Abstract

Cycles and narratives have always been the core topics of the global crypto market. In the past, the industry used Bitcoin halving as a reference to perceive cycles and explore the direction of large narratives. However, after the approval of Bitcoin and Ethereum spot ETFs, the crypto market is highly coupled with the trend of the global financial market, and the variables affecting the trend of the crypto market are increasing.

Against the background of soaring chaos values, how to perceive the cycle more clearly and discover the future narrative trend is very important. As innovative narrative catchers, investment institutions have always been relatively cutting-edge. In view of this, OKX specially planned the "Crypto Evolution" column, inviting mainstream crypto investment institutions around the world to systematically output topics such as the cycle of the current market, the direction of a new round of narratives, and the subdivision of hot tracks, to throw bricks and jade.

The following is the second issue of content, which was jointly launched by OKX Ventures, Multicoin Capital and 1kx around the topics of "DeFi's Present, Past and Future". I hope their insights and thoughts on the DeFi track will inspire you.

About OKX Ventures

OKX Ventures is the investment arm of OKX, a leading crypto asset trading platform and Web3 technology company, with an initial capital commitment of $100 million. It focuses on exploring the best blockchain projects globally, supporting cutting-edge blockchain technology innovation, promoting the healthy development of the global blockchain industry, and investing in long-term structural value. Through its commitment to entrepreneurs who support the development of the blockchain industry, OKX Ventures helps build innovative companies and brings global resources and historical experience to blockchain projects.

About Multicoin Capital

Multicoin Capital is a research-driven investment firm focused on investing in cryptocurrencies, tokens, and blockchain businesses that can reshape trillion-dollar markets. We manage a hedge fund and multiple venture funds, covering investments in both public and private markets.

About 1kx

1kx is a crypto investment firm focused on ecosystem growth. We are committed to exploring the art and science of network building, focusing on making the ideal decentralized future a reality. We believe that community-driven software will give token networks nearly unlimited potential to impact the global economy and society. At 1kx, we support outstanding founders to launch token networks. Our community engagement is second to none, and as hands-on advisors on token model creation, design, and iteration, we help the best ideas in the Web3 space find a path to growth and economic sustainability.

1. The past and present of DeFi

1. Looking back at the past, what is the core of DeFi's ability to drive the growth of the crypto market?

OKX Ventures (Esme Zheng): The rise of DeFi dates back to 2018, when Ethereum founder Vitalik mentioned that finance would become the first pioneer in blockchain applications. From 2018 to 2020, DeFi protocols were divided into three main directions: decentralized stablecoins, spot trading, and lending.

First, decentralized stablecoins, mainly DAI launched by Maker, have laid the foundation for the DeFi ecosystem as the native currency and transaction medium of the on-chain economy, while the emergence of decentralized automatic market maker mechanisms such as Uniswap and Bancor, which introduce non-custodial peer-to-peer transactions, has opened up the industry to use blockchain technology to achieve transactions without the need for centralized entities or middlemen while allowing users to retain control of funds. The development of DEX has not only opened up new opportunities for cross-border transactions, but also paved the way for new financial instruments such as synthetic assets and stablecoins.

As the demand for DeFi grows, the number of protocols has expanded exponentially, one type provides users with a means to trade tokens, and the other supports lending and staking assets. So far, the three core financial primitives in the traditional financial market have been completed through decentralized means. Although decentralized liquidity pools are widely used in AMMs and LP tokens have triggered a chain reaction of DeFi innovation, without sufficient liquidity, the token exchange function of DEX will be limited, and users will face high slippage costs when trading large amounts. This demand has given rise to liquidity guidance mechanisms, and Yield Farming and liquidity mining have become important means for new protocols to attract capital, driving the outbreak of DeFi Summer.

After 2020, the second layer of DeFi began to rise, and mature financial modules in traditional finance were introduced into the decentralized world, maintaining the similarity of financial principles, but emphasizing Code is Law and concepts such as "trustless" and "permissionless". This stage gave rise to derivatives trading platforms such as dYdX, futures contracts and options, and structured finance. In addition, the liquidity pledge protocol represented by Lido has promoted the rapid increase of Ethereum's pledge rate. As the amount of pledge on the chain increases, we further support SSV's DVT technology to bring a more decentralized and secure solution to the node operation level. With the maturity of Layer 2 technology, the launch of a large number of Rollups, and the development of Bitcoin and other ecosystems, the blockchain world is also facing a greater liquidity fragmentation problem. The market's demand for secure and scalable cross-chain asset solutions is becoming more urgent. Against this background, we invested in Orbiter and Zeus to promote the development of cross-chain DeFi.

