Original title: "The great return of DeFi"
Original author: @tradetheflow_; twitter
Original translation: zhouzhou, Ismay, BlockBeats

Editor's note:The current prospects for the revival of DeFi are optimistic. The current environment has many similarities with the last "Summer of DeFi". A new generation of more mature DeFi protocols are also emerging, and relevant data indicators continue to improve. At the same time, more and more institutional investors are participating in it, which has promoted the expansion of the DeFi ecosystem. In addition, the Federal Reserve's loose monetary policy has injected sufficient liquidity into the market, attracting more investors to seek high-yield opportunities. This series of factors together constitutes favorable conditions for DeFi to flourish again and is a driving force for further growth.

The summer of 2020, known as the "Summer of DeFi", is an extraordinary moment in the crypto industry. For the first time, DeFi is no longer just a theoretical concept, but has demonstrated its feasibility in practical applications. During this time, we have witnessed the explosive growth of multiple DeFi infrastructure protocols - such as @Uniswap's decentralized exchange (DEX), @aave's lending protocol, @SkyEcosystem's algorithmic stablecoin, etc.

Immediately afterwards, the total locked value (TVL) of DeFi applications also soared rapidly. Starting from about $600 million at the beginning of 2020, TVL exceeded $16 billion at the end of the year and hit an all-time high of more than $210 billion in December 2021. This wave of growth was accompanied by a strong bull market in the DeFi field, making DeFi a core focus of the crypto world.

Crypto industry TVL chart from 2020 to the end of 2021
Source: DeFi Llama

It can be said that the two key catalysts driving the "Summer of DeFi" are:

1. The breakthrough progress of the DeFi protocol has enabled it to scale and provided users with clear application scenarios.

2. The Federal Reserve has launched an easy monetary policy, during which interest rates have been significantly reduced to stimulate the economy. This has injected ample liquidity into the market, prompting investors to look for more attractive income opportunities because traditional risk-free interest rates are extremely low. This is undoubtedly an excellent environment for the rapid rise of DeFi.

Chart of the Federal Funds Rate from May 2018 to January 2022
Source: Fred St Louis

However, like many disruptive new technologies, DeFi adoption has followed a familiar S-curve path, often referred to as the Gartner Hype Cycle.

Chart showing adoption of various consumer products over time
Source: Bullish Case for Bitcoin

From a macro perspective, this is how it went: In the early days of the “Summer of DeFi,” early investors were confident in the technological revolution they were investing in. For DeFi, the core idea was that it could completely disrupt the existing financial system. However, as more and more people entered the market, enthusiasm quickly peaked and investment behavior became driven by speculation, with investors focusing more on short-term profits than underlying technology. When this wave of enthusiasm reached its peak, prices fell, public interest in DeFi waned, and we entered a bear market, followed by a long period of stability.

Chart of the Gartner Hype Cycle
Source: Speculative Adoption Theory

There is every reason to believe that this boring plateau is not the end of DeFi, but the true beginning of its journey to mass adoption. During this period, developers continue to drive innovation and firm believers are gradually increasing. This lays a solid foundation for the next round of Gartner Hype Cycle, which is expected to attract more large-scale users in the future.

DeFi Renaissance

So far, the prospects for the DeFi renaissance are looking quite positive. Similar to the catalysts of the last DeFi summer, we now have: a new generation of more mature DeFi protocols being built; healthy and growing DeFi data indicators; institutional investors joining in; and the current easing policy cycle of the Federal Reserve. All of this together constitutes an ideal environment for DeFi to flourish again.

Towards DeFi 2.0

Over the years, DeFi protocols and applications have evolved significantly from the first wave of enthusiasm in 2020. Many of the problems and limitations faced by first-generation protocols have been largely addressed, forming a more mature ecosystem, which is the rise of what we now call the DeFi 2.0 movement.

