The DeFi party is not over yet -

2020 is coming to an end. Looking back at the blockchain industry this year, DeFi can be said to be the hottest and most popular thing in 2020. Even Bitcoin, which will drive the bull market back again after its fourth halving this year, has seemed dim in the months when DeFi was popular, and has been temporarily forgotten by investors.

If we observe carefully, we will find that the development trajectory of DeFi is a bit like that of celebrities in the entertainment industry. After being tepid and ignored for a long time, it suddenly becomes a hit at a certain point in time.

After the lending protocol Compound launched liquidity mining in June this year, DeFi has been unstoppable, and related protocol products have sprung up like mushrooms after rain. A number of vegetable food tokens have emerged one after another and permeated the entire market. The game between the classic leeks and the new leeks has begun, with the new leeks diving into the DeFi token river, while the classic leeks "watch the fire from the other side of the river".

Looking at the development trend of DeFi in recent years, it was almost ignored before the first half of 2019, and the total locked value was negligible in the entire historical line. DeFi really attracted attention in 2019. Last year can be said to be the year of DeFi, and decentralized finance has become a hot spot that cannot be ignored in the industry. Related products have surged, and the market is growing.

As of June 30 last year, the total locked value of DeFi was US$1.49 billion, an increase of nearly 5 times from US$302 million on January 1 in half a year. However, it is surprising enough that the nearly 5-fold increase is insignificant in 2020. The development trend of DeFi this year has exceeded almost everyone's expectations.

DeFi Feast

DeFi's market value has soared in 2020 and has now exceeded $15 billion, nearly ten times that of last year. Decentralized finance is undoubtedly a potential blue ocean market. The ecosystem is becoming more and more complete, including more than a dozen major categories such as decentralized exchanges, lending, analysis tools, prediction markets, and stablecoins.

According to defiprime data, there are currently 215 DeFi projects, which is 20 fewer than in September. Among them, 203 are based on Ethereum, 22 are based on EOS, and 26 are based on Bitcoin.

Source: defipulse.com

Source: chainalysis.com

From the data of Defipulse and Chainalysis, we can see that DeFi has performed very calmly in recent years. It was not until 2019 that it showed a significant improvement, and its market value began to grow significantly in June 2020. In January of this year, the total value of US dollars locked in DeFi was US$690.9 million. In November, it exceeded US$15 billion. As of November 11, the total locked-in volume of DeFi protocols reached US$15.55 billion. The top three are Uniswap V2 with US$3.15 billion (-0.34%), Maker with US$2.31 billion (+3.81%), and WBTC with US$1.92 billion (+0.40%). Although the popularity of DeFi is getting smaller and smaller, and the top ten DeFi projects have generally fallen sharply in the past period of time, the locked-in volume of DeFi projects such as Uniswap, Maker, and Compound has maintained a steady upward trend recently. The growth trend is recovering.

However, many issues in DeFi's user experience, product development, regulation, compliance, and ecology have always caused a lot of concern. And this concern has not changed fundamentally in 2020.

The DeFi story is far from over.

The great waves wash away the ups and downs

Currently, the popularity of DeFi is fading, a number of liquidity mining projects and food tokens are showing signs of decline, and the entire industry is becoming calmer. Most of the DeFi tokens that were popular in WeChat Moments have disappeared from the eyes of investors.

Only 11 of the 41 DeFi tokens tracked by Messari have risen in the past 30 days. The hardest hit high supply inflation tokens include Compound, Balancer, MCDEX, Curve, and mStable, all of which have fallen by at least 60% since the beginning of September.

There is no DeFi without sushi. The emergence of Sushiswap can be said to have added fuel to the fire of DeFi. SushiSwap, a copycat of Uniswap, performed very well as soon as it went online. The locked-up amount exceeded US$700 million in 3 days and US$1 billion in 5 days, becoming the fifth DeFi project to reach US$1 billion in locked-up amount after Aave, Maker, Curve, and Uniswap. It was once speculated that it might surpass the former. Sushiswap's locked-up amount is still ranked fourth in DEX, second only to Uniswap, Curve, and Balancer. But the price of its token sushi has been falling all the way.

