2020 Review: DeFi in My Eyes

Editor’s note: the story is written by Pingfeng, a DeFi analyst with 8btc.

“Participating in blockchain is a bit like playing Adventure Island. With the progress bar moving forward, you’re driven to follow it closely, otherwise, game over.” This is what I thought about DeFi last August when the sector is booming.

Looking back at the DeFi in 2020, I concluded it into three phases,

• January – May, silence before the storm
• June – September, craze of liquidity mining
• October – December, resume surge with mainstream cryptos

Silence before the storm

Judging by the growth of TVL (Total Value Locked), the DeFi sector has exploded in popularity since June 2020. The keyword in the first half of the year is silence under the shadow of epidemic and economic crisis. As for DeFi, what we’ve observed was the slump of Maker DAI impacted by the 312 crash. Meanwhile, however, the rising stars of the DeFi sector have quietly gone online and finished their iteration in the first half of the year, including decentralized stablecoin exchange Curve, money market protocol AAVE and Compound, and V2 version of Dex leader Uniswap. What the public thought was a sudden rise was in fact the accumulated strength from the DeFi protocol developers and the community.

Craze of liquidity mining

In mid-June, Ethereum-based credit market Compound started distributing its governance token COMP which gave the protocol’s users the right to vote on the upgrade and change of the Compound protocol. Demand for the token kicked off the later craze and moved Compound into the leading position by TVL in DeFi. At that time, the TVL in DeFi hit the $1 billion mark with Compound contributing $500 million in just a few days. Now the TVL has broken through the scale of $15 billion, achieving a 15-fold growth in just half a year.

Compound quietly opens the Defi’s Pandora Box, with many starting to imitate its pattern of liquidity mining. Inspired by the “I’m sorry everyone, I’ve failed” YAM, hundreds of projects named by vege or fruits emerged in August. Almost all of these food-meme projects had a short life cycle, while the surviving Sushi was able to compete with the has-been number one DEX.

Sushi went from zero to one quickly in a “parasitic” way – sucking up liquidity and taking with it over 70% of Uniswap’s liquidity at one time, but it didn’t actually drain Uniswap of liquidity. Some see Sushi’s success from copying code as opportunistic, while others see it as a unique model innovation that could have done Uniswap’s two-year-long work in just a few days. It appears that the market is willing to pay for all the innovation.

Liquidity is a scarce resource when the underlying assets are limited. Such a tricky vampire sucking is just like using the lever to leverage scarce resources, the success of Sushi start can be regarded as a reward for the clever use of lever.

One of the questions that people like to ask at various Defi’s online and offline events is: Is there a moat between the Defi protocols? Do you have your own answer now, community? Ecosystem? Brand? Or token design model tied to LP interests? At such an initial stage, it is still too early to talk about moats, and whoever can make use of DeFi features can win a certain living space for survival and later development.

The deepest impression that “liquidity mining” left on its participants is probably the tens of times or even hundreds of, thousands of times the annual income they might bring. No doubt, “liquidity mining” is 2020 DeFi’s most eye-catching keywords. For the DEFI project, the significance of liquidity mining lies in (1) facilitating the cold start of a project; (2) return governance to the community through the distribution of governance tokens.

Decentralized exchange, stablecoin, credit market, and many applications in the field of oracle machine, is the DeFi vanguard in terms of product and user scale. They’ve quietly completed the cold start as early as in the past couple of years, so for them, the meaning of liquidity mining lies in the practice of blockchain’s decentralization in the regards of community governance. Among them, fund management project Yearn takes the lead in the fair start and the vibe of decentralization, its governance token YFI also created a price myth in the secondary market, pushing the 2020 DeFi craze to a climax.

From the boom of DEX and credit market to money management featuring the concept of “Valut”, we can see a clear difference between DeFi and the ICO of 3 years ago. DEX and credit projects have real users and complete business closed-loop, and their business logic can be simply compared to exchanges and commercial banks. Due to the openness and transparency of blockchain, we can clearly find “business data” on the chain. After the rollout of liquidity mining of DEX and credit projects, it is natural that the search for income maximization fund management tools has emerged. What the narrative of YFI touches investors is not only the spirit of fair start, but the real income it’ll generate for them. As bubbly as the DeFi sector is, the objective trading data on-chain tells us that there is real value beneath the bubble.

