2022 hasn’t been a favorable period for the cryptocurrency ecosystem. The Terra catastrophe in March triggered a widespread selloff, wiping away billions of dollars from the crypto market. The aftereffects of this quadrupled over the months amid a never-ending streak of hacks and exploits, paired with rising inflation, frequent interest rate hikes, and worsening geopolitical conditions.
The decentralized finance (DeFi) market, the blockchain universe’s answer to traditional brick-and-mortar finance, found itself at the epicenter of this unfolding drama. Throughout the first half of 2022, the total DeFi market capitalization experienced a steep slump, sliding from around $142 billion to $36 billion within three months. Although DeFi rebounded modestly during the third quarter, the aggregate DeFi capitalization remains far from its previous highs.
There’s Something Inherently Wrong with DeFi
This year, the number of vulnerabilities exploited across DeFi protocols and applications has been an outsized contributor to persistent downward pressure. Per the latest Chainalysis report, “2022 has been the worst year for DeFi with the most DeFi hacks.” To put these figures in context, hackers swiped nearly $1.3 billion from DeFi during the first quarter of 2022 alone.
These numbers escalated as the year trudged on, with October 2022 earning the title of the “worst month ever” for DeFi. During the first 15 days of October, hackers managed to drain roughly $718 million from 11 different DeFi projects - a new monthly record. Year-to-date, the DeFi ecosystem has lost nearly $3 billion across 125 separate hacks. At this rate, this year’s total funds lost to hacks will soon surpass 2021’s record of $3.2 billion.
Unfortunately, the aforementioned is just the tip of the iceberg. The DeFi ecosystem faces many other serious deficiencies. As the DeFi market struggles to regain its footing, stress is arising from multiple directions, be it Sam Bankman-Fried’s proposal for DeFi regulations that might kill DeFi entirely or the FBI’s decision to tag the recent Mango Market exploit as more of a “market manipulation” than a hack.
While the Terra implosion undoubtedly cemented the 2022 crypto winter, investors can’t overlook the fact that there is something inherently broken with DeFi.
According to EOS Network Foundation Vice President of Communications Zack Gall, “One of the critical components that DeFi still needs to solve before it can achieve wider adoption is its exposure to exploits and hacks. Not only do DeFi protocols need to ensure that their own smart contracts are secure, but also mitigate the risks associated with the other products that they interface with, such as derivatives and wrapped tokens being bridged from other chains. "
Gall stresses, “There have been over $2 billion worth of hacks in 2022 across the blockchain sector, which is an area to improve for EOS by combining a risk mitigation system with a liquidity incentive program to essentially provide an insurance layer for our DeFi ecosystem.”
Inching Toward a New Beginning Built on Past Experience
Despite the disappointing DeFi backdrop, this prolonged crypto winter has provided developers and entrepreneurs time to reconsider their approach. The DeFi community has been busy identifying gray areas associated with regulation, user experience, infrastructure, and code integrity of existing products and services.
Will 2023 be any different?
According to DeFi industry insiders, the answer is a resounding yes. Confidence in the outlook on the part of DeFi application builders largely stems from the lessons they have learned over the past year and how they believe the next DeFi boom will materialize. According to AllianceBlock’s CEO Rachid Ajaja, every bear market is a learning experience, and this one is no different.
Per Ajaja, “The lesson out of this difficult year in DeFi is that it's not the technology that is the problem, it is not the users that are the problem, but the players that are the problem. So, we need a solution that uses identity, privacy, compliance, and regulation to ensure that DeFi continues to grow to its full potential while making sure the players are playing fairly, and our solutions have the users' welfare at the forefront.”
The AllianceBlock team is already addressing the compliance and identity-related problems from the DeFi space needed to make it more appealing for retail and institutional investors. “The most crucial thing for the next phase of DeFi is to have this compliance layer ready for mass adoption,” explains Rachid Ajaja. “When this occurs, the protocols will have to implement this, which shifts the user to the center of the solution, meaning the user won't have to sign into multiple providers but can choose to do it themselves.”
On the other hand, CVI’s Chief Innovation Officer Yoni Neeman believes that the ongoing crypto winter has played a valuable role in helping weed out many undesired DeFi solutions which weren’t built on solid ground. The CVI team has developed a decentralized variant of the S&P 500 Volatility Index (VIX) alongside its native “volatility tokens” to help streamline the fragmented DeFi market.
Talking about the way forward, Neeman notes, “It's important to put things in perspective, mass adoption will come - but it will arrive only once the onboarding rails are mature enough. The onboarding of retail and institutions to DeFi is going to change significantly in the coming two years.”
Neeman concludes, “To sum it up - it's still early days, and it's very evident that more advanced technological solutions will have to arrive before the next boom. Luckily, many promising solutions are already in advanced stages of development and are going to be launched for early adopters in 2023 to be battle-tested before they are ready for mass adoption.”
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.