If before 2022, people built various financial building blocks on the barren land of blockchain and established a framework for global financial transactions. Then the biggest change in DeFi from 2022 to now is the deepening of its connection with the real world. Traditional asset management companies like BlackRock have begun to get involved in DeFi and launched tokenized asset funds based on Ethereum to bring stable returns on the chain to users. At the same time, there are more discussions about on-chain economic security. Projects such as Eigenlayer and Babylon are committed to solving the security and economic efficiency problems of blockchain. Ecological projects like StakeStone and EtherFi have also emerged one after another, improving the security and transparency of on-chain financial products and providing users with more choices and higher profit potential.

The prosperity of DeFi stems from the pursuit of Open Finance, and disintermediation reduces transaction costs. Through smart contracts and blockchain technology, DeFi has improved transaction speed and transparency and enhanced market liquidity. At the same time, DeFi is of great significance in achieving inclusive finance and allowing more people to participate in and benefit from the financial market.

Multicoin (Kyle Samani): OKX Ventures has covered this in detail, especially in reviewing the DeFi development path. We will focus here on a few reasons why DeFi has flourished because it has provided some unique value propositions that CeFi cannot provide in the past few years:

· Allows trading, lending, etc. while maintaining asset autonomy.

· Ability to acquire long-tail assets in advance before CeFi exchanges list these assets.

· Ability to trade NFTs. NFTs have almost no trading volume on CeFi.

1kx（Mikey 0x）: The first application scenario that promoted the gradual adoption of DeFi was spot trading. Before 2020, MakerDAO and Uniswap had established the main demand for buying and selling tokens on the chain. Uniswap, on the other hand, created a new type of user, the passive market maker. Especially Uniswap V2, in this version, no liquidity provider has a pricing advantage, and everyone provides prices on the same curve. DeFi increases trading volume by serving new coins and profits from regulatory arbitrage.

The second application scenario is the protocol that optimizes returns. In 2020, Yearn Finance ushered in the DeFi farm era, allowing users to earn passive income through token inflation. The inflow of these native tokens came from people wanting to stake them for returns, which drove prices up, attracted more attention, and eventually formed a flywheel effect. The subsequent emergence of DeFi 2.0 further promoted price speculation, promised higher returns, and attracted a lot of liquidity.

The third reason for the rapid rise of DeFi in the past few years is the advancement of on-chain trading mechanisms, especially the emergence of Uniswap V3 and on-chain order books. For example, CowSwap introduced a model that prioritizes user interests. Uniswap V3 is closer to traditional order books, allowing liquidity providers to customize their own price ranges and pool liquidity, thereby achieving better on-chain price execution and increasing the attractiveness of on-chain trading. Perpetual trading platforms such as dYdX and Hyperliquid have created a more user-friendly user interface and experience, and are actively promoting the process of full decentralization. Another protocol worth noting is GMX, which pioneered the pooled perpetual contract model, allowing passive liquidity providers to profit from the transaction fees and counterparty profits of platform users. Overall, the development of L2 has driven the increase in the number of users in this field. Currently, the average amount of each transaction on Uniswap has dropped from five figures in the early days of DeFi to less than $100 today, which clearly reflects the trend of retail investors pouring into DeFi.

2. What are the main challenges facing the DeFi field?

OKX Ventures (Esme): We believe that the current development of DeFi mainly faces three problems:

First, the infrastructure still needs to be improved compared to traditional finance. The market and user scale of DeFi are more mature than other tracks in the crypto industry, but the infrastructure is still backward compared to traditional finance. For example, in the payment scenario, the traditional financial system has infrastructure such as bank branches, ATMs, and a wide range of financial networks, which can provide people with more convenient services, but Crypto payments still face problems of inconvenience and inefficiency. Therefore, infrastructure that can improve user experience and lower the threshold for first-time users is worthy of attention, such as account abstraction, smart account integration, etc.

The second is the problem of liquidity fragmentation. At this stage, on-chain assets and transaction volumes are scattered in different ecosystems, and the liquidity in the same ecosystem is also concentrated in the pools of different head protocols. This liquidity fragmentation has led to the current problems of increased on-chain transaction costs, slower transaction speeds, and reduced leverage opportunities, which in turn affects the user's trading experience. Although some protocols with high interoperability and composability can amplify liquidity efficiency, given the different standards of different financial protocols (such as risk management) and different security levels, this has invisibly increased the systemic risk of the DeFi ecosystem.

