In 2023, the total capitalization of the crypto industry is $1.15 Trillion. While the total capitalization of DeFi is just $42 Billion, it is just 3.6% of the whole crypto industry. This means that 96.4% of the people, who already believed in crypto enough to buy and hold it, don’t trust DeFi, no matter how high profits can be.

The next big thing in DeFi will be able to breach this barrier and move DeFi to this “untouched” market. On the way, it will make richer all who believed in the project. So what will this “big thing” look like?

Let’s first explore the reason why this market is untouched to understand how this obstacle can be overcome.

Where We Come

DeFi initially got attention as a good way to earn high profits on many projects and their respective tokens. But everywhere where there are people eager for high returns always appear scammers ready to abuse them.

Just in 2021 alone, crypto scams revenue hit $10.9 Billion. This is a significant number, but you probably still heard about some bloggers or traders who were able to make profits in crypto. If they are not scammers, which there is a high probability that they are, they share stories of how they earned high returns.

Part of them made money by buying some project tokens, and another is using some yield farming strategy. Let’s take a look at both of them.

High Stakes

First, DeFi token traders usually do not share stories of how they invested all their money in some token that they weren’t able to sell fast enough and, as a result, lost all their money. But this is what happens with most of the traders. Enough to check simple numbers.

Every time when you hear that some trader invested $1,000 and returned $100 000, it means that somewhere we have 99 traders, each of them invested $1,000 and lost everything.

Project tokens, like every type of securities, cannot get money from anywhere. When someone wins, someone must lose. Like in our previous example, if you invest in this lucrative token with 100x returns, you have a 99% chance of losing your money. Which is not a great deal from this angle.

High Yields

The second category of “winners” is yield farmers. They usually were able to invest in some early projects with high yields or continuously adjust some yield strategy. While the risks are much lower in comparison with regular trading, they are still high.

Hacks

The most common risk with yield farming is smart contracts hacks. In 2022, hackers stole $3.8 Billion. Usually, such hacks occur with new protocols, which created a belief: “The older a protocol in DeFi, the safer it is.”

On the one side, it is good. It gives us an understanding of the high risks of investing in new protocols.

On another side, it is bad because it creates a misbelief that old protocols cannot fail. The reality, of course, is not so simple.

For example, Anchor, which lived for more than two years. They kept the highest safety scores in all rating systems up until it failed as a regular Ponzi scheme. Another case with SushiSwap, which was hacked after 3 years of work. All of them show how fragile even “old” protocols can be.

Hacks are continuous threats to any program, including smart contracts, which don’t disappears over time. But good projects have audits. Are they not helping?

Even if the project has audits, they are usually done by the company that paid for this project. They do not check anything except the code itself. The audit does not check the team and who has access to control or update the code.

For example, the same SushiSwap at the beginning of life, struggled with a Rug Pull from his creator, Chef Nomi, for 38000 ETH. Users of SushiSwap were able to save money only because Chef Nomi decided to return the money later.

But the possibility that someone, who you do not even know, can take your money always exists. Especially with any protocol that control accesses you do not know where. This risk is independent of fact have this project audits or not.

Business Models

Even if we imagine the protocol in which we invest is safe and cannot be hacked. High APY on the screen, which they draw, does not guarantee high returns. For example, the Uniswap project is known for lucrative returns, but in reality, half of the Uniswap liquidity providers lose money.

And most of the users are not able to earn more than 3% APY on their investment.

This is not a mistake of yield farmers. The DEX model, by definition, causes impermanent losses, which significantly decrease profits or even eat the initial investments.

The DEXes not only struggle with a business model which harms its users. Many projects pay their rewards in their own project tokens, which are continuously minted. As you can expect, if you print more and more money, the price will decrease.

It means that users who invested in the project and believed in it will receive a devaluing token as a reward. The token which losing the value of people who believed in it enough to buy it.

Questionable DeFi Potential

What is the actual future of DeFi if it is filled with scams and hacks from all sides and with big projects which actually do not generate any value? What value of DeFi itself in this case?

DeFi can still have protocols that can generate real value and, as a result, real yield. For example, lending protocols like Compound are able to generate profits in 3–5% APY more or less stably and equally for all of its liquidity providers.

Also, projects like Bancor are trying to solve DEXes’ “impermanent” problems.

A profit of 5% APY is good, but it is quite comparable to investment opportunities in traditional finances. But how strange is it? Even though DeFi is a new finance system, they still work on the same basic economic principles and, as a result, can generate only the same profits as traditional finances.

So, in the end, we have the same finances as they were before. What is the reason for using it? Even DeFi struggles with multiple problems. These problems also exist in traditional finances. We just forgot about it.

On another side, DeFi is the first financial system that has the potential to solve them.

The Reality Which We Do Not Want to See

The “new” problems of DeFi always existed in TradFi (traditional finances). For example, hacks. As an engineer and solution architect with 8 years in the software industry, I can say that any computer system can and will be hacked. And as more complex the system is, the sooner it will be.

And financial systems are one of the most complex types of software.

For example, not so long ago, in 2015, $1 billion was stolen from 100 banks around the world. A little bit closer, in 2019, 885 million financial records were stolen from First American Financial Corp. In the same year, a bank “accidentally” gave a woman $37 million by mistake.

Hacks in the financial sector are not less common than in DeFi. Even more, these hacks are still not solved over the years of the existence of TradFi. Who knows, maybe your money is now accidentally given to someone? Try to ask your bank to share who has access to your money.

Or where are all bank assets now? Or at least share the code which operates your money. No one bank will answer.

DeFi, on another side, operates more openly. You can check the code which operates your money. You can even check where your money flow or how much the project has in free assets. Also, you can easily check who has access to the project and what exactly they can do.

The question is only the expertise and time which you need to put in to make such checks. But as with any common problem, somewhere on the horizon, there’s a startup trying to solve it. The project that will define the future of DeFi.

The Future of DeFi

The future of DeFi is actually set on a question: “Will DeFi be able to solve the safety problems of TradFi?” The actual next big thing in DeFi will be not with the highest yields or with the funniest NFTs. It actually will be the most boring but also the most critical thing.

The project will be able to provide a higher level of security and transparency than TradFi banks.

The project will define standards for the future finance industry and will change people's and funds' mindsets about the safest places to invest money. It will make people think that holding money is too risky when you can invest it in DeFi.

“No one will steal your money. No one has access to them” — the belief people had about banks, matrasses, and crypto-wallets in different moments of history. Of course, from all of these places, money was stolen and will be stolen again.

As you remember, everything that can be hacked will be hacked. But DeFi will breach the gap to become the new financial industry only when it will share this belief in the minds of people. And someone must make this happen.

Our team realized it long ago when we started to work on a solution that would be safe enough to make it happen. If you are interested to hear how we see this solution, subscribe to us. I will make the next post in this series soon, where I will dive into the solution deeper.

If you want to support our work, check our site and join the waitlist for our protocol.

Also published here