Decentralized finance is a promising yet young financial landscape which is gradually taking shape & moving towards maturity. Defi’s underlying concept, i.e. open, free & decentralized financial markets, is no less than a foundation of the financial revolution. In the era of a centralized banking system, the idea of eliminating intermediaries and yet having the ability to earn interest, lend/ borrow or execute peer-to-peer financial transactions with complete transparency attracts investors globally. The concept of Defi gained immense popularity in 2020, and its market size skyrocketed in 2021. The total locked value (TVL) increased from $15 billion (Jan 2021) to $124 billion in mid-May.
Just when Defi started to stabilise its market & was seen as a rising financial industry, the crypto world came crashing, starting with the Terra debacle. The tragic Terra-Luna crash wiped off over $30 billion from the Terra Defi ecosystem and made the Defi and the entire crypto industry bleed in red. Following the Terra-Luna crash, many overleveraged hedge funds, such as Three Arrow capital, defaulted on their loans and filed for bankruptcy. Many companies like Celsius Network, Voyager digital, etc., who promised high returns to investors, failed to return the users’ funds. These events shook the investor’s trust in the entire ecosystem and pushed the crypto market into the deep & harsh winters.
Although the market went into hibernation and retail investors turned their back on Defi for a brief period, the development of Defi protocols with different use cases continued. From May to the end of August 2022, the market started to recover. Soon, the most awaited Ethereum update took place in Sept 2022. Post Ethereum Merge, i.e. on converting from PoW to PoS, the potential of Defi has increased multiple folds. Right after the merge, as per Nansen’s report, the demand for liquid Ethereum staking, Ethereum transactions and value stored in contracts increased significantly, representing users’ increased interest in scalable Defi protocols.
After a few months, the FTX fraud came to light and shook the entire industry. However, FTX has done more damage to centralized exchange than Defi. The fall of Sam Bankman Fried’s FTX encouraged investors to take their crypto assets ownerships in their hands. Hence, the outflow is observed from centralized exchanges to the decentralized exchanges or other Defi protocols. It seems more like investors have learnt their lessons from the devastating events and hence placed their trust in Defi.
The Ethereum Merge revived the Defi market by 25.6% (from Q2) in Q3 2022, but its market cap declined by 70% compared to Q1. Irrespective of the market sentiments, the pace of development in the Defi space is unstoppable. Decentralized finance is a newly emerging space; therefore, a lot of work must be done to bring innovation, security & use cases at the par of excellence. The complexity of the field is another hurdle to its mass adoption. The protocol and technologies involved must develop the platforms in such a way that users can easily understand the use cases & benefits. The road ahead looks promising for decentralized finance, but it significantly depends on the government’s regulatory framework, investors’ awareness & time taken in the mass adoption.