The past year has been a crazy journey for the blockchain industry. Between the crippling effects of the COVID-19 pandemic across industries and Bitcoin’s marathon bull run, the year was great for some and catastrophic for many.
Decentralized finance is at the epicenter of most of the blockchain hype today. From the rise of mainstream decentralized exchanges to the overwhelming demand for liquidity mining, DeFi hasn’t just caused a stir – it has brought billions of dollars to blockchains.
On June 15, DeFi platform Compound began distributing its COMP token to users, handing over control of its protocol to the people. On August 15, more than $ 1 billion worth of Wrapped Bitcoin (WBTC) had been sold, giving even Bitcoin holders access to the world of Ethereum-based DeFi applications.
Some DEXs even rival centralized exchanges, and the term “vampire mining” will always remind us of blockchain rather than pale bloodsucking creatures with pickaxes and hard hats. But while DeFi set off the fireworks last year, it was Bitcoin (BTC) that made everyone stop and stare. Its unprecedented rise to nearly $ 40,000 makes it one of the most profitable and fastest growing assets in history.
But was DeFi at least partially responsible for this? Earlier stages of Bitcoin’s rise have been negatively correlated with DeFi, with many even speculating that it was the result of money transfers from DeFi platforms to Bitcoin. The total value of digital assets locked smart contracts has grown a hundredfold in the past two years. However, much of this growth has taken place in recent months and is due more to the appreciation of assets already invested than to an increase in new investments.
Just as many argue that DeFi has had a substantial impact on BTC and blockchain technology, Bitcoin also has an impact on DeFi. Blockchain may be the new, exciting financial technology of the next decade, but it is Bitcoin that brings the brand equity. That’s only part of the equation, but is it really a substantial one?
Duel or duet?
As the total trading volume on DEXes has increased significantly in the past year, some have attributed Bitcoin’s recent growth to the increase in the use of DeFi platforms. According to Robert Leshner, CEO of Compound, “Bitcoin’s rise to $ 40,000 coincided with a surge in WBTC activity.” The Compound Protocol is also the main holder of WBTC, with over $ 1.2 billion in BTC used as collateral to borrow stablecoins and other assets.
One of the most commonly reported metrics in the DeFi space is the total value locked, or TVL. It represents the value of digital assets locked into DeFi smart contract platforms and has grown from a few hundred million a few years ago to more than $ 26 billion today. This is mainly due to the recent rise in the value of large market capitalization investments such as Bitcoin and Ether (ETH).
According to Scott Stuart, co-founder and chief product officer of blockchain developer Kava Labs, the rise in Bitcoin’s value is an incredibly positive sign for the DeFi space: “DeFi requires a healthy amount of collateral to use in products. The more valuable BTC is, the more collateral, and therefore the greater the use in DeFi. “
There is a lot of hype and misinformation surrounding the TVL statistic in blockchain circles. While it’s not the most accurate representation of what DeFi networks are worth today, it does indicate how much people are willing to risk for them. Despite the fact that regulatory requirements, such as customer identification, could sooner or later collapse most mainstream DeFi applications, they only seem to be growing.
However, not everyone sees regulations as a threat. “It’s a losing battle for regulators,” Stuart said, adding, “Even if you can crush a product or a platform, it’s probably going to show up elsewhere – it’s open-source software.”
This is similar to how peer-to-peer file transfers take place unregulated on the Internet. Strict parents create sneaky kids. However, the results of a regulatory limitation of Know Your Customer verification in DeFi can also lead to more compatible applications. While this is arguably limiting, decentralized financing cannot grow sustainably beyond legal boundaries. Bitcoin regulation is already complicated and DeFi will make things a lot more challenging. So the correlation seems to be clearer here.
Old ideas, new energy
Last year, DeFi also pushed for Ethereum to become the most widely used blockchain, making its cumulative transaction fees even higher than Bitcoin’s. This is often a strong sign of a network’s ability to generate greater returns, and the upgraded Ethereum 2.0 promises even better performance and cheaper transactions. Now that the transition to Eth2 is in full swing, DeFi could get another big boost up and running. Despite the impressive growth over the past year, DeFi’s market cap is still barely 2% of the total cryptocurrency market cap.
The amount of Bitcoin used within DeFi is is approaching 0.9% of the total BTC supply, with nearly $ 300 million WBTC alone traded daily. This is probably a good thing as it means that DeFi is being discussed not just for its profitability, but more for its ability to improve financial systems.
The short negative correlation between Bitcoin and DeFi in 2020 may be due to traders siphoning money from DeFi, but both have progressed by leaps and bounds since then. According to Jeremy Musighi, head of growth at Balancer Labs, a non-custodial portfolio manager, Bitcoin’s bull run in general brings a lot of global attention to cryptocurrency:
“I think there is a natural progression for newbies drawn to crypto: first they learn about Bitcoin, then they find their way to Ethereum and then they find their way to DeFi. […] From a market mechanics point of view, during crypto bull runs, we often see gains from Bitcoin valuation being cycled to other crypto assets. During this run, we see this rotation from Bitcoin to Ethereum and DeFi tokens. “
Bitcoin and decentralized finance have a very symbiotic relationship where they drive each other’s growth. More Bitcoin in DeFi brings more platforms that offer value, and with a seemingly endless stream of new DeFi projects popping up all the time, they’re generating hype and creating innovative use cases for cryptocurrencies as a whole.
The challenges ahead
“The biggest challenge for new DeFi projects is code security and auditing,” says Leshner, adding, “Auditors are thin, and most developers are first-time writing Solidity.” Blockchain is still incredibly young, and while millions of people worldwide own cryptocurrencies, it is still only scratching the surface of mainstream adoption.
While some view the current frenzy of the crop of agriculture as unsustainable, others believe it could be the start of many new things to come. Stuart said DeFi’s credit and loan rates are likely to normalize, and platforms will start making efforts to attract long-term users with better user interfaces and cheaper network costs.
The trends affecting DeFi will certainly affect Bitcoin as well, but the two seem to be growing independently. In addition to its current inability to scale, there are many other issues that Bitcoin needs to solve before reaching mainstream adoption. First, as a safe haven, Bitcoin’s liquidity could be impacted as pegged Bitcoin on DeFi platforms could take off in the coming years.
When Bitcoin was created, his vision of a decentralized financial system was not achievable without the decentralized infrastructure in place and constantly evolving. After more than a decade, DeFi is finally making progress to take us one step closer to that vision.
Ultimately, Bitcoin is a digital asset that will never go out of style. The first-mover benefit is real here, and newcomers to space are more likely to test the waters with BTC than with an obscure DeFi token. As global exposure to cryptocurrencies increases, so does the demand for decentralized asset services. People may come for Bitcoin, but they’ll stay for DeFi.