Source: Non-small

YFI is the first and only token to have a higher price than Bitcoin. On September 13, the token was worth more than $43,000. On November 5, the price dropped to $8,000, a drop of 80%. It has recovered slightly recently and has been trading at $16,600 in the past week.

Source: Non-small

One DeFi project that has to be mentioned is PICKLE, which stands out from a host of food tokens such as kimchi, hot dogs, and spring rolls, and is quite attractive. PICKLE's goal is to balance the returns of each liquidity pool to ensure that market pressure can normalize the price of stable tokens. More rewards are given to stablecoins below the liquidity pool, while stablecoins above the liquidity pool receive less rewards. This enables people to sell stablecoins above the liquidity pool and buy stablecoins below the liquidity pool. Micro-innovation made it stand out, and its contracts soon locked up $200 million worth of cryptocurrency, making it a leading food project outside of SushiSwap. The token also soared by more than 1,000% in 24 hours, from $5 to $70. But it also showed a downward trend in the later period, and is currently stable at around $20.

Source: Non-small

FTX's DeFi perpetual index shows that a large part of the DeFi bubble has burst and has returned to the level of June. What really remains are DEX projects that provide better trading experience, lower slippage, lower costs, and smaller impermanent losses.

Qinglong, a special analyst of Matcha, said in Ostrich Blockchain Crypto Intelligence: The blockchain infrastructure is imperfect, speculators are currently occupying the market, whether DeFi applications can solve the problems of Internet finance needs time to test, and DeFi's financial regulatory policies are risky. Three major reasons hinder the development of DeFi. The most serious is the proliferation of speculators. When a certain outlet of the blockchain is hyped up, it is easy to form a network effect, and a large amount of funds will pour in. This is why the token prices of many early DeFi projects have been hyped up to several times or even dozens of times. However, the value of the project itself does not support the consensus that it maintains a high price. After the wave recedes, institutional funds and project funds will quickly realize and withdraw funds. Then the sharp drop in the top 10 DeFi projects is only the inevitable return of prices to rationality.

Dao Fa Ziran, a researcher at Haru Capital, said that the total value of assets locked in DeFi is still very high, but the continued decrease in trading volume and liquidity are insufficient to maintain such a high lock-up volume. In addition, the sharp decline in many DeFi projects has a great impact on investor psychology, so DeFi has come to an end for now.

TokenInsight analyst Ma Yiding believes that the DeFi bubble will burst in about a quarter, and only after the bubble is eliminated can it truly develop healthily.

The first round of DeFi hype was rough and chaotic, and it was also a stage of experimentation and self-healing. However, the preheating of DeFi is still there. Keep3r, which is popular in the market, shows that as long as there are suitable projects, people are still interested in DEX. There will be more high-quality projects in the next round of DeFi, so wait and see.

DeFi is just the first round of retreat, but it is not over.

DEX and CEX, long-term coexistence

Decentralized exchanges (DEX) are a bright spot in the DeFi space. During this wave of enthusiasm, DEX trading volume has grown strongly, with the top ten DEXs achieving $30 billion in trading volume in September. In the third quarter, the trading volume of the top 10 DEXs increased by an average of 197% per month. In contrast, the data for centralized exchanges (CEX) was only 35%.

Much of DeFi’s growth this year can be attributed to four platforms: Uniswap (version 1 and 2), Kyber, Curve Finance, and 1inch Exchange, all of which are DEXs.

The decentralized exchange Uniswap is undoubtedly the most popular DEX, ranking first in both locked-in amount and trading volume.

Source: debank.com

According to Uniswap official data, the asset liquidity (i.e. locked amount) in the protocol exceeds 3 billion US dollars, close to 3.1 billion US dollars, a record high. In terms of the specific size of the fund pool, ETH locked amount exceeds 1.4 billion US dollars, WBTC locked amount is close to 450 million US dollars, followed by USDT, USDC and DAI. Uniswap alone occupies about 25% of the entire DeFi market. The number of users of the exchange has also increased from 100,000 at the beginning of the year to more than 400,000 now.