Finally, the protocol governance is inefficient. Currently, the governance of DeFi protocols mainly relies on manual static methods to manage protocol risk parameters. Smart contracts require complex trusted infrastructure to process external data, and a single trusted API is difficult to guarantee data accuracy. Therefore, the challenge facing many protocols is how to separate logic and dependencies from underlying primitives, create a more powerful advanced service market, introduce dynamic governance while minimizing the contract attack surface and effectively unifying liquidity.

Multicoin (Kyle Samani): The DeFi 1.0 era focused on defining and building basic financial primitives, such as spot trading, lending, and cross-chain bridges. These elements have been perfected and laid the foundation for DeFi to develop more complex products. We believe that the next major opportunity for DeFi lies in the derivatives market, such as perpetual contracts and options. The main challenge facing derivatives is performance during market fluctuations, because the DeFi derivatives system is very complex and has extremely high technical requirements. At present, DeFi is gradually gaining the ability to reliably support on-chain derivatives trading. A notable example is Drift, which is natively built on Solana, a high-performance chain specifically designed to host DeFi applications such as perpetual contracts.

1kx (Mikey 0x):In the DeFi market, there are many exciting developments in spot trading, perpetual contracts, lending, policy frameworks, MEV (maximum extractable value), and payments.

The current main trend is vertical integration. Perpetual contract platforms not only launched memecoin launch platforms, but some have also created entire chain ecosystems or stablecoins. The core of this approach is to attract users, and DeFi projects that form sticky ecosystems will have a strong moat. Infrastructure advances are also driving this trend. For example, Fastlane, Sorella, and Semantic are transferring MEV from technically complex participants to upstream entities such as protocols, user exchanges, or liquidity providers.

In terms of core DeFi primitives, a wave of "DeFi 3.0" is emerging, with the goal of improving composability and efficiency. Morpho improves market structure in the lending space by introducing a custodian role, and Euler is about to launch v2, focusing on meeting diverse needs. Uniswap v4 incorporates more flexibility in liquidity provision and plans to launch long-tail applications such as options, perpetual contracts, and prediction markets.

In our view, the main challenge at present is to provide a user experience comparable to that of centralized trading platforms, especially to attract users to DeFi. The proportion of spot trading volume on decentralized exchanges (DEX) has always been low, especially in the field of perpetual contracts. This challenge is even more daunting because all operations need to interact with the blockchain. Account abstraction (ERC-4337) and smart accounts supported by projects such as Safe* and Rhinestone* are moving towards solving these problems.

2. DeFi "industry" in the new cycle

1. What role will DeFi play next?

OKX Ventures (Esme):Most of the DeFi projects that have survived to this day have performed more robustly. Although there are no speculative short-term narratives and concepts compared to many other fields, the currency price has a stronger correlation with fundamentals, business revenue, etc., and it is more blue-chip. The current cycle is mainly centered around ETH and BTC re-staking and several new L1 and L2, which are competing for a small number of existing users. The current stage of DeFi is dominated by major trends. The protocol is shifting from a monolithic structure to smaller, more fine-grained primitives. Developers at this stage will also benefit from a new and unique ecosystem.

Back in the DeFi summer of 2020, Ethereum firmly dominated the DeFi space, accounting for over 95% of all network TVL, now down to about 60%. Nearly a third of the total TVL is divided between competitor L1 and various L2 networks. We also saw Bitcoin's share of total TVL rise to nearly 1%. The emergence of token standards Ordinals and Runes introduced DEXs on Bitcoin and created new markets for Bitcoin NFTs and memecoins.

Yield has also become the new normal. The two latest DeFi narratives - native yield and re-staking - are very popular. In the first six months of 2024, EigenLayer's TVL soared from $1.3 billion to $20 billion, making EigenLayer the second largest DeFi protocol in the world after Lido. It is undeniable that liquid staking protocols, re-staking, native yields, and RWA tokenization are creating a more active DeFi ecosystem in the current cycle.

Multicoin (Kyle Samani): Every new cycle brings a new trend. The last trend was about NFTs, and this cycle's trend is about memecoins. Almost all memecoin trading activity occurs in the DeFi ecosystem on Solana. And this is not a coincidence. Solana provides fast and low-cost transactions, lowering the barrier for users to get started and trade. In addition, all memecoins are natively launched through on-chain liquidity.

1kx (Mikey 0x): We believe that on the crypto-native side: DeFi will continue to play the role it has always played. Users have access to protocols that allow them to leverage, trade, borrow, and earn yield. Innovation in the space is making it more efficient and cheaper for users to participate in these use cases. In particular, on the memecoin side, it is interesting to see that these tokens tend to deploy on V2 rather than V3, perhaps because liquidity management is easier on V2.

