Decentralized Finance aka DeFi has witnessed a Cambrian Explosion ever since it came into its own in the summer of 2020 aka “DeFi Summer”. DeFi protocols have now amassed over $80 billion in capital, a staggering growth considering there was less than $1 billion locked in DeFi protocols less than 18 months ago.
A brief history of DeFi
Launched in 2017, Maker foundation with its decentralized stable coin DAI can be considered as pioneers of DeFi movement within the Ethereum ecosystem, having gone on to achieve significant success with over $14 billion deployed today. Etherdelta was another early DeFi project which focused on the decentralized exchange of tokens which worked on an order-book model.
A defining moment in the evolution of DeFi was the launch of Uniswap in 2018 which was the first Automated Market Maker(AMM) built on the concept of liquidity pools. Uniswap’s AMM enabled permissionless exchange between any ERC-20 tokens which opened up liquidity for long tail assets.
DeFi summer was flagged off in June 2020 by the liquidity mining program of Compound through their governance token and the rest as they say is history. DeFi summer mainstreamed protocols such as Uniswap, Aave, Compound, Yearn, Sushiswap, Curve Finance, Synthetix, Balancer and so forth. All these protocols are household names today with an ever increasing user base, revenue and TVL.
DeFi 2.0 and beyond
While it seems DeFi’s mission to eat Traditional Finance(TradFi) may finally come to pass, several core ideas of DeFi have yet to be realised.
Scalability has been a significant challenge for DeFi within Ethereum with obscene gas costs preventing retail users from utilizing Ethereum dapps. Multiple scalability solutions such as Polygon, Optimism, Starkware, Arbitrum are currently in research or already deployed on Mainnet and as witnessed by the success of Aave, Curve and Sushi on Polygon it seems the DeFi ecosystem within Ethereum is well on its way to solve the scalability problems.
Capital Efficiency is another major challenge for AMM styled exchanges such as Uniswap and Sushiswap where significant capital remains underutilized. Uniswap V3 with concentrated liquidity is a step in the right direction of improving capital efficiency as witnessed by the early results.
While existing money market protocols have amassed significant liquidity there remain inefficiencies that need to be addressed. Existing lending and borrowing protocols are not fully decentralized, market creation requires an unwieldy process due to governance voting mechanisms. This restricts liquidity for long tail assets wherein projects are dependent on the money market token holders who decide which token can be used as a collateral.
Arbitrary collateralization ratios have led to capital inefficiency wherein tokens with different risk profiles have similar collateralization ratios. Deciding collateralization ratios for every asset via governance mechanisms means additional operational overhead.
Oracle attacks have drained millions from the DeFi ecosystem till date. Every lending and borrowing protocol is only as strong as their weakest link i.e the price oracles that feed the liquidation engines. Oracles remain a significant roadblock for scaling and securing money market protocols outside of the deeply liquid top tier assets.
DeFi has clearly achieved product-market fit as evidenced by the success of multiple protocols mentioned above. However, it’s time for the DeFi ecosystem to take the next leap forward where we address the inefficiencies mentioned above. We at Timeswap are excited to be building solutions that specifically address some of these. We are calling this next phase DeFi 2.0, wherein we realize the vision of creating fully decentralized, secure and highly efficient protocols as we prepare to onboard the next billion users to DeFi.
Come join us on our discord to learn more about what we are building!
