The Next Phase of DeFi Is Here

The crypto market is entering a new phase in 2024 with renowned optimism. Having overcome the turmoil of the last 18 months and bolstered by recent regulatory approvals, the shifts in monetary policy and new Web3 innovations are paving the way for a new wave of crypto innovation.

Developments in decentralized finance (DeFi) are especially promising. With central banks signaling rate cuts, DeFi yields are becoming increasingly attractive as alternative investment forms. Additionally, new ecosystems and a new generation of protocols are introducing fresh financial primitives into the space.

However, to cross the chasm of widespread adoption, this phase of DeFi needs to differ from the previous one. What are the key pillars required for the evolution of DeFi, and how are they manifesting in this market? Let’s explore.

The first phase of the DeFi market was characterized by the launch of highly incentivized ecosystems that created artificial, unsustainable yields across various ecosystems, but also laid the foundation for protocol innovations. The viability of incentive programs was often challenged, yet they addressed the cold start problems in many ecosystems. Regrettably, with changing market conditions, a significant portion of DeFi activity in these ecosystems dwindled, and the yields decayed to levels that were no longer attractive from a risk-return perspective.

Read more: What Is DeFi?

Another notable aspect of DeFi v1 was the dominance of complex protocols encompassing a broad range of functionalities, leading to questions about whether they should be referred to as financial primitives at all. After all, a primitive is an atomic functionality, and protocols like Aave include hundreds of risk parameters and enable very complex, monolithic functionalities. These large protocols often led to forking to enable similar functionalities in new ecosystems, resulting in an explosion of protocol forks across Aave, Compound, or Uniswap and various EVM ecosystems.

Meanwhile, security attacks emerged as the main barrier to DeFi adoption. Most DeFi hacks are asymmetrical events in which a large percentage of the TVL of protocols is lost. The combination of these hacks and the decline in native DeFi yields significantly contributed to deterring investors.

Despite these challenges, DeFi v1 was a…