The Evolving Landscape of Finance: DeFi's Challenges and Opportunities

Money market funds are currently delivering returns of over 5% annually, while Ethereum stakers are seeing returns of just 3.3%.

In the midst of the ongoing cryptocurrency bear market, decentralized finance (DeFi) is emerging as a significant casualty. The total capital locked in DeFi protocols plummeted to its lowest point since February 2021 on Thursday, as traders shift liquidity to seek higher yields with lower risk.

When DeFi initially gained traction in 2020 during what was dubbed "DeFi summer," many believed that the capacity to borrow and lend without intermediaries was revolutionary, and that DeFi companies were poised to disrupt their traditional finance (TradFi) counterparts.

However, DeFi's vision of being the "future of finance" was swiftly challenged as the broader crypto market entered a bearish phase in 2022. Global interest rates continued to rise, prompting central banks to search for ways to combat inflation. This led to higher yields in money market funds and mortgage funds, leaving the DeFi sector lacking incentives for fresh capital.

Competition from TradFi

Presently, Vanguard's money market fund is presenting clients with a yield of 5.28%, while the returns for staking Ethereum on Lido are at a modest 3.3%. This results in a minimal risk-to-reward ratio in comparison to products in traditional finance.

This caused DeFi's fragile liquidity to flee, with the total value locked (TVL) across all protocols dropping from $163.5 billion in April 2022 to today's figure of $36 billion.

Folkvang's Head of DeFi Trading, Vyomesh Dua, remarked:

 "There is certainly less yield in everything now. But even in this low TVL regime we see a lot of high activity and opportunities around the new stuff people have been developing."

"Every time a new DeFi product catches a lot of attention, activity in the whole ecosystem surrounding it increases and there’s exciting but short-lived opportunities to make money," Dua added. "However the capital one can deploy in this space today is limited as the opportunity sizes are smaller."

Several emerging narratives have surfaced, such as liquid staking, which lost much of its appeal after Ethereum transitioned to a proof-of-stake network, tokenization of real-world assets (RWAs), on-chain derivatives, and new blockchains. However, none have managed to generate the same level of interest as was witnessed in the summer of 2020.

During that period, it was not unusual to see DeFi yields surge to between 18% and 35%. Of course, this high yield came with its share of risks, as hackers targeted the sector with a series of intricate exploits to separate investors from their funds.

DeFi hacks proliferated in 2022 and 2023, with a report earlier this month detailing how $212.5 million was recently pilfered in a three-week span.

In 2023 alone, there have been 297 crypto hacks, resulting in a loss of $1.89 billion, according to Money Monger's crypto heist report.

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