DeFi Begins to Move From a Niche Market to Mainstream Finance

In one year, the total value of Ether (ETH) locked in DeFi markets has increased from $317 million to over $1 billion. With the increasing level of activity in the market sector, the next logical progression appears to be focused on making DeFi solutions more mainstream.

However, like other decentralized apps, DeFi protocols still have issues with usability among everyday users. Factors such as liquidity and governance could also hold serious implications for introducing DeFi products to the broader financial market.

With lending products occupying the greater majority in the current DeFi ecosystem, DApp developers have to consider real-world hitches like loan repayment and defaults. Also, the volatility of crypto prices that act as collateral can exert significant stress on the market.

Currently, solutions like multi-collateralized and non-collateralized lending appear to be gaining some popularity in the market. However, these systems might still require more robust stress testing to evaluate their effectiveness in dealing with internal and external stressors.

Apart from handling price instability, a larger DeFi market could mean greater regulatory scrutiny and more significant competition with legacy finance systems. The crypto market as a whole continues to be subject to even tighter regulatory standards with Anti-Money Laundering being a major focus for governments across the world.

DeFi market growth crosses $1 billion milestone

As previously reported by Cointelegraph, the total ETH value locked in the DeFi market has crossed the $1-billion mark. Data from analytics platform Defipulse.com reveals that the current value of the market represents an almost-300% increase from 12 months ago.

In an email to Cointelegraph, a spokesperson for the Maker Foundation highlighted the growth rate of the DeFi market, stating that the pace is exciting, adding: “I believe it speaks to the shared human desire to have more control over critical elements of our lives, like our financial futures and opportunities.” Akiva Lai, chief product officer at blockchain governance and auditing platform Maxonrow, highlighted the significant growth in the DeFi market for Cointelegraph. According to Lai:

“It’s pretty astounding, to be honest. $1 billion in locked DeFi value may seem minuscule compared to legacy finance, but we need to examine it for what it could be — not what it currently is. Paired with the ballooning growth of exchange products, from derivatives to staking services, and it’s only natural that more users will tap DeFi products in the never-ending search for yield amid an uncertain economic backdrop of negative interest rates and slow growth.”

According to Defipulse data, lending DApps command the largest share of the DeFi market, and MarketWatch forecasts that the lending market will reach a valuation of $8 trillion within the next two years. For Jonathan Loi, founder of derivatives exchange platform Level01, the DeFi market is on course for continued growth. In a private note to Cointelegraph, Loi said that the pace of growth is a vote of confidence, adding:

“The majority of value is staked in lending protocols: Because of these protocols collateralized and transparent nature with potential dividend upside, it becomes attractive to investors leading to the quick pace of adoption. Other industries such as financial trading is also gaining pace as evident in the growing interest in direct P2P trading platforms that facilitates transparent and autonomous settlement for the trading of options contracts.”

Lending holds the lion share

Indeed, MakerDAO’s DAI stablecoin accounts for more than 60% of the DeFi market. Thus, lending controls the greater majority of activities in ETH-based decentralized finance. Other major lending products include Compound, InstaDApp and dYdX.

The popularity of lending within the DeFi market space comes as no surprise, given that the total crypto loan industry currently stands at about $4.7 billion. As previously reported by Cointelegraph, the presence of higher interest rates within the sector is driving adoption.

The robust growth in the crypto loan industry comes despite the bear market conditions that characterized the crypto scene in 2018 and 2019. Even with the close to 90% drop in the underlying collateral (usually ETH), crypto loan products have shown some degree of robustness.

DeFi lending proponents will be hoping that such resilience will be pivotal in attracting greater institutional interest in the market. Lai of Maxonrow is of the opinion that DeFi-based lending products could be major drivers for the market as a whole, telling Cointelegraph:

“The biggest impact areas will likely continue to be borrowing/lending because debt is such an integral component of a growing economy. However, collateralized loans still preclude many poorer people from the financial system without collateral to offer, so developments that can lower the barrier in terms of friendly rates and maybe non-collateralized crypto lending are important.”

