The Renaissance of Decentralized Finance: Making DeFi Great Again
The European Renaissance that began in the 14th century ignited a revival of art, culture, and thought, fundamentally transforming modern civilization.
Today, we are witnessing a similar awakening in the crypto space—the renaissance of decentralized finance (DeFi). Much like the historical Renaissance, this movement is breaking down barriers and reshaping our understanding of money and finance. Driven by blockchain technology and smart contracts, DeFi democratizes financial services, enabling people worldwide to access a trustless economic system without traditional financial intermediaries. It has the potential to revolutionize finance entirely.
Just as the European Renaissance thrived on technological advancements and social transformations, the resurgence of DeFi is propelled by several key factors helping it overcome early challenges and enter a new phase of growth and innovation.
1. DeFi Is Emerging from the Valley of Disillusionment
In 2020 and 2021, DeFi experienced a surge, with high hopes that it would completely disrupt traditional finance (TradFi). However, like most emerging technologies, the early hype led to disappointment as the infrastructure was still developing, resulting in a downturn in 2022.
Yet, as with any revolutionary movement, DeFi has become more resilient, successfully navigating the "Valley of Disillusionment" and beginning to ascend the "Slope of Enlightenment." The Gartner Hype Cycle is an effective framework to illustrate this journey, and currently, DeFi is showing signs of recovery.
After two years of adjustment, key metrics like Total Value Locked (TVL) are rebounding, as shown in the chart below. While some improvements are attributed to rising crypto asset prices, trading volumes on DeFi platforms have also significantly increased, nearly returning to 2022 levels, indicating that this resurgence is genuine.
In fact, some foundational DeFi projects, like Aave, have even surpassed metrics from their 2022 peaks. For instance, Aave's quarterly revenue has exceeded levels from Q4 2021, which was considered the peak of the last bull market.
This suggests that DeFi is maturing, entering a new phase of productivity, and preparing for long-term scalability.
2. New Interest Rate Cycles Will Make DeFi Returns More Attractive
The revival of DeFi is not solely driven by internal factors; external economic changes also play a crucial role. With global interest rates shifting, high-risk assets like crypto and DeFi have become more attractive to investors seeking higher returns.
As the Federal Reserve implemented a 50 basis point rate cut in September, the market is gearing up for what could be a period of lower interest rates, similar to the environments that propelled the crypto bull markets in 2017 and 2020, as shown in the chart below. Bitcoin (and other cryptocurrencies) bull markets are indicated in green, typically occurring in low-interest-rate environments, while bear markets are in red, which often happen during periods of rising rates.
DeFi benefits in a low-interest-rate environment in two key ways:
Lower Opportunity Costs for Capital—With treasury bonds and traditional savings accounts offering lower returns due to rate declines, investors may turn to DeFi protocols to earn higher yields through yield farming, staking, and liquidity provision.
Lower Borrowing Costs—The cost of financing decreases, encouraging DeFi users to borrow and use funds for productive purposes, thereby increasing activity throughout the ecosystem.
While rates may not drop to near-zero levels as seen in previous cycles, the opportunity cost of participating in DeFi will significantly diminish. Even moderate rate decreases can have a substantial impact, as the difference between rates and yields can be amplified through leverage.
Moreover, we expect the new interest rate cycle to be a vital driver of stablecoin growth, as it significantly reduces the capital costs for traditional finance (TradFi) funds to enter DeFi in search of yields. In the previous cycle, the federal funds rate (FFR) had an inverse relationship with stablecoin supply growth, as illustrated in the chart below. As rates decline again, stablecoin supply is expected to grow, providing more capital for the acceleration of DeFi.
3. Finance: The Greatest Product-Market Fit for Cryptocurrencies
The crypto space has experimented with various application scenarios, including NFTs, the metaverse, gaming, and social networks. However, from most objective indicators, they have not genuinely found a product-market fit (PMF).
For instance, although 2024 saw a brief revival due to Bitcoin Ordinals, daily trading volume for NFTs continues to decline.
As for the metaverse and gaming, there has yet to be a breakout Web3 game widely accepted by global fans. The two OG-level Web3 metaverse projects, Decentraland and Sandbox, struggle to break a few thousand daily active users, while Roblox boasts daily active users of up to 80 million. Although TON games have impressive daily active user figures, it remains uncertain how many will continue once economic incentives fade.
