The emergence of decentralized finance (DeFi) is a landmark moment in the history of the crypto industry. The potential for highly liquid and interoperable financial services without centralized intermediaries offers tremendous potential in lowering the barriers to entry to financial markets and enabling seamless value exchange.
Charting the growth of DeFi, it is clear that participation in this new, open, financial economy is accelerating at a tremendous pace. According to DeFi Pulse, in July 2020, the total value locked on DeFi platforms was around US$3.6 billion; today that figure stands at US$99.6 billion. But statistics alone don’t do justice to the incredible levels of innovation that the sector has cultivated over such a short period since its inception.
Well documented is the role decentralized exchanges such as Uniswap have in leading this development, but there is an incredible range of exciting new use-cases being built, such as; Etherisc’s decentralized insurance applications or non-fungible token (NFT) marketplaces such as OpenSea.
Such rapid growth has not come without teething problems; issues of high gas fees and congestion on Ethereum, with demand often outstripping network capacity. While Ethereum gas fees recently reached a historical six month low, long term solutions are needed to maintain the capacity for a wide degree of participation in the sector.
Bridging DeFi to other rapidly growing sectors of the crypto economy is the next step in the growth of the sector. Proof-of-stake (PoS) has quietly risen to become the dominant consensus mechanism in the blockchain industry. With a market cap in excess of US$321.4 billion today, the majority of top-ranking tokens are PoS, with the likes of Cardano and Polkadot regarded as industry stalwarts. The transition to Ethereum 2.0 and PoS consensus is another significant validation of PoS, and how staking and DeFi can fit hand in glove.
Reasons for the growth of PoS are myriad, not least its scalability, the possibility for financial inclusion and capacity for decentralization. Many platforms now offer high-speed transaction throughput, which can compete with payment incumbents like Visa. Solana, for example, can process up to 50,000 transactions per second, compared to Visa’s 1,700.
However, in the case of DeFi, PoS presents specific opportunities in the form of staking. For investors, staking, the act of locking native tokens on a network to receive rewards, offers a contrast to the volatility of DeFi, presenting stable low-risk positive yields.
The potential of staking has received considerable appetite from investors at both a retail and institutional level. Banking giant JPMorgan recently issued a bullish note on staking, which predicted that the asset class could balloon into a US$40 billion industry by 2025. Earnings predictions for Coinbase indicate that the firm will earn US$200 million from staking in 2022, compared to US$10 million in Q2 of this year. The services for investors to capitalize on this opportunity have also increased significantly, with institutional-grade staking-as-service now offered by a variety of participants.
The drawback of staking lies in its bonding period. To unlock rewards, users must commit to locking their stake on-chain for a predetermined period. These bonding periods can last for anything from a few days to an indeterminate number of years in the case of Ethereum 2.0. Such locked capital is unproductive, and in the highly efficient and automated crypto economy, could be put to considerably better use. Bridging the currently siloed staking industry to that of DeFi can unlock this liquidity, as well as act as an on-ramp for an entirely new cohort of participants to the DeFi economy.
Liquid staking offers this bridging capacity, enabling participants to unlock staked capital to use in the DeFi ecosystem. This process involves the tokenization of staked assets via a derivative contract which can then be leveraged on other protocols.
The key to the success of this model lies in interoperability. As discussed, DeFi has moved beyond the confines of Ethereum, with other ecosystems gaining market share on the original platform. Platforms that can seamlessly integrate the staking industry with multiple different DeFi ecosystems are needed to truly unlock the liquidity of staked assets, and bring investors and their respective communities into DeFi.
Such a transition won’t happen overnight, but it is on the way. DeFi has shown tremendous capacity for innovation in the short period it has existed. I for one, am tremendously excited to see where it goes next.