Here are my predictions for DeFi in 2020:
1. Stablecoin market cap will exceed $15b
In 2019, the total stablecoin market cap grew roughly 50% from $3.3B to $5B+, with Tether dominance reaching ~80%.
The 3x growth of stablecoins will come from multiple areas:
- Launch of Libra
- New stablecoins from CELO, Velo, Saga, Franklin Templeton and others
- Growth of non-speculative use cases and speculative use cases
- Multi-collateral Dai accepting new assets as collateral (BTC, treasuries)
- Increased appetite for yield in a negative interest environment
2. Interoperability will arrive in 2020
2020 will see the much anticipated launch of Polkadot, in addition to Keep’s tBTC, Thorchain, Ren mainnet, a growing Cosmos ecosystem, Interledger Protocol, Kava, 1 way pegs, 2 way pegs, bridges, atomic swaps, oh my!
I have high conviction that interoperability across protocols will be “solved” in 2020, but low conviction on which approach will gain market share.
Despite the inevitability of interoperability, I believe the largest implications will be around Bitcoin as very few other digital assets are worth interoperating in the context of DeFi (the majority of stablecoins are already ERC-20 tokens and privacy solutions are coming to Ethereum).
Focusing on Bitcoin specifically, Deribit Research succinctly highlights the trade-off space for interoperability solutions:
Censorship-resistance: Anyone can create, redeem, and use the token, no matter their identity or jurisdiction.
Confiscation-resistance: Neither the custodian nor other third parties can seize the coins in deposit.
Price-stability against Bitcoin: The proxy token closely tracks the price of Bitcoin and thereby inherits its monetary properties.
Acceptable operating cost: The system can offer its service at a price that attracts both users and custodians.
Amongst the sea of cross-chain plays, I believe 2020 will see the arrival of a solution that satisfies these trade-offs and finally enables BTC to be exchanged trustlessly across chains. Leading to my next prediction:
3. 🔥BTC will eclipse ETH as the primary value locked in DeFi🔥
While I may get called a maximalist for this one, it’s helpful to take a step back and look at the current centralized lending market for clues on the impact of introducing Bitcoin as collateral in DeFi.
BTC is the primary form of collateral for derivative markets like BitMEX, that have cleared more than $1 trillion in annual trading volume. Similarly, Genesis Capital, a leading institutional lender, notes that they have roughly $215m of BTC earning yield on their books as of Q3 2019 while Celsius, highlights that BTC is their most deposited coin out of ~$163m net deposits.
I continue to believe growth in DeFi will be driven by speculative use cases like margin lending and Bitcoin as collateral to go leveraged long will supercharge total value locked across DeFi protocols.
Bitcoin is 3x more liquid, has 8x the market cap and is historically less volatile than ETH (surprisingly, current ETH volatility is level with BTC), making it a superior form of collateral assuming that BTC can trustlessly interoperate with DeFi protocols as discussed in Prediction #2.
4. Rollups + non-custodial exchanges will 10x current “DEX” market share
IDEX recently released a demo of their 2.0 DEX that leverages Rollups. DeversiFi (formerly Ethfinex, spun out of Bitfinex) is partnering with Starkware to leverage ZK-Rollups for their hybrid non-custodial exchange, which leverages Bitfinex’s order books.
Assuming non-custodial “decentralized” exchanges can provide similar trading experiences, avoid issues with front running and dip into liquidity from centralized order books (basically, if ZK Rollups are as magical as they seem and interoperability solutions actually work), I believe we’ll start to see traders move over for two reasons:
- Non-custodial trading mitigates counterparty risk
- Being able to trade with a custodian of your choice (or self-custody) is a better experience
In addition, crypto has seen increased regulatory scrutiny, with many exchanges de-listing assets like privacy coins and exchanges bearing high regulatory / insurance costs associated with being a custodian. Given the historical track record of exchange hacks, it’s always struck me as odd that exchanges also double as custodians given the different core competencies required to build a trading platform / diligently manage custody risk.
With the tech finally catching up to the 2017 hype, 2020 will see non-custodial exchanges gain significant market share.
5. Collateral ratios will remain above 100%
Given the inherent volatility of crypto collateral, collateralization ratios will always need to provide a meaningful buffer as the underlying can move significantly before a liquidation can occur.
While I believe 2020 will see some improvements, I think we are still at least a couple years away from the decentralized identity and credit scoring primitives that would make undercollateralized loans a reality.
My gut is that we’ll begin to see centralized providers implement a hybrid model that utilizes a combination of traditional credit scoring data and alternative data sources to offer undercollateralized loans. My money is on Calibra eventually leveraging FB’s massive data set to offer loans to thin-file applicants.
However, in the meantime, the introduction of less volatile collateral such as treasuries, fiat-backed stablecoins like USDC, gold, tokenized real estate / invoices, etc. hold promise to incrementally lower collateral ratios.
In addition, I’m hopeful we’ll continue to see more experiments like Union, a credit union DAO that combines a form of on-chain identity (wallet address, KYC, etc.) + social vouching (new DAO members must be staked by 2 existing members).
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Roy Learner is an Associate at Wave Financial. The views expressed in this report reflect Roy Learner’s personal views about the subject companies, platforms, issuers, security and non-security investments (“investments”) and not those of Wave Financial. Roy Learner’s comments are not intended to be construed as recommendations or an offer to buy, sell or hold any investment. Roy Learner’s compensation is not directly or indirectly related to the specific recommendations or views contained in the research report. The ecosystem landscape included in this post is intended to provide generalized guidance; nothing in this analysis is intended as investment advice, a recommendation or an introduction to particular funding or capital resource.