For several months now, the decentralized finance sector (DeFi) has been on the receiving end of a major bear market, so much so that the total value locked within this space has fallen from an all-time high of $150 billion (recovered in May 2022) to the current level of just over $50 billion.
Despite this, the amount of capital flowing into this space from “centralized avenues” has grown, largely due to the collapse of FTX alongside other prominent entities such as Celsius, Genesis, Vauld, etc – even doubling trading volumes on many platforms over the course of time alone from November 2022. Not only that, amid the recent market volatility, several decentralized exchanges and lending platforms continued to function smoothly, especially when compared to their centralized counterparts.
So, for DeFi to really reach its maximum potential, the sector needs a significant transformation. This is because a large number of protocols operating within this space have continued to offer users unsustainable returns for far too long. In addition, investor interest in decentralized options appears to be waning, with the recent rise in interest rates, the level of inflation – and the so-called “risk-free” yield on six-month Treasuries exceeding 5%.
In fact, even the rapidly changing macroeconomic environment has impacted DeFi, with several established projects making significant changes to their compensation structures in order to remain competitive. For example, MakerDAO recently voted to increase its Dai (DAI) savings rate tenfold to 1%.
How can DeFi regain consumer trust?
According to Rachid Ajaja, founder and CEO of AllianceBlock – a decentralized infrastructure platform that connects traditional financial institutions with Web3 applications – DeFi, like all other global markets, is currently going through a cycle. And while what happened to Terra, Celsius, Three Arrows Capital and FTX certainly shattered investor confidence, the problem lies with the players operating in the market, not the technology itself. He told Cointelegraph:
“To strengthen and maintain consumer confidence, DeFi must focus on solutions that put users at the center and protect them. This means working on compatible DeFi solutions that focus on identity management, data encryption, user ownership of data, and reliable KYC practices.”
“These could pave the way for the tokenization of real-world assets and financial instruments, drawing more cash flow to DeFi, including from traditional players and institutions that place a high value on compliance and sustainability,” he added.
Similarly, Varun Kumar, founder and CEO of the decentralized exchange Hashflow, told Cointelegraph that right now, this niche industry needs stronger products capable of solving real-world problems. “The DeFi ecosystem is still in an exploratory phase, with many projects still identifying their respective market fits,” he said.
However, Kumar argued that while there is a direct correlation between consumer confidence and declining dollar volumes, it is important to consider other factors as well. For example, the 2021 DeFi boom took place in a strong macroeconomic environment, which had a significant impact on the industry:
“This rapid growth was a great kickstarter for the space and created a lot of opportunities. However, now that circumstances are different and volumes are much lower, business models and value propositions are being reshaped. Superior products will always win, resulting in consumer confidence.”
Juana Attieh, co-founder and chief product officer for Fluus, a fiat-to-crypto gateway aggregator with a crypto-ramping network, told Cointelegraph that DeFi’s decline and loss of trust are due to centralized entities abusing their power. and exploit their consumers. again and again.
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To restore market confidence, DeFi participants must prioritize improving transparency and creating standards for sharing information about underlying assets, protocols, governance mechanisms, and more, she says.
“Security measures need to be significantly improved to protect users’ assets and information. This may include conducting regular audits, implementing bug bounties and other measures to ensure the safety and security of DeFi protocols,” she said.
Attieh further believes it is critical for the industry to work closely with lawmakers to gain regulatory clarity and develop governance frameworks that can reduce volatility and uncertainty while restoring confidence.
Not everything looks bad
While the market is a bit stalled at the moment, Robert Miller, vice president of growth for Fuse, a blockchain-based Web3 payment ecosystem, told Cointelegraph that DeFi (particularly automated, market maker-based applications) seems to have taken off during its latest innovation cycle. found a hugely successful product-market fit. He said:
“Despite the decline, the fact that $50 billion in liquidity is currently still being committed to DeFi protocols is exciting and unprecedented in the financial world, where we would normally have to rely on institutional market makers and lenders as a catalyst to get the economy moving . again.”
Miller admitted that greater consumer confidence and demand will only come with improved user experiences. “Even as a seasoned crypto professional, I still have trouble using well-known DeFi apps, so I can’t imagine how difficult it must be for the layperson,” he added.
Andy Ku, CEO of Altava Group, a Web3 digital content ecosystem, believes that sometimes things have to get really bad to finally become stable. He told Cointelegraph that in the past, bad actors have loosely used the word DeFi to promote platforms that were more or less completely centralized.
However, he says, most quality DeFi projects today are firmly rooted in the ethos of transparency, with a growing list of these offerings now undergoing smart contract audits and publishing proof-of-reserve reports to help build confidence in this space. to recover.
“The growing mistrust of traditional financial institutions has given birth to DeFi. The balancing act now is how DeFi can evolve into something that has more transparency, oversight and accountability,” he said.
Where does the future of DeFi lie?
Learning from the several high-profile scandals of 2022, Ajaja believes the next wave of DeFi will have a stronger emphasis on compliance and customer experience. In this regard, she noted that we are already seeing the emergence of projects aimed at delivering compliant DeFi solutions that integrate the trusted Know Your Customer and Know Your Transaction protocols, which are essential for long-term adoption by traditional industries.
Moreover, the concept of self-preservation is also quickly becoming important in the minds of many users, with more and more DeFi projects working on self-preservation solutions that give full control and ownership of their assets and data. These wallets make it easy to manage and recover assets, store encrypted digital identities and verifiable credentials, and give users complete control over how they share this information.
Attieh believes that while the bear market may have led to a decline in the use of some DeFi projects, particularly as investors become more risk averse, it is likely that the most robust projects with strong fundamentals and real-world use cases will continue to exist. flourish and gain traction, even in challenging economic conditions.
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In a somewhat similar vein, Daniel Fogg, president and chief operating officer of IOVLabs, the company behind Rootstock — a smart contract platform secured by the Bitcoin Network — told Cointelegraph that the only positive result of the ongoing crypto winter is that it reduced the white noise around the ecosystem and added:
“We see more builders and fewer buzzwords. For the DeFi sector to bridge the gap, teams building crypto projects must focus on accessibility, usability, and usability. We need to build products that solve real problems for real people – pay bills, send money to relatives abroad, get protection from runaway inflation, find safe places to save their money.
Therefore, as we move into a future driven by decentralized technologies, it will be interesting to see how the fast-evolving decentralized finance paradigm continues to mature, especially as more and more people look for avenues that do not use middlemen.