As the leader of decentralized exchanges, Uniswap's trading volume exceeded Coinbase as early as the end of August, when the total trading volume on Uniswap exceeded $10 billion. DEX data shows that Uniswap's trading volume reached $6.5 billion from July to August alone. The trading volume exceeded that of the old centralized exchanges, which was regarded as an important sign, and later triggered a lot of heated discussions about whether DEX can replace CEX. Although decentralized exchanges have not yet been compared with many centralized exchanges such as Huobi, OKEx, and Binance, and the gap in user base and trading volume is huge, it is an indisputable fact that decentralized exchanges have huge potential.

Many industry insiders, including Xu Mingxing, believe that DEX and CEX will coexist for a long time in the next few years.

A safe haven for money launderers

The dollar value locked in DeFi has grown exponentially in 2020, bringing with it potential new money laundering risks.

Data released by blockchain forensics company CipherTrace shows that in the first 10 months of 2020, losses from cryptocurrency theft, hacking and fraud reached $1.8 billion, and the sharp growth of DeFi platforms has exacerbated this loss. DeFi platforms have become the most profitable target for crypto hackers. DeFi crime is on the rise. DeFi hackers accounted for about 21% of digital currency hackers in 2020, and even hackers who did not commit crimes directly on DeFi platforms often use DeFi platforms to launder stolen funds. But compared with the entire cryptocurrency ecosystem, DeFi platforms are less risky for illegal activities.

The CipherTrace report stated that DeFi protocols are generally designed without any clear regulatory compliance, and anyone in any country can access them with little or no KYC information collected.

Therefore, DeFi can easily become a safe haven for money launderers.

For example, Uniswap is the most popular DeFi platform, which has no KYC or AML verification process. When using UniSwap, users only need to connect their wallets and then they can start trading. This makes UniSwap an attractive channel for cybercriminals to choose.

On September 25 this year, KuCoin exchange was hacked and $281 million was stolen. Of this, $17.1 million of tokens were sold through decentralized exchanges. The decentralized exchanges involved mainly include Uniswap, Kyber Network, DEX.AG, 1inch.exchnage and Tokenlon.

Forbes published a commentary article stating that the KuCoin theft incident shows that the risk of DeFi being used for money laundering is increasing. DeFi innovation has many risks, such as the lack of KYC/AML measures and lack of protection during transactions. The lack of safeguards will lead to an increase in "bad guys", bringing this field to a dangerous situation, and also making some DeFi project parties suspected of money laundering and terrorist financing. And this is not the first time that DeFi has been used for money laundering.

While the value of stolen and scammed funds peaked in October, the percentage of illicit transactions was only 0.05%. This significant drop in percentage compared to the peak of 1.00% in May can be attributed to the fact that the overall market has grown a lot since then. From this perspective, 0.05% is a fairly small number when compared to the 1.1% of total cryptocurrency transaction volume received or sent by addresses associated with illegal activity.

Source: chainalysis.com

About Regulation

DeFi platforms do not act as active intermediaries like some cryptocurrency platforms, nor are they subject to regulation like traditional money service businesses, such as the Bank Secrecy Act, securities laws, and other compliance requirements.

Of course, who audits the code of DeFi platforms? Who handles vulnerabilities? Who handles related scams and other forms of financial crime? Who helps victims? There are still a lot of questions to be faced and solved. Regulators may explore other ways to enforce the law on DeFi platforms, whether or not they are affiliated with formal companies.

However, as cryptocurrency researcher Ryan Selkis pointed out in a recent briefing, this debate is currently moot because most DeFi platforms have core teams behind them that are able to update the protocol to freeze user funds or block transactions when necessary. This was most evident after the KuCoin hack in September, when cybercriminals attempted to launder stolen funds by exchanging them on DEXs such as Uniswap and Kyber. The teams behind these projects froze some of the funds controlled by the hackers, indicating that these platforms are not as decentralized as some claims have been made.

Ultimately, it will take time for regulators to decide how to apply existing regulations to DeFi platforms, or create new regulatory agencies if necessary, to protect the integrity of the financial system.