By Arthur Cheong & Eugene Yap
Compiled by: TechFlow
The European Renaissance, which began in the 14th century, inspired a revival of art, culture, and thought, and profoundly changed modern civilization.
Today, we are witnessing a similar awakening in the cryptocurrency space - the Renaissance of decentralized finance (DeFi). Similar to the Renaissance in history, this movement is breaking down barriers and redefining our understanding of money and finance. Through the power of blockchain and smart contracts, DeFi democratizes financial services, allowing users around the world to participate in a trustless economic system without relying on traditional financial intermediaries. It has the potential to revolutionize the financial industry.
Just as the European Renaissance relied on technological advancement and societal change, the DeFi Renaissance is being driven by a few key factors that are helping it move beyond its early challenges and into a new phase of growth and innovation.
1. DeFi is emerging from the trough of disillusionment
DeFi experienced rapid growth in 2020 and 2021, with many people placing high hopes on it, believing that it would revolutionize traditional finance (TradFi). However, like most new technologies, early hype brought disappointment as the infrastructure was not yet mature, leading to a downturn in 2022.
However, like any revolutionary movement, DeFi has become more resilient and is moving out of the “Trough of Disillusionment” and beginning to climb the “Slope of Enlightenment.” The Gartner Hype Cycle is an effective framework to describe this process, and DeFi is currently showing signs of recovery.
After two years of correction, key indicators such as total locked value (TVL) are rebounding, as shown in the figure below. While rising crypto asset prices have led to improvements in some indicators, DeFi platform transaction volumes have also increased significantly, almost returning to 2022 levels, proving the authenticity of the recovery.
In fact, some core DeFi projects, such as Aave, even surpassed their 2022 peaks on multiple metrics. Aave's quarterly revenue, for example, has surpassed levels seen in the fourth quarter of 2021 - the height of the last bull market.
Our full analysis of Aave is here.
This shows that DeFi is gradually maturing and entering a new stage of development, preparing for long-term scalability.
2. The new interest rate cycle will make DeFi returns more attractive
The recovery of DeFi not only relies on internal factors, but external economic changes also play a key role. As global interest rates change, risky assets like cryptocurrencies, including DeFi, become more attractive to investors seeking higher returns.
With the Federal Reserve implementing a 50 basis point rate cut in September, the market may be entering a period of low interest rates, similar to the environment that drove crypto bull markets in 2017 and 2020, as shown in the figure below. Bitcoin (and cryptocurrency) bull markets typically occur in low interest rate environments (green areas), while bear markets often occur during periods of rising interest rates (red areas).
DeFi benefits from two main factors in a low interest rate environment:
Reduced opportunity cost of capital - As interest rates fall and returns on Treasuries and traditional savings accounts decrease, investors may turn to DeFi protocols to earn higher returns through yield farming, staking, and providing liquidity.
Lower loan costs - The cost of financing decreases, encouraging DeFi users to borrow money and use it productively, thereby driving activity in the entire ecosystem.
While interest rates may not return to the near-zero levels seen in previous cycles, the opportunity cost of participating in DeFi will be significantly lower. Even modest reductions in interest rates can have a significant impact because of the leverage effect that can magnify the difference between interest rates and earnings.
In addition, we foresee that the new interest rate cycle will become an important driving force for the growth of stablecoins, as it significantly reduces the capital cost for traditional financial funds to turn to DeFi in pursuit of returns.
In the last cycle, the Federal Funds Rate (FFR) showed an inverse relationship with the growth of stablecoin supply, as shown in the figure below. As interest rates fall again, stablecoin supply is expected to increase, providing more "dry powder" for the accelerated development of DeFi.
3. Finance: The Biggest Product-Market Fit for Cryptocurrency
The crypto space has tried a variety of application scenarios, such as NFT, metaverse, games, social networking, etc. However, from most objective indicators, they have not yet truly found product-market fit (PMF).
For example, even during Bitcoin Ordinals’ brief recovery in 2024, daily NFT trading volumes continued to decline.
As for the metaverse and gaming space, there are currently no breakthrough Web3 games that have been widely accepted by fans around the world. Two early Web3 metaverse projects, Decentraland and Sandbox, struggle to even reach a few thousand daily active users, while Roblox has 80 million daily active users. While the number of daily active users for TON games is impressive, it is uncertain how many people will continue to play games on TON without more financial incentives.
DeFi, on the other hand, has proven its product-market fit. The growth of core DeFi categories, such as liquid staking and lending, has increased by more than 100% year-on-year, proving its appeal. At the same time, new billion-dollar categories, such as re-staking (Eigenlayer) and basic trading (Ethena), which had zero TVL a year ago, are now emerging rapidly. This explosive growth demonstrates the composability and permissionless nature of DeFi, with new financial "Legos" built on top of each other to unlock new use cases.
Although regulatory barriers have long limited DeFi’s potential to disrupt traditional finance, its inherent advantages are clear. For example:
Fees for cross-border transactions and remittances average 6%, and transfers take 3-5 business days.
Stock exchanges have bloated back-end systems and limited operating hours, which makes them inefficient.
Tokenization of real-world assets, such as real estate, can unlock liquidity and enable composability in DeFi, such as for use as collateral.