With greater penetration of DeFi lending, certain market realities like bad debt and loan defaults could come to fruition. Developers and entrepreneurs in the industry will have to contend with the effects of such stressors not only on their products but on the entire crypto market when having to liquidate the collateral backing the bad debt.

According to the Maker Foundation, it is the responsibility of regulated lenders to do their due diligence while offering services to customers. As part of its email to Cointelegraph, a spokesperson for the foundation explained:

“Maker provides the building blocks along with the built-in checks and balances for regulated organizations to provide financial products like loans. Consequently, a regulated loan originator would integrate Maker's architecture to issue loans that they ultimately are responsible for operating. Originators would do so with the full knowledge that Maker uses a collection of smart contracts to ensure the system on the backend remains secure and robust.”

For Michael Gasiorek, head of growth at stablecoin platform TrustToken, overcollateralized loans will give way to undercollateralized loans as market risks become better understood. Writing to Cointelegraph, Gasiorek explained that they will require to be backed by something additional to crypto, like the trading/loan history reputation, Know Your Customer or AML information, or lead to the creation of a credit score system:

“These opportunities will become mainstream only once the mechanisms, returns and risks are well understood and will most likely happen slowly as institutions (the real mainstream when it comes to making loans at eye-popping quantities) watch crypto-savvy consumers test the market and technology.”

DeFi moving toward mainstream adoption

The question for DeFi as it moves toward mainstream adoption is whether the emerging market will seek to dislodge legacy systems or run concurrent perhaps maybe even collaboratively with mainstream finance. For Lai, the latter appears most likely:

“Crypto and DeFi won’t subvert conventional finance, it will coexist — with some hybrid components shared between the two. Who knows, maybe in the future, banks will rely on DeFi lending platforms to manage repayment, collateralization and debt swaps while building the liquidity fail-safes and regulatory components (e.g., KYC) on their back-end.”

A mature DeFi market brings with it the possibility of more flexible options for retail investors with some products likely possessing useful trade-offs in comparison to legacy systems. For Alex Melikhov, CEO of stablecoin platform Equilibrium, DeFi’s march toward greater global adoption follows two paths. Writing to Cointelegraph, Melikhov anticipates two scenarios:

“The first is a long-awaited mass adoption that goes beyond the retail approach. This scenario requires that DeFi developers and entrepreneurs have more usability, wider community education, UX simplification, and so on. At some point, we will see ordinary households investing in liquidity pools on Compound.”

According to Melikhov, the second pathway is more sophisticated, and it involves developers expanding their focus from building financial primitives toward more cutting-edge DeFi-based offerings, like the multiple Dai extensions already on offer.

But, to achieve mainstream adoption, DeFi might also need to undergo a simplification of many of the available products. To this end, developers may need to consider on-ramps that ease the transition between fiat-based systems to more digitized marketplaces.

Pain points for decentralized finance

While developers and entrepreneurs work toward enhancing the penetration of the DeFi market, these DApps still require some work in making them more suitable for everyday users. Several commentators agree that improvements of the in-app user interface remain a key factor not just for DeFi products but for blockchain DApps in general.

Regarding the issue, Lai told Cointelegraph: “The problem with DeFi right now is that it’s really only used by crypto enthusiasts in developed countries.” Likewise, Gasiorek identified UI issues as one of the four pain points for DeFi:

“The user experience needs to dramatically improve so as to be usable by the non-crypto layperson from both the user interface and ‘requisite starting knowledge’ level.”

For Gasiorek, moving past the usability hurdle will allow stakeholders to focus on matters like liquidity, which becomes even more significant once scalability increases. Then comes the need to properly gauge the risks associated with the market and the creation of robust regulatory provisions to prevent the emergence of problems like a crypto collateral loan bubble.

The growth in the DeFi market marked one of the main developments in the crypto market for 2019. The focus for 2020 appears to be one of consolidation and more gains that could put the industry in the spotlight of financial regulators, given the increased level of attention being paid to the crypto space.