2020 was the year of the DeFi explosion. Having had modest beginnings in 2018 and 2019, decentralized finance really took off this year, with the likes of Maker, Compound and Aave combining to push the total value locked (TVL) into the DeFi space to over USD 16bn.
This peak represents a growth of more than 2,000% compared to the size of the DeFi sector on January 1, 2020. The question is: will DeFi have a similarly great 2021, and what will be the main trends in the sector next year?
According to industry figures speaking with Cryptonews.com, DeFi may not grow quite as rapidly as it did in 2020, yet it will almost certainly continue its general upward trajectory. At the same time, we can expect such trends as the growing use of layer two (L2) scaling solutions that are built on base layer protocols, e.g. Ethereum (ETH), the emergence of insurance and derivatives products, more retail-facing applications, and also the expansion of staking options.
DeFi growth in 2021
Much of DeFi’s growth this year occurred between June and the beginning of September, when TVL exploded from USD 1bn to just under USD 9bn. This was driven largely by two things: a drop in bitcoin (BTC)’s volatility and a corresponding demand for yield farming products, which provided depositors with interest rates that Vitalik Buterin himself described as “unsustainable”.
Given that bitcoin itself and the wider crypto market has picked up after several months of relative ‘stagnation,’ 2021’s growth might be less aggressive, although it should still be healthy.
“It depends on a lot of macro components. The current trajectory has set up more growth,” said Ilya Abugov, an advisor to DappRadar and partner at Strategic Round Capital.
“Some of the yield farming hype has subsided, but new trends are emerging. The gaming and collectibles sector appears to be trying to integrate with the DeFi stack,” he told Cryptonews.com.
“2020 was an explosive year for DeFi, but now I think it’s starting to attract more institutions ([in November], Copperannounced CopperConnect, a new tool to securely connect institutions to DeFi), which is a big step toward moving DeFi towards mainstream adoption,” said Isa Kivlighan, the digital marketing manager at Aave.
Likewise, Apollo Capital Chief Investment Officer Henrik Andersson said that “the growth in DeFi adoption [will continue] accelerating going into 2021.”
To a large extent, DeFi’s continued growth into 2021 will be facilitated by a growing focus on various layer-two scaling solutions, which involve building sidechains to help reduce the burden on the Ethereum blockchain (on which most (but not all) DeFi platforms are built).
“We believe the biggest trend is DeFi in 2021 will be the move to L2. For example Uniswap and Synthetix are both looking to move to Optimistic Rollup,” said Henrik Andersson.
Optimistic Rollup is a L2 solution that enables running smart contracts at scale while still being secured by Ethereum, according to EthHub.
Andersson added that such solutions could “significantly positively impact” the user experience in DeFi and make using decentralized financial platforms more viable for smaller users. This, in turn, will invite and accommodate greater demand for DeFi products.
2021’s focus on scaling will also be fed by Ethereum’s gradual transition to Ethereum 2.0, which aims to increase throughput while also reducing fees (a significant bottleneck on DeFi’s growth).
Insurance, derivatives, and retail products
We’ve already noted the recent growth of the insurance sub-sector of DeFi, and 2021 might bring an acceleration of this emergent trend.
This would mean that platforms such as Nexus Mutual, Etherisc, Opyn and CDx would enjoy further growth, on the back of new product launches, such as Etherisc’s Flight Delay product that pays out in the case of flight delays or cancellations.
Such platforms are classed by DeFi Pulse under the banner of ‘derivatives,’ which is a wider category of DeFi platforms which is estimated to become increasingly in-vogue throughout 2021. This includes platforms like Synthetix (tokenized assets), HEGIC (options trading), and Erasure (predictions marketplace).
“I think derivatives and insurance segments will get a lot of attention in 2021,” said Ilya Abugov, who nonetheless added that “it might be retail facing applications that see the most growth.”
In other words, due to the infiltration of the likes of PayPal and Facebook into the cryptoasset sector, crypto-only DeFi firms might increasingly try to develop their own alternatives that offer easy financial products for consumers.
“We see that established players like PayPal and Facebook are trying to build retail facing functionality. If the DeFi sector can get a few popular retail facing applications it could really catalyze adoption,” Abugov added.
There are already signs of this, with the not so decentralized crypto-lender, BlockFi launching its own credit card in December that offers cashback in the form of bitcoin.
There’s more at stake
Given that staking was so big in 2020, it will also form a key part of DeFi’s 2021. Not only will existing platforms continue with their current staking products, but we might see new staking services launched in order to capitalize on strong interest.
“Staking has been a growing trend as well in 2020 that I think will continue into 2021. One innovation from Aave is “Safety Mining” where people can stake their assets and earn rewards in exchange for securing the protocol,” said Isa Kivligha.
“This is something that could grow, as it’s not just rewarding people for using the protocol, but it rewards those who protect the protocol.”
Security, regulation, and composability
Lastly, it’s worth pointing out that DeFi will not only need new products in order to grow next year, but will also need to solve existing problems. One of these is security weaknesses.
“There were some hacks in 2020 that were the result of unaudited code, and I’m an advocate of self-regulation within DeFi. Security is the top priority at Aave, and I think it’s important to set and uphold industry standards for security,” said Isa Kivligha.
Similarly, the DeFi and the whole crypto sector will sooner or later need to confront a swelling tide of regulations.
“Externally, regulation remains the big unknown. For instance, the proposed STABLE Act looks scary for algorithmic stablecoins,” said Ilya Abugov.
Lastly, one technical challenge will be to maintain composability, enabling different platforms to integrate and use the same technologies and solutions.
“One big challenge will be to keep composability in DeFi despite the different solutions for L2. We hope the industry can build momentum around a single technology like [Optimistic Rollup],” said Henrik Andersson.