On the institutional side: DeFi will help legitimize the space as banks and financial institutions are developing more and more use cases. On the real world assets (RWA) side, a lot of progress has been made in part thanks to players like Blackrock and Franklin Templeton. Key crypto-native players include Ondo and Superstate*. As of the time of writing, the size of US Treasuries tokenized on-chain is approaching $2 billion.

Many teams are building frameworks or brand new blockchains to comply with existing U.S. anti-money laundering (AML) and know your customer (KYC) laws. Aethos and Sphere are two players worth watching.

2. In the new cycle, what direction will DeFi innovation iterate in?

OKX Ventures (Esme):The first phase of DeFi was mainly driven by artificial financial incentives, but the next phase should be more practical, organic, and simple to verify its feasibility as a parallel financial system to traditional finance. Among them, the key infrastructure required to onboard new users (such as fiat currency deposits and withdrawals, smart accounts, and account abstraction) must be significantly improved to attract the next wave of millions of Web3 users. Protocols such as Infinex (created by the founder of Synthetix), Gnosis Pay, and some other protocols are helping to solve these problems.

In order to improve user experience and promote large-scale adoption, all current DeFi applications (such as transactions, cross-chain, wallets, etc.) can be redesigned around "intention". Intent-based bridges may become the biggest winner. For example, protocols such as Across and Connext are moving from the existing relay bridge design to an intent-driven model. In addition, UniswapX is also making some intent-based innovations, and some perpetual protocols have tried an intent-driven approach similar to Symmio, but found it a challenge to attract market makers to participate in order to complete all transactions.

In order to achieve "universal intent", some infrastructures have begun to build intent layers, aiming to provide the necessary conditions for DApps to achieve specific intents. In this way, the on-chain user experience will become as smooth as using traditional apps. The process that used to require complex operations between multiple chains (such as opening a cross-chain bridge, signing assets across chains, paying cross-chain fees, switching networks to interact with DApps, and paying transaction fees) can now be simplified to one step, that is, users only need to sign once for the transaction they want to complete.

The future of DeFi is bound to be layered, combining more granular and composable financial primitives so that developers can create new protocols, provide powerful financial services to institutions, and improve user experience, thereby removing barriers to retail adoption. For example, the base layer functional logic solved by modular lending and the abstraction layer, aggregation layer, etc. ensure accessibility and user-friendliness respectively. Compared with centralized databases and services, the blockchain itself is very inefficient, but its permissionless access and composability, as well as the ability to choose self-custody or trust service providers, are enough to make up for the costs and troubles faced by our users. If there is a better way to execute these primitives, most top-level protocols and service providers will be able to quickly migrate users to new primitives because higher-level services have been designed to be modular. For example, Uniswap is moving towards a modular AMM and will eventually transform into a local liquidity layer, on which many liquidity and money markets will be built. Uniswap is moving towards Ethereum's Rollup-centric route, seeing Hooks as where innovation happens and keeping the base protocol simple. And v5 may bring Uniswap to the application chain.

Multicoin (Kyle Samani): By far, the most important area of design in DeFi is on-chain derivatives. They provide an efficient structure to trade nearly any asset. We are focusing much of our energy on this area, especially working closely with our portfolio company Drift, as we believe they currently have the best DeFi derivatives product on the market.

1kx (Mikey 0x): As mentioned earlier, the main trend is for protocols to capture value through vertical integration. It will be interesting to see how verticalization leads to liquidity fragmentation and, as a result, user churn. While chain abstraction tools and gas abstraction may make it easier for capital to flow between different rollups and ecosystems, protocols gain better discoverability when they are part of an ecosystem. For example, many teams in the Berachain ecosystem were able to successfully raise funds simply because they launched on Berachain. In addition, non-EVM ecosystems also have the opportunity to gain significant market share in the coming year.

3. Iteration of opportunities and corresponding investment logic

OKX Ventures (Esme):In our view, practicality will become the most powerful narrative of DeFi, and DeFi itself is already a trend. We always believe that being the first to enter the market is not the key, and the real long-term winners are often those who first achieve product-market fit.

Currently, the main use cases revolve around re-staking of Ethereum and Bitcoin and AVS secured using re-staking protocols. In addition, new L1s, such as Berachain, are bringing significant economic changes that may give rise to new DeFi primitives that are difficult to achieve on other chains.

