The world of decentralized finance (DeFi) this year, among other developments, will likely see rising popularity of tranche lending, increased use of Layer 2 protocols as a scaling solution, faster tokenization on Ethereum (ETH), and improved mobility of staked ETH, estimates ConsenSys Codefi, a unit of ETH-focused major blockchain company ConsenSys.
The Q4 2020 DeFi Report stated that despite the DeFi summer cooling, user adoption of DeFi application continued to soar. But DeFi as an industry is still in its infancy, and “there are many new innovations just on the horizon that will further increase [its] accessibility and variability.”
The report highlighted several trends to watch out for in 2021.
Tranche lending products
While interest rates in DeFi are constantly changing, with their volatility preventing individuals and institutions looking for predictable and stable returns to enter the space, tranches emerged as a solution. This product has received significant interest, shown by BarnBridge’s nearly USD 400m in total value locked (TVL) for farming its governance token, wrote ConsenSys.
“Tranche lending exemplifies just how composable all of these innovations are,” said the report, with the teams behind these systems building “an entirely brand new product on top of the existing lending protocols.” This doesn’t come without risks, the report noted, as a failure of one underlying protocol presents a systemic risk to the products that interact with it, as well as this highly complex work of structuring products being done by non-financial experts.
High fee challenges and solutions
Doing stuff in DeFi comes with high fees. Generally, the Ethereum blockchain has been plagued by high fees, exasperated by the rising popularity of DeFi projects.
The report further noted that, with these high fees, different types of blockchains may increasingly try to attract Ethereum-based DeFi applications. Crypto exchange FTX, for example, decided to build its decentralized exchange Serum on Solana (SOL).
But there are scalable solutions like Layer 2 protocols (those built on top of Ethereum) that batch transactions before attesting to the Ethereum mainnet, such as rollups, which are “starting to attract gas-guzzling DeFi protocols.” As reported, Ethereum co-founder Vitalik Buterin is a big supporter of rollups as a (part of) solution to the network’s scaling issue.
Tokenization and interoperability
Connected to the previous point, “the network effects of Ethereum are one of the major reasons why more DeFi applications haven’t been quick to rewrite their smart contracts in a new protocol,” the report said. “It’s why so many crypto assets like bitcoin (BTC) and filecoin (FIL) are being tokenized on Ethereum, a trend we expect will accelerate in 2021.”
ConsenSys also predicts that, as interoperability between different blockchain is still being researched, more projects might consider moving to other protocols ahead of Ethereum 2.0 (ETH 2.0) – however, “the gravity of Ethereum will push more activity to Layer 2 protocols already interoperable with Ethereum,” it added.
Staked ETH mobility
The first of ETH 2.0 phases, Phase 0, went live last December, and it introduced staking, which begun with the launch of the deposit contract in November. It has ETH 2.84m (USD 3.6bn) staked at the time of writing.
And while most people staked knowing that their ETH is locked there for a couple of years, “there are already a number of DeFi solutions for stakers wanting liquidity and mobility on their staked ETH,” the report said. These include LiquidStake‘s USDC loan on staked ETH, Lido‘s derivative stETH, and Coinbase‘s derivative version of ETH.
“With the proliferating programmable token standards on Ethereum, new types of business logic can be incorporated directly in Ethereum,” argued the report. Speaking of central bank digital currencies (CBDCs) and what the economy connected to them would look like, the report said that, if the venue for computing will be increasingly on blockchains, “that suggests that CBDC rails should come not just with pre-installed national money, but also pre-installed applications for the use of that money.”
The rise of DEXs
Meanwhile, the latest Kraken Intelligence report, argued that 2020 was “the year of a bull” and “a uniquely efficacious time for bitcoin and the broader crypto asset market,” and that is has set the stage for “another wave of adoption as we enter 2021.”
As for DeFi specifically, it said that nearly 96% of all locked ETH are in decentralized exchanges (DEXs) or lending protocols, and although DEXs have less than half the amount of locked ETH than the amount locked in lending protocols, “its near +2,800% increase towers over the +60% rise in ETH locked in lending protocols.” At this rate, it concluded, DEXs will soon control the lion’s share of the TVL (ETH) in the DeFi space.”
Although the yield farming trend seems to have legs, the team said, in their opinion, “if there is a bright future for DeFi, it likely won’t revolve around yield farming as much as it will around the actual benefits of utilizing decentralized financial services.”