Resume the surge with mainstream cryptos

When it came to October, the liquidity mining boom gradually subsided, while the TVL is still increasing but at a significantly lower speed. In the afterheat of DeFi, the crypto community seems to be reluctant to part with the excitement of liquidity mining. People are wondering whether some new things can be combined with DeFi to stir up the storm again, such as NFT+DeFi，DAO+DeFi, etc. Public chains and centralized exchanges were also brewing some mining activities… But that’s no longer the case, as mainstream cryptocurrencies are starting their show, with Defi diving into the water after a spectacular summer leap. At the end of the year, the two small splashes in DEFI field are the AC effect and the algorithm stablecoin Hype.

Defiprime picked Andre Cronje, the founder of Yearn, for the year’s most pivotal DeFi builder, crowning him the landslide winner.

However, as speculation swirled around who would follow Hegic, Pickle, Cover, Cream, AkroPolish and Sushi, the “Cover to Over” incident occurred, it is the second security incident in DEFI insurance protocol after Nexus Mutual. Prior to it, there were 15 big hacks (no rug pulls or bugs like with YAM). These are relatively well-known projects, other less known incidents from anonymous teams like copying and forking are many more. Security has always been a matter of participants on tenterhooks, the progress DeFi is making is also a path of patch upgrade.

And at this point, DEFI observers have the time to review, rethink, and re-examine some concepts.

For example, the TVL, media used to broadcast the spiking TVL value. However, if the number of assets locked in DEFI remains the same, but the price of underlying assets such as BTC and ETH continue to rise, the TVL value displayed will keep increasing. But can such TVL reflect the real activity in the DEFI world? In addition, we all know that the platform will generate LP tokens and lending certificate tokens once liquidity is provided to DEX and lending platform, which can be used as collateral again to flow into the platform. This will make the TVL “puffy”. In fact, the data statistics platforms have taken these problems into consideration and issued adjustment plans, such as DappRadar‘s aTVL and true TVL from DeBank.

Lightning loans. DeFi is not simply moving traditional finance onto the blockchain and doing it all over again. The most typical example is the lightning loan, which is a primitive product of the blockchain which does not exist at all in traditional finance. It can realize lending without collateral, and only needs to complete the borrowing and repayment operations in the same block. Lightening loans are often associated with hacker attacks, but they are designed to serve three legitimate needs: arbitrage, collateral replacement, and self-clearing. And you don’t have to be a hacker who can write code to conduct lightning loans, non-coders as long as you know the principles can also use Furucombo, Instadapp (an intuitive interface helping users that lack the necessary technical and financial experience) and other tools to directly initiate the lightning loan.

Some blockchain industry watchers in China have done an “intergenerational classification” for DEFI as follows:

1st generation: MKR, KNC, ZRX-DAI was born – DEX came into view. These are the most classical DEFI!

2nd generation: LEND, SNX, REN – Lightning Loans, derivatives. Cross-Chain appeared!

3rd generation: COMP, CRV, AMPL – usher in liquidity mining!

4th generation: YAM, YFI, CVP – upgrade of liquidity mining! Revenue and governance aggregator appears!

5th generation: Hegic, Lien, Barnbridge – more complex derivatives appear! Graded fund and bond concept debut!

6th generation: KP3R, Cover, Axie – Developer crowdsourcing, blockchain native insurance, Game + Defi +NFT…

7th generation: better algorithmic stablecoin and datastream option trading

Will there appear the 8th generation? Just yesterday, we saw DEX Bancor of the classical first-generation announced that they are exploring the development of a cross-chain bridge to Polkadot. On a Substrate Hackathon, a developer states that the scalability of Defi’s composability on Polkadot is to be expected, but that the current infrastructure is inadequate. Can DEFI grow new species outside of the Ethereum ecosystem? It is something worth keeping thinking about, exploring and practicing in 2021.