We believe that the concept of shared economic security is critical at this stage. Improving network security by optimizing the financial commitment of PoS chains increases the cost of attacks. Projects such as EigenLayer and Babylon are driving development in this direction. EigenLayer releases liquidity in the ecosystem through a re-staking mechanism, while Babylon provides an additional layer of security through checkpoints. These mechanisms not only enhance security, but also reduce the need for AVS extension validation nodes and shorten the unbonding time for stakers. As the economic incentives and technical iterations of operating networks evolve, we will witness the exploration of different solutions for shared economic security.

Economic models and revenue models will also usher in changes. DeFi will gradually move to a real revenue model, rewarding users with actual income rather than token incentives. For example, Aave's new token economic model reduces the selling pressure and emission of $AAVE through protocol revenue and increases value capture through buybacks. Aave also introduced a new security module, Umbrella, to isolate the risks of different assets and improve system security. For DeFi, it is either through Ponzi hype consensus or through real income to drive the protocol away from its dependence on governance tokens and achieve sustainable growth. We have the opportunity to witness the professionalization of Farming as a Service, making it easier for ordinary investors to participate and profit, and enhancing the attractiveness and popularity of DeFi.

Technological iteration is solving existing problems. For example, by combining ZK privacy technology, it is possible to ensure that verified users are not on the regulated criminal blacklist while protecting their privacy. The problem of inefficient governance will also be improved through more automated dynamic governance that relies on data and machine learning. In terms of protocol design, the protocol has a vested interest in identifying user behavior and making corresponding adjustments. For example, personalized credit and interest rate adjustments will be achieved through a credit scoring system, and users with good behavior will enjoy lower credit or mortgage rates, improving user engagement and loyalty. At the same time, innovative protocols will dynamically adjust interest rates and collateral requirements, refine risk management, improve security, and manage user risks more effectively.

The future development of DeFi is bound to be an evolution from speculative trading to practical applications. Based on the results of previous iterations, integrating expansion technology solutions, new token paradigms, zero-knowledge proofs, AI and other technologies, the focus is on creating a more secure and interconnected ecosystem, using the latest infrastructure advances to promote application changes. By addressing past limitations and introducing a more sustainable economic model, it aims to revolutionize user experience and accessibility, providing lower fees and an intuitive interface.

Multicoin (Kyle Samani):The most significant opportunity is in on-chain derivatives. We have yet to fully tap the potential of perpetual derivatives and on-chain options. They have the potential to significantly increase financial market inclusion, bring new asset classes on-chain, and unlock better ways to hedge, leverage, and invest. That’s why we are focusing most of our efforts in this area and believe Drift is the DeFi protocol with the best potential to capture this opportunity.

1kx (Mikey 0x):At 1kx, we are more focused on long-term growth prospects than short-term gains. Real World Assets (RWAs) are probably the most attractive area from a narrative perspective. If DeFi is to grow 100x in the next decade, we must rely on the power of institutions. Over time, the value proposition will become clearer: open, transparent, and composable ledgers that can significantly reduce intermediation costs.

Another direction is the concept of "on-chain CEX" proposed by Hyperliquid. Although perpetual contracts are an important part of the trading platform business, they have many other sources of income, such as directing customers to their chain through indirect products. Hyperliquid's vision is similar. They started with perpetual contracts, gradually expanded to spot token launch platforms, and built an ecosystem around these two products.

In a relatively mature market like DeFi, the key to layout is to find a team with unique advantages in distribution and marketing. Today, it is difficult to drive major changes by core mechanism innovation alone. I think the real breakthrough point may have passed.

As the field expands and more protocols are launched, layout based on fundamentals will become a key theme. New fund managers want to see real cash flow and growth prospects. At present, the market is pricing extremely high growth expectations for the entire DeFi stack (based on basic indicators such as price-to-earnings ratio). Although this growth target is achievable, it may take longer than expected.

For OKX Ventures’ disclaimer, please visit the official website for details.

For Multicoin Capital’s disclaimer, please click here for details.

For 1kx’s disclaimer, please click here for details.

Risk Warning and Disclaimer

This article is for reference only. This article only represents the author's views and does not represent the position of OKX. This article is not intended to provide (i) investment advice or investment recommendations; (ii) an offer or solicitation to buy, sell or hold digital assets; (iii) financial, accounting, legal or tax advice. We do not guarantee the accuracy, completeness or usefulness of such information. Holding digital assets (including stablecoins and NFTs) involves high risks and may fluctuate significantly. You should carefully consider whether trading or holding digital assets is suitable for you based on your financial situation. Please consult your legal/tax/investment professionals for your specific situation. Please be responsible for understanding and complying with local applicable laws and regulations.

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