The great return of DeFi
The summer of 2020, known as “DeFi Summer,” was an incredible time for the crypto industry. For the first time, the decentralised finance (DeFi) movement became more than just a theoretical idea; it became a concept that worked in practice. During this period, we witnessed a surge in the popularity of several DeFi primitives—DEXes (decentralised exchanges) with Uniswap, borrowing and lending protocols with Aave and Maker, on-chain yield with Yearn Finance, and much more.
Subsequently, the total value locked (TVL) in DeFi applications grew massively. From around $600 million at the beginning of 2020, TVL rose to more than $16 billion by the end of the year and reached a historic all-time high of over $210 billion in December 2021. This growth was also coupled with a strong bull market in the DeFi sector.
Source: DeFi Llama
We could argue that the main catalysts behind this “DeFi Summer” were twofold: First, breakthrough advancements in DeFi protocols made them ready to scale and provided clear use cases. Second, we were at the beginning of a Fed easing cycle, during which interest rates were being cut aggressively to boost the economy. This made liquidity abundant in the system and incentivised people to seek more exotic yield opportunities, as traditional risk-free rates were very low. A perfect setup for DeFi to thrive.
Source: Fred St Louis
But, as with many new disruptive technologies, the adoption of DeFi has followed a common S-curve path, often referred to as the Gartner hype cycle.
Source: The bullish case for Bitcoin
At a high level, this is how it worked: At the beginning of DeFi Summer, early buyers had strong conviction about the transformative nature of the technology they were investing in. For DeFi, it was the idea that it could radically transform the current financial system. However, as more people entered the market, enthusiasm peaked, and buying became increasingly driven by speculators more interested in quick profits than in the underlying technology. Following this peak of euphoria, prices dropped, public interest in DeFi waned, and we faced a bear market followed by a long phase of plateau.
Source: Speculation adoption theory
However, there is a strong case to be made that this boring plateau phase was not the end of DeFi but rather the beginning of a new journey toward mass adoption. During this time, developers continued to build, and the number of strong believers slowly grew. This has set a solid base for the next iteration of a Gartner hype cycle, which could bring a much larger set of adopters and be far greater in magnitude.
The DeFi renaissance
As of writing, it seems that the setup is promising for a DeFi renaissance. Similar to the catalysts behind the last DeFi Summer, we currently have: a new generation of much more mature DeFi protocols being built; healthy and growing DeFi metrics; the arrival of institutional players; and a Fed easing cycle underway. Again, a perfect setup for DeFi to thrive.
To get a clearer picture, let’s analyse these components:
Towards DeFi 2.0
Over the years, DeFi protocols and applications have evolved significantly from their initial wave of hype in 2020. Many of the problems and limitations faced by the first iteration of these protocols have been solved, leading to a much more mature ecosystem. This is what we now refer to as the emergence of the DeFi 2.0 movement.
Some of the key improvements include:
- Better user experience
- Cross-chain interoperability
- Improved financial architecture
- Improved scalability
- Enhanced on-chain governance
- Improved security
- Proper risk management
Moreover, we have seen the emergence of several new use cases. DeFi is no longer just about trading and lending, as it was in its early stages. New trends like restaking, liquid staking, native yield, new stablecoin solutions, and real-world asset (RWA) tokenization have made the ecosystem much more vibrant. But what’s even more exciting is to also see that new primitives continue to be built as we speak. The latest one to catch our attention is on-chain credit default swaps (CDS) and fixed-rate/term loans built on top of existing lending infrastructure.
Healthy and growing DeFi metrics
Since the end of 2023, we have witnessed a revival of activity in DeFi protocols. First, looking at the total value locked (TVL) in the crypto ecosystem, we observe that after a long period of plateau, momentum has started to return. From $41 billion in October 2023, TVL nearly tripled to reach a local high of $118 billion in June 2024 before consolidating to current levels of around $85 billion. While this is still below all-time highs (ATH), it is nonetheless a significant move upward, and there is a strong case to be made that this could be the first wave of a longer-term uptrend in TVL.
Source: DeFi Llama
Another interesting metric is the DEX to CEX spot trade volume, which measures the relative trading activity between centralised exchanges (CEX) and decentralised exchanges (DEX). Again, we note a positive long-term trend, suggesting that more and more trading volume is shifting on-chain—a strong signal of increased interest in DeFi.
Source: The Block
Last but not least, the mindshare occupied by the DeFi sector relative to the broader crypto ecosystem has been on the rise in recent months. In a market where everyone competes for attention, DeFi is starting to make noise again. This is yet another positive signal.
Source: Kaito
The arrival of institutional players
While the first wave of DeFi participants back in “DeFi Summer” were mostly individuals trying to grasp the power of this new technology, we have recently witnessed the arrival of several big traditional finance players into the DeFi space.
In March of this year, BlackRock, the largest asset manager in the world, launched its first tokenized fund on the Ethereum blockchain—the BlackRock USD Institutional Digital Liquidity Fund (BUIDL Fund)—allowing investors to earn US Treasury yield directly on-chain. This first DeFi initiative from BlackRock was a clear success, with the fund already attracting over $500 million in assets under management.
Source: rwa.xyz
Another notable example of growing institutional interest is PayPal’s PYUSD stablecoin, which recently reached a major milestone: over $1 billion in market capitalisation just one year after its launch.
Source: Paypal
These examples show that the broader financial industry is finally starting to acknowledge the value proposition of building a financial system on decentralised blockchain technologies. To quote PayPal's CTO, "If it can lower my overall cost and give me benefits at the same time, why not embrace it?" As more institutional players begin experimenting with this technology, we can argue that this should act as a strong catalyst for the DeFi sector.
A FED easing cycle underway
In addition to these previous points, the current path of US monetary policy is yet another potential catalyst for DeFi. Indeed, we are nearing a major inflection point in the economy and in his recent Jackson Hole speech, Powell provided clear forward guidance that a rate cut in September would occur —“The time has come for policy to adjust.” For the first time since the FED began its post-COVID fight against inflation, it is preparing to cut rates and begin a new easing cycle. This is demonstrated by the expected path of the three-month average SOFR, which serves as a good proxy for the future path of Federal Funds rate.
Source: Bloomberg
The beginning of this new monetary easing cycle supports two key arguments for the DeFi bull case. First, this easing cycle is bound to increase liquidity in the system. Liquidity is a key element for financial markets, and excess liquidity is beneficial as it implies that more money is available to enter the markets. Inevitably, DeFi and the broader crypto market should benefit from this. Second, a decrease in Fed fund rates will also mechanically increase the relative attractiveness of DeFi yields. Put simply, as traditional risk-free rates decline, investors will begin seeking other yield opportunities. This could lead to a market rotation toward DeFi, which offers a wide range of attractive yields in stablecoins and other more exotic strategies—much more secure and reliable than they were just a few years ago.
Will history rhyme?
All in all, it seems that there is a convergence of elements pointing towards a resurgence of DeFi.
On one hand, we are witnessing the emergence of several new DeFi primitives that are much more secure, scalable and mature than they were some years ago. DeFi has proven its resilience and established itselfs one of the few sectors of crypto with proven use cases and real adoption.
On the other hand, current monetary conditions are also supporting a revival in DeFi. This is a similar setup to that of the last DeFi Summer, and the current DeFi metrics suggest that we might be at the beginning of a much bigger uptrend.
History never repeats itself, but it does rhyme.
