Introduction

Pessimism on the timeline is at all time highs. What liquidity remains in the market is continuously being spread thinner and thinner; in the first half of 2024 already more tokens have launched than the entire history of crypto COMBINED. Frameworks have gotten better, technologies easier to use, and networks cheaper, all of which fueled this Cambrian explosion.

From 2020 onward, DeFi was touted as the “future of finance”. However, if you held bags of DeFi majors since then, you’d have significantly under-performed BTC and ETH in the last year. So despite the fancy talk about DeFi being the future, thus far the market has disagreed.

However, there is hope yet for DeFi in upcoming cycle(s). The confluence of improved technology and social awareness makes me excited about DeFi again despite the years of poor price performance for the majority of protocols.

History

I conceptualize the history of DeFi into 3 sections (not including the present).

Pre-history (Proto-DeFi) (2016-2018): ETH itself is still brand new and the earliest versions of what we might recognize as DeFi technologies came into being. Not many people were actually using these, but these early experiments would inform much of what was to come.

DeFi 1.0 (2019-2021): Uniswap, Compound, Synthetix, Curve etc. The OGs of DeFi, most of which are still integral parts of the ecosystem today begin launching. They provide the suite of basic actions required for a financial ecosystem (swap, borrow, mint (stables), liquidate, etc). The successful projects of this era were chiefly concerned with the question “How do I get liquidity in the door?” - and thus the modern airdrop and liquidity mining program were born.

DeFi 2.0 (2021/2-2023): OHM, TOKE, SPELL, CVX, etc. The 2.0 era was defined by the need to control the flow of liquidity within DeFi and not just its ingress and egress from the ecosystem as a whole. During this time we were introduced to concepts like the vote escrow system, protocol owned liquidity, and bribe markets. Many more DAOs with significant treasuries (and a need to manage their capital) emerged. Additionally DeFi financial games got more complicated.

Current and Past DeFi Token Problems

DeFi 1.0 and 2.0 brought a lot of innovations. But they did not address the underlying issue: what, really, is the point of all of this? DeFi protocols are like a set of financial games, except without the traditional objectives a game should have. The rules and primitives are abstractions but without an initial “real” thing to have been abstracted from. Put differently: “The Purpose of a System is What it Does”. DeFi was for a long time a meta-game. Earlier iterations of DeFi landscapes were not inherently broken, they just needed different inputs to properly capture value.

This Time its Different

An assumption I have seen in the past that attempts to solve the meta-game issue of DeFi is that in the future, other consumer/user -centric usecases of crypto will tie into DeFi even if the institutions don’t pick it up for their forex settlement or whatever anytime soon. Perps markets on friend tech keys, borrow/lend markets for NFTs, etc. Generally over the last few years, despite there being some consumer success stories in crypto (although briefly; think Axie, FT, Dapper, Sweat etc), as it turns out people don’t really like financializing something that is otherwise supposed to be fun and relaxing.

DeFi needs something “real” to build itself up around in order to make the system more robust. The abstract financial games need to ultimately be built atop something in order to be sustainable. That something is Native ETH Yield.

The last few years have built tremendous liquidity (by crypto standards) in LSDs (I’m still using LSD and not LST because it sounds funnier). Before there wasn’t much more to do with them besides leverage them. Now, we’ve seen the huge growth of rates markets (i.e. Pendle) and Restaking Protocols. DeFi is reconstituting itself with the base-layer yield as the core financial primitive, and this is a very good thing. 11% of all staked ETH has already been gobbled up into this stack through restaking alone this year. And in that same time period the total share of ETH being staked increased 13.7%. “Productive” LSDs are gaining market share rapidly in 2024 even as the market itself continues to grow.

My Outlook

With an ETH ETF on the way, expectations of lower interest rates in the medium term, and the potential for a crypto-friendly regime in the US by November, the 3-6% base ETH yield will look increasingly attractive.

Having something “real” (staking rewards) backstopping DeFi financial games more and more, the liquidity sloshing around between protocols has more reason to stay and stop looking at the market as a game of hot potato.

With restaking there’s another benefit to be had: DeFi is given an opportunity to benefit directly from (some) of the non-DeFi growth in crypto via AVS (actively validated services). This is a happy-medium solution in my opinion, where protocols can still capture value from consumer apps/protocols while not ruining users’ UX.

In a post-ETF world, we should (eventually) expect inflows to crypto and in particular ETH to increase significantly. The majority of this will be mid-curve capital, that parks itself in an ETH ETF or similar vehicle and does very little. But, as always, the far-right of the curve (which will include increasing numbers of savvy tradfi firms alongside degens) will increasingly position in such a way that they capture upside in ETH yield from increased activity.

Since its inception we have seen several different attempts at tying DeFi into something else: NFTfi, GameFi, CeDeFi (i.e. Celsius/BlockFi) all of which weren’t particularly successful. What sets 3.0 apart is the fact that ETH Yield is already built into DeFi and most protocols can adapt to support / leverage yield-bearing assets if they haven’t already. This feels far more like a logical progression of things than the above-mentioned “fi’s” because the yield is already naturally a part of the system and does not need a complicated scheme to shoehorn in something external.

RWAs and Stablecoins have a role to pay here too. However I believe the most valuable DeFi applications will sit within the { Yield → Tokenized Yield → Tokenized Yield Derivatives } stack before long. As an optimist, I expect there to be trillions of national debt, foreign exchange, equities etc settled on-chain. But this outcome could take a long time to implement. In the meantime, we have a truly “crypto-native” ecosystem, both attractive to new investors AND beneficial to the space as a whole, emerging in front of our eyes. As a result, this cycle I am most interested in the protocols that interface with / extend the LSD stack as much as possible.

DeFi is NOT COOKED!