In contrast, DeFi has demonstrated its product-market fit. The growth of core DeFi categories, such as liquid staking and lending, has expanded year-over-year by over 100%, showcasing its strong appeal. Meanwhile, entirely new, billion-dollar categories like restaking (Eigenlayer) and basis trading (Ethena) are emerging, with their total value locked (TVL) nearly at zero just a year ago. This explosive growth illustrates DeFi's composability and permissionless nature, where new financial "Legos" can stack together to unlock new applications.
Regulatory barriers have long constrained DeFi's potential to disrupt traditional finance (TradFi), but its inherent advantages are clear. For example:
The average fee for cross-border transactions and remittances is 6%, with transfers taking 3 to 5 business days.
The backend systems of stock exchanges are bloated and limited by operating hours, resulting in inefficiencies.
Real-world assets (RWAs), such as real estate, can unlock liquidity through tokenization and achieve composability in DeFi, serving as collateral.
DeFi operates 24/7 with lower costs, higher liquidity, and no intermediaries, making it a more efficient alternative. The technology is in place; the challenge lies in whether regulators will allow DeFi to disrupt this $100 trillion global financial industry, which relies on inefficiencies.
To illustrate how DeFi outperforms TradFi in operational service costs, let's compare their cost structures. According to a study by the International Monetary Fund (IMF), here’s the breakdown:
Labor Costs: DeFi's labor costs are nearly 0%, while TradFi's range from 2% to 3%. For example, DeFi loans are processed automatically without human intervention, whereas TradFi requires manual review and paperwork.
Operating Costs: DeFi’s operating costs are just 0.1%, while TradFi ranges from 2% to 4%. DeFi does not require large offices or intermediaries; smart contracts handle transactions, and blockchain provides verification.
Overall, the marginal costs of traditional finance reach 6% to 8% in developed economies and 10% to 14% in emerging markets, with these costs ultimately passed on to end users. DeFi eliminates these inefficiencies—it's that simple.
Additionally, innovation in the fintech sector has been minimal over the past 15 years, aligning with findings from Blockchain Capital. While we’ve made significant strides in areas like artificial intelligence and global internet access, fintech remains stuck in outdated systems, such as the SWIFT system, which has been in use for 50 years and typically takes 1 to 4 business days to complete transfers.
Most fintech advancements, like digital payments, fractional shares, and APIs, focus on improving user experience rather than addressing the core inefficiencies of traditional finance (TradFi). For example, Robinhood and Plaid offer convenient solutions for purchasing stocks, but they still rely on old financial infrastructure. The real issue is that fintech merely connects to outdated systems to utilize them better rather than creating something entirely new. While these changes are helpful, they have not tackled the deep-rooted problems plaguing TradFi.
DeFi, on the other hand, is designed to be fully digital from the ground up. DeFi does not work around the old financial system; it integrates financial services directly into the internet. In DeFi, fractional shares, over-collateralized loans, and global payments are not innovations but fundamental functionalities. This marks a fundamental shift from minor improvements to a complete overhaul of how finance operates.
By embracing DeFi, we can move beyond incremental adjustments and start unlocking vast new economic opportunities, enhancing financial access, and creating wealth in areas often overlooked by traditional finance. This is about reinventing the financial system to operate better in a digital world.
Looking ahead, the 2024 U.S. elections may provide clearer regulatory directions. A Trump administration may introduce crypto-friendly regulations, while the recently warming stance of the Harris administration towards the industry may also remain positive. Regardless of the political outcome, the momentum behind DeFi is undeniable.
DeFi is just getting started; the future of finance is decentralized and will unfold on-chain.
4. Improved User Interfaces/Experiences, Infrastructure, and Security
The early interfaces of DeFi were complex and technically challenging, leaving many users confused and alienated. However, user experience, infrastructure, and security have significantly improved over the past few years, making DeFi more accessible to mainstream users.
One of the most important improvements is in wallet infrastructure. Previously, managing seed phrases and private keys was a significant barrier, but new smart wallets and embedded wallets have greatly simplified this process, making it more secure. Features like social recovery, biometric authentication, and passwordless login now allow users to manage funds easily without facing the complexities of traditional Web3 wallets.
There have also been enhancements in security, as thorough audits before deploying smart contracts have become standard practice. Platforms like ImmuneFi incentivize ethical hackers to discover vulnerabilities and security issues through bug bounties, ensuring that issues are addressed
