DeFi Is Losing the Race to Become the Future of Finance

Decentralized finance (DeFi) is rapidly emerging as the biggest loser in the ongoing cryptocurrency bear market.

The total amount of capital locked on DeFi protocols dropped to its lowest point since February 2021 on Thursday as traders pull liquidity to secure higher yields that come with less risk.

When DeFi burst onto the scene in 2020 in a period that was dubbed "DeFi summer," many believed that the ability to borrow and lend without and intermediary was groundbreaking and that DeFi firms were about to dislodge its traditional finance (TradFi) counterparts.

However, DeFi's "future of finance" narrative was soon knocked over as the wider crypto market succumbed to a bearish cycle in 2022. Interest rates continued to spike across the globe as central banks scrambled for a way to fight inflation. This led to increased yields across money market funds and mortgage funds, leaving the DeFi sector without any incentives for new capital.

TradFi competition

Now, Vanguard's money market fund is offering clients a yield of 5.28%, the returns for staking Ethereum on Lido meanwhile stand at just 3.3%, leaving a minimal risk to reward ratio compared to traditional finance products.

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

"There is certainly less yield in everything now," Folkvang's Head of DeFi Trading Vyomesh Dua told CoinDesk. "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."

There has been a few of emerging narratives like liquid staking, which lost much of its interest after Ethereum switched to a proof-of-stake network, tokenization of real world assets (RWAs), on-chain derivatives and new blockchains, but none of these have been able to capture the level of appetite last seen in the summer of 2020.

That summer, it was not uncommon to see DeFi yields soar to between 18% and 35%. This yield of course came with a risk as hackers honed in on the sector with a series of complex exploits to part investors with their money.

DeFi hacks proliferated in 2022 and 2023, with a report earlier this month describing how $212.5 million had recently been stolen in a three-week period.

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