Some of the key improvements include:

· Better user experience

· Cross-chain interoperability

· Improved financial architecture

· Improved scalability

· Strengthened on-chain governance

· Improved security

· Proper risk management

In addition, many new application scenarios have emerged in DeFi. It is not limited to early trading and lending. New trends such as dual pledge, liquid pledge, native yield, new stablecoin solutions, and tokenization of real-world assets (RWA) make the ecosystem more vibrant. What's more exciting is that new infrastructure is being built continuously. What currently catches my attention is the on-chain credit default swaps (CDS) and fixed-rate/term loans built on the existing lending infrastructure.

Healthy and Growing DeFi Metrics

Since late 2023, we have witnessed a resurgence in DeFi activity as a new wave of DeFi protocols have emerged. First, looking at the Total Value Locked (TVL) in the crypto ecosystem, we notice that momentum is starting to pick up after a long period of plateauing. From $41 billion in October 2023, TVL has almost tripled, reaching a local high of $118 billion in June 2024 before falling back to current levels of around $85 billion. While this is still below the All-Time High (ATH), it is certainly a significant upward move, which could be the first leg of a long-term upward trend in TVL.

Chart showing the evolution of TVL in the crypto industry
Source: DeFi Llama

Another interesting metric is the DEX to CEX spot volume ratio, which measures the relative trading activity between centralized exchanges (CEX) and decentralized exchanges (DEX). Once again, we notice a positive long-term trend, indicating that more and more trading volume is moving on-chain.

Chart showing the ratio of DEX to CEX spot trading volume
Source: The Block

The DeFi sector’s influence in the entire crypto ecosystem has risen in recent months, and in a market where everyone is vying for attention, DeFi is regaining attention.

The Arrival of Institutional Participants

While the first wave of participants in the DeFi summer were mainly individuals trying to master the new technology, a new wave of DeFi protocols is beginning to attract several large players in traditional finance to enter the DeFi space.

In March, BlackRock, the world’s largest asset management company, launched its first tokenized fund, the BlackRock USD Institutional Digital Liquidity Fund (BUIDL Fund), on the Ethereum blockchain, enabling investors to receive returns on U.S. Treasuries directly on-chain. BlackRock’s DeFi initiative has clearly been a success, with the fund’s assets under management exceeding $500 million.

Another notable example of growing institutional interest is PayPal’s PYUSD stablecoin, which reached a major milestone of over $1 billion in market cap just one year after launch.

These examples show that the traditional financial industry is finally beginning to recognize the value proposition of building a financial system based on decentralized blockchain technology. As PayPal’s CTO said, if it can reduce my overall costs while giving me benefits, why not embrace it? As more institutional players begin to experiment with this technology, we can assume that this will become a powerful catalyst for the DeFi space.

The start of the Fed’s easing cycle

In addition to the previous points, the current path of US monetary policy is another potential catalyst for DeFi. In fact, we have just crossed an important inflection point in the economy. The recent September FOMC meeting, which marked the first 50 basis point rate cut since the Fed launched its post-pandemic anti-inflation measures, is an important signal that a new round of easing cycle is starting. The expected path of the federal funds rate further proves this point.

The start of this new round of monetary easing cycle provides two key arguments for the DeFi bullish theory:

1. This easing cycle will inevitably increase liquidity in the system. Liquidity is a key element of the financial market. Excess liquidity means more funds are available to enter the market. Inevitably, DeFi and the entire crypto market should benefit from it.

2. The decline in the Fed funds rate will also mechanically increase the relative attractiveness of DeFi returns. Simply put, as traditional risk-free rates decline, investors will begin to look for other opportunities for income. This could lead to a market shift towards DeFi, which offers a wide range of stablecoins and other more attractive strategies that are safer and more reliable than they were a few years ago.

Will history repeat itself?

Overall, there are multiple factors that point toward a DeFi resurgence.

On the one hand, we are witnessing the emergence of multiple new DeFi primitives that are more secure, scalable, and mature than they were a few years ago. DeFi has proven its resilience and established itself as one of the few industries in the crypto space with real-world use cases and real adoption.

On the other hand, the current monetary environment is also supporting the resurgence of DeFi. This is similar to the context of the last DeFi summer, and current DeFi indicators suggest that we may be at the starting point of a larger upward trend.

History will not simply repeat itself, but it always repeats itself in a strikingly similar way.

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