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A Look Back at 2020, the Year of DeFi
For better or worse, 2020 has chiseled its way into the history books for some not-so-admirable reasons. While the world faced unprecedented global challenges, the crypto space turned bullish again as developments in decentralized finance (DeFi) spurred incredible wealth generation for many. By most measures, DeFi exceeded expectations as the total value locked (TVL) grew from $700 million to $15 billion, a remarkable 2,100% increase. DeFi saw a huge expansion in critical infrastructure, including borrowing and lending, decentralized exchanges, yield farming, and insurance.
Although most DeFi traders will reflect on 2020 as favorable, it wasn’t always a smooth ride. Successful decentralized platforms – never tested at a multi-billion dollar scale – were frequently attacked or copied, resulting in smart contract exploits, lost funds, and outright scams. While 2020 was the year DeFi exploded, it’s also the year it faced the harsh reality that - in a space as new as this - anything that can happen, will happen.
However, it’s hard not to be in awe of DeFi’s progress over 2020. Crypto tends to ebb and flow: the down periods feel painfully sluggish, and the up periods move so quickly we might as well measure them in dog-years. This past year definitely fits into the latter category, just like 2017 did during the ICO craze. In 2020 we witnessed the adoption of reliable alternatives to centralized financial services and the birth of groundbreaking platforms that challenged our preconceived notions about how finance can or should work. Let’s take a look at how DeFi’s incredible year played out, going all the way back to the magical, pre-COVID time of January 2020.
A swell before the storm
At the beginning of the year, DeFi’s TVL was $700 million, a paltry sum compared to what it would soon capture. DeFi appealed mostly to developers working behind the scenes and traders willing to take substantial, calculated risks. Protocols like Compound, Uniswap, Synthetix and bZx quietly improved their products and gained more users. It was a glimmer of what was to come, and some experts predicted 2020 would be the year decentralized finance would finally break out.
Then, in February, a hacker exploited bZx and stole nearly $1 million. It was a massive blow for bZx which subsequently shut down for several months. The exploit was a harbinger of what DeFi would encounter over the next year, and one of the thousands of attempts to exploit these smart contracts securing millions of dollars. Blackhats always follow the money, and DeFi was now on their radar.
While the bZx hack was a setback for DeFi, it didn’t stop the funds from gradually rolling in. DeFi’s TVL reached over $2 billion in February, and more investors and developers took note of its potential impact on crypto and finance. Most importantly, people began to cozy up to the idea that you can actually use your crypto to generate more crypto.
By March, COVID-19’s threat to the financial system had become apparent, and cryptocurrencies plunged, with Bitcoin reaching as low as $5,000. The forecast was gloomy and reminiscent of the 2017/18 bubble, but the market demonstrated surprising resilience and had bounced back to $10,000 by May. Cryptocurrencies once again regained status as a possible hedge against global instability; though susceptible to the existential panic caused by world-changing events like the current pandemic, they seemed capable of rolling with the punches and getting up off the mat. The pandemic also forced many people to work or stay at home, leading to a crypto renaissance with open finance at the center. DeFi saw a massive uptick in engagement, development, and interest.
Bitcoin’s recovery segued into an explosion in adoption, volume, TVL and innovation across DeFi platforms. One of the biggest driving forces was Compound’s creation of COMP. By issuing its own governance token, Compound could simultaneously attract more users and make their protocol more decentralized. Other platforms like Aave, yearn.finance and Curve quickly followed suit, igniting a new trend called “yield farming” in which users moved their funds around multiple platforms in search of the best APY and returns. Andre Cronje claimed that yearn.finance’s governance token, YFI, has “0 financial value,” but speculation drove its price as high as $40,000. Meanwhile, Aave’s TVL grew from $58 million in early June to over $1 billion by September.
Money poured into DeFi markets from June to October as TVL exploded from $1 billion to $15 billion. This solved one of DeFi’s most apparent obstacles: liquidity. Low liquidity means friction and volatility, and the higher the TVL, the better protocols can operate. By the end of October, the total amount of money locked in DeFi topped $10 billion. Uniswap, the most popular decentralized exchange, reached nearly $1 billion in daily trade volume in late August, a shot across the bow of centralized exchanges like Binance and Huobi. Uniswap also issued its governance token, UNI, to every wallet that interacted with the platform, an airdrop valued at $1,200. MEME, an NFT project, gave dozens of lucky users an airdrop that was valued at $700,000 at one point.
A lot was going on during this time, including many experiments in deflationary supply, rebase tokens (like Ampleforth), and yield farming. More than anything, this was a period of tremendous growth as millions of dollars entered the market on a daily basis. DeFi wasn’t yet mainstream, but it was certainly getting the attention of crypto traders and financial institutions.
DeFi users were elated, and somewhat blinded, by the incredible wealth generation possible during DeFi’s peak this year. As crypto entrepreneurs are wont to do, developers began to make clones and copies of projects to piggyback on their success. Hundreds of yield farms opened which had no real value beyond pure speculation, and many were poorly coded or unaudited, leading to even more smart contract exploits. Eventually, the returns from yield farming slowly dried up due to saturation and hyper-inflationary APY. Farming had now become a game mostly for whales, and many investors lost funds at the tail-end of the craze, either through hacks or over-speculation.
Furthermore, Ethereum transaction fees (‘gas’) escalated to a crippling degree, reaching as high as 500 gwei in September. This made farming inaccessible to average users. Though Ethereum did produce its first 2.0 block earlier this month, the network still faces serious problems with congestion and scaling due to the complex smart contracts produced by DeFi protocols. As the hub for nearly all of DeFi, Ethereum must find scaling solutions so these transactions are less taxing.
This period also taught many about the innate risks of getting involved in such a nascent space. There are too many debacles to list here, but some of the more notable and peculiar ones include SushiSwap’s developer running off with $14 million in ETH (only to return it shortly after), the theft of millions through the smart contract exploits of YAM and Eminence, and the proliferation of outright scams. As an average user, it’s always important to measure risk-reward since DeFi is uncharted territory. For most, finding a reliable, secure and insured platform to put your crypto will be more beneficial than locking up huge amounts in new, possibly vulnerable protocols.
During DeFi’s boom, Bitcoin and Ethereum remained pretty stable in price, with Bitcoin going sideways around $10,000 for several months. This greatly benefitted the DeFi ecosystem as it could grow and improve while the rest of the market stayed fairly stable. By October, however, Bitcoin began to take off, and as of today, it’s nearing an all-time high of nearly $30,000. As expected, this has driven a lot of the volume away from DEXs and altcoins for now. Despite the lower volume, DeFi’s TVL continues to rise and is closing the year at around $15 billion. This means that, although trading activity has decreased, investors are still locking their funds in DeFi protocols to generate rewards. Looking toward 2021, this is a healthy and bullish position for DeFi overall.
It’s difficult to predict what will happen next. In the last couple of weeks, non-collateral stablecoins like Empty Set Dollar (ESD) and Dynamic Set Dollar (DSD) have been the new darlings of open finance. Indeed, the next great development always seems to be right around the corner. This can make DeFi an exhausting space to follow daily, but an exhilarating one as well. Given the rapid innovation in 2020, it’d be fair to expect that 2021 will bring even more protocols that bridge the divide between crypto and traditional finance as well as push DeFi to new, unforeseen places.