How DeFi on Ethereum Is Evolving Through Crypto Winter

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Key Takeaways

  • DeFi has suffered in the crypto slump, but many staple projects are still building.
  • The likes of Aave, MakerDAO, Uniswap, and Lido have all put forward experimental governance proposals or made major announcements in recent months.
  • If DeFi is to reclaim its highs, those building through the bear should emerge stronger than ever.

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Some of Ethereum’s most prominent DeFi protocols are taking advantage of the current market downturn to rethink their governance structures or offer completely new services. Others have focused on shoring up their operations to improve resiliency. 

DeFi Projects Plan for the Future

DeFi protocols are continuing to build despite the ongoing crypto market decline. 

Notable among the projects showing signs of evolution are mainstays of Ethereum DeFi such as the lending protocols MakerDAO and Aave, the popular decentralized exchange Uniswap, and the leading Ethereum liquid staking platform Lido. These protocols, along with a few others such as Curve and Compound, are considered fundamental to the ecosystem’s financial stack due to their technical innovations, high security, and the amount of capital entrusted to their smart contracts.

While the market downturn has exposed weaknesses in decentralized finance, most notably through the collapse of the Terra blockchain and its algorithmic UST stablecoin, these so-called “blue chips” appear to be weathering the current storm and have continued developing their protocols and even expanding their offerings. Join Crypto Briefing as we take a look at some of the most notable DeFi updates of the last few months.

MakerDAO Integrates Traditional Finance 

The first project on our list is the decentralized stablecoin issuer MakerDAO. The protocol lets users lock up volatile assets as collateral to mint the dollar-pegged DAI stablecoin. 

The protocol has been making waves lately, most notably for its DAO’s recent decision to invest 500 million DAI from its treasury into U.S. treasury bills and corporate bonds in an attempt to generate yield while diversifying its holdings. 

MakerDAO has also voted in favor of allowing the Huntingdon Valley Bank, a fully regulated Pennsylvania-based bank, to borrow up to 100 million DAI against off-chain collateral, marking the first time a traditional financial institution has taken out a loan from a DeFi protocol. Additionally, MakerDAO already operates five other real-world assets vaults and is planning on adding more in the future.

The recent advancement of the protocol’s product offerings has led to another proposal on the MakerDAO forum to create a new advisory board in charge of fully researching and later educating MKR token holders on future proposals. The proposal was narrowly rejected in a hotly contested vote that saw more than 30% of the MKR supply committed to vote, a record in DeFi governance. Still, the vote’s near approval hints that attitudes toward the extreme decentralization pioneered by DAO governance structures may be changing. 

Uniswap Expands to NFTs

Another notable development in the DeFi space comes from Uniswap, the world’s largest decentralized exchange. Uniswap lets users trade tokens without needing to trust a third party. They can also earn yield by providing liquidity to the exchange’s various trading pairs. According to data from Defi Llama, the protocol currently holds more than $4.8 billion of total value locked across Ethereum mainnet, the Layer 2 networks Arbitrum and Optimism, as well as Polygon and Celo. 

The protocol announced last month that it had acquired Genie, a market aggregator for NFTs. Genie pulls listings from all major Ethereum marketplaces like OpenSea and LooksRare, and also offers bulk purchasing through an optimized smart contract to reduce transaction fees. The Genie integration will likely result in Uniswap offering users a wider array of NFT purchase options than any single marketplace.

While this is not the protocol’s first foray into NFTs (Uniswap previously pioneered NFT liquidity pools with Unisocks, and later adopted NFTs to represent liquidity provider positions in Uniswap V3), the Genie integration signals a significant expansion of Uniswap’s product offerings. NFT trading is set to be enabled on the Uniswap web app sometime in the future. 

Beyond NFTs, the Uniswap governance forum is also currently discussing an idea suggested by Ethereum co-founder Vitalik Buterin to turn the UNI token into a price oracle token in order to ensure the robustness of Ethereum’s stablecoin ecosystem.

Aave Discusses Launching Its Own Stablecoin

Despite the market decline, Aave also has its sights set on the future. The lending platform is currently mulling a proposal to launch its own decentralized stablecoin called GHO. 

To mint GHO, users would need to deposit collateral in Aave Vaults, similar to how DAI is minted on MakerDAO. However, Aave would differ from MakerDAO’s approach by introducing “facilitators,” DAO-approved entities that can generate or burn GHO in a trustless manner. Representatives from other DeFi protocols, such as the Frax Protocol and Yeti Finance, were among those offering to take on facilitator roles, even though the structure hasn’t been fully mapped out yet. 

Lido Experiments With Governance

Like MakerDAO, the decentralized staking service provider Lido is also questioning whether the standard token voting DAO governance model best serves its needs. 

Lido has seen rapid growth with the protocol now processing over 30% of all staked ETH. Users can stake their ETH through Lido to receive stETH tokens, which can then be used as collateral in various DeFi protocols while still accruing staking yields of between 4 to 5%. 

Lido’s growing ETH market share has prompted questions over whether the platform has inadvertently made Ethereum more centralized. The DAO discussed the idea of self-limiting Lido’s potential market share before eventually deciding against such a proposal.

Lido is, however, considering a new governance model that would essentially create a “checks and balances” dynamic between holders of stETH and of LDO, Lido’s governance token. Under the dual-governance model, stETH holders would be given veto and anti-veto powers over proposals submitted by LDO holders. The mechanism would make a governance take over much more difficult, while also aligning the interests of stETH and LDO holders.

DeFi Tokens Lag Behind

Although many DeFi protocols appear to be making strides in governance, the space has suffered from weak price action for more than a year. 

Most major DeFi governance tokens peaked in May 2021 and the ecosystem effectively entered a bear market as NFTs boomed and liquidity was flocking to the crypto ecosystem throughout the second half of 2021. The global economic downturn of 2022 has only accelerated the decline. The governance tokens of MakerDAO, Uniswap, Aave, and Lido are all over 75% short of their highs at press time. 

Interestingly, many DeFi tokens have underperformed even though their protocols accrue significant profits from user fees. According to Token Terminal data, Uniswap has made $45.2 million in the last 30 days, Aave $9.3 million, MakerDAO $1.9 million, and Lido $17.6 million. 

While these projects continue to see usage, their governance tokens currently do not capture any of the revenue they generate. The lack of value accrual impacts token holders, but it can also lead to governance capture. If the price of a governance token suffers a significant drop, a malicious actor may be incentivized to acquire a large portion of the supply and force a vote in favor of transferring protocol funds to themselves.

The question of value accrual has been raised to no avail in several DeFi governance forums, most recently on Uniswap and Lido. Notably, Yearn.Finance has distinguished itself with a plan to install a buyback mechanism to support its token price, but YFI holders are yet to earn protocol fees. 

What’s Next for DeFi?

After a spectacular run in 2020, DeFi fell out of vogue in 2021 as Ethereum and other Layer 1 networks took center stage during the crypto market rally. While many DeFi tokens soared to new highs in May 2021, most have suffered brutal losses in dollar and Ethereum terms in recent months. Nonetheless, the recent developments in Ethereum’s foremost DeFi communities shows that the ecosystem is evolving. If DeFi eventually returns to its former glory, the projects building during the current winter phase should be the ones to reap the benefits.

Disclosure: At the time of writing, the author of this piece owned ETH and several other cryptocurrencies.

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