DeFi’s 24/7 operation, low cost, high liquidity, and lack of intermediaries make it a more efficient option. The technology is mature; the question is whether regulators will allow DeFi to disrupt the $10 trillion global financial industry that relies on inefficiencies.
To show how DeFi outperforms traditional finance (TradFi) in terms of efficiency, we can compare the cost of running services. According to the research of the International Monetary Fund (IMF), the following analysis is made:
Labor costs: DeFi’s labor costs are almost 0%, while TradFi’s labor costs are 2-3%. For example, DeFi loans are processed through automation without human intervention, while TradFi requires manual review and paperwork.
Operating costs: DeFi's operating costs are only 0.1%, while TradFi's operating costs are between 2-4%. DeFi does not require large offices or intermediaries because smart contracts can process transactions and blockchains are responsible for verification. Overall, TradFi's marginal costs in developed economies reach 6-8%, and in emerging markets it is 10-14%, and these costs are ultimately borne by users.
DeFi eliminates these inefficiencies. It’s that simple.
Furthermore, the financial technology (Fintech) industry has seen little innovation in the past 15 years, which is consistent with Blockchain Capital’s findings. Despite our tremendous progress in areas such as AI and global internet access, Fintech still relies on outdated systems, such as the 50-year-old SWIFT system used by all banks, where transfers typically take 1-4 business days.
Most fintech advances, like digital payments, fractional stocks, and APIs, are focused on improving the user experience rather than addressing the core inefficiencies of traditional finance. For example, Robinhood and Plaid offer convenient solutions for buying stocks, but they still rely on legacy financial infrastructure. The real problem is that fintech is simply connecting to outdated systems to maximize their use rather than creating entirely new ones. While these changes help, they don’t solve the deeper problems that plague the traditional financial world.
DeFi is different from traditional finance. It is designed for digitalization from the beginning. DeFi no longer relies on the old financial system, but integrates financial services directly into the Internet. In DeFi, fractional stocks, overcollateralized loans, and global payments are no longer innovations, but basic functions. This marks a fundamental shift in the way finance works from minor improvements to radical innovation.
By embracing DeFi, we can do more than just make small adjustments, we can unlock massive new economic opportunities, improve financial access, and create wealth in places that traditional finance often overlooks. This means reinventing the financial system to work better in a digital world.
Looking ahead, the 2024 US election could bring clarity to regulation. If Trump is elected, crypto-friendly policies may be introduced, and the Harris administration’s recent positive attitude toward the industry may continue. Regardless of the political situation, DeFi’s momentum is unstoppable.
DeFi is just getting started, and the future of finance will be decentralized and on-chain.
4. Improved UI/UX, infrastructure, and security
DeFi troubled users in its early stages due to unfriendly interfaces and technical complexity. However, user experience, infrastructure, and security have all improved significantly over the past few years, making DeFi more accessible to mainstream users.
One of the most significant improvements is in wallet infrastructure. Managing seed phrases and private keys used to be a major hurdle, but new smart wallets and embedded wallets make the process easier and more secure. Features like social recovery, biometric authentication, and passwordless login now make it easier for users to manage their funds without the complexity of traditional Web3 wallets.
Security in DeFi has also been significantly improved, with comprehensive smart contract audits prior to deployment becoming standard. Platforms like ImmuneFi, through bug bounty programs, encourage ethical hackers to identify vulnerabilities and security issues and ensure they are addressed before they can be exploited. These advancements in wallet infrastructure and security make DeFi safer and more efficient for all users. The number of DeFi hacking incidents has dropped significantly over the past year as a result of these improvements.
With these advancements, DeFi is gradually moving towards mainstream markets, including institutional adoption, driving its continued growth.
5. Make DeFi great again
Just as the European Renaissance reshaped society, DeFi is poised to revolutionize the financial industry. DeFi has huge potential for innovation, and we are just beginning to witness its impact. As more and more users and investors join DeFi, the future of global finance will increasingly shift to on-chain, making the financial system more efficient, open, and accessible.
DeFi has the power to eliminate inefficiencies, break down barriers, and create new opportunities for financial inclusion. This is not just a passing trend, but a fundamental shift in the way the world interacts with money. From global payments to universal financial services, DeFi makes it possible for anyone to participate in the financial system.
Currently, the total market capitalization of all DeFi protocols is approximately $33 billion, accounting for only 1.4% of the total cryptocurrency market value of $2.3 trillion.
Figure: Data as of October 13, 2024
Despite challenging market conditions and industry environments, the growth and success of DeFi has been overlooked recently, but this will change. As DeFi protocols continue to develop at an incredible pace and return growing value to token holders, such as Aave’s recent token economics change proposal, market participants will pay more attention to the fundamentals and potential of DeFi and realign their capital allocation.
We expect DeFi assets’ share of the total cryptocurrency market capitalization to grow from 1.4% to 10% in the next two years as DeFi continues to expand and the market wakes up to its new momentum and potential.
Make DeFi great again.
Acknowledgements
The person who popularized the term “DeFi Renaissance”
The Great Return of DeFi
Important Notice: This document is for reference only. The views expressed in the document do not constitute investment advice or recommendations. Persons receiving this document should conduct sufficient due diligence before investing based on their specific financial situation, investment objectives and risk tolerance (which are not covered in this document). This document does not constitute an offer or invitation to buy or sell any assets mentioned in this document.
