Cycles and narratives have always been central to the global crypto market. In the past, the industry often referenced Bitcoin halving events to perceive market cycles while exploring major narrative trends. However, with the approval of Bitcoin and Ethereum spot ETFs, the crypto market has become more closely coupled with global financial markets, leading to an increase in the variables that influence market trends.
In the context of rising chaos, gaining a clearer understanding of cyclical patterns and identifying future narrative trends has become crucial. As innovation narrative pioneers, investment institutions have consistently been at the forefront of this exploration. In light of this, OKX has specially curated the "Crypto Evolution" series, inviting leading global crypto investment institutions to systematically discuss current market cycles, emerging narrative directions, and popular niche sectors, aiming to provide thought-provoking insights.
In this second issue, OKX Ventures, Multicoin Capital, and 1kx explore the present, past, and future of DeFi, and share their insights and reflections on the DeFi sector.
About OKX Ventures
OKX Ventures is the investment arm of global leading crypto exchange and Web3 technology company OKX, with an initial capital commitment of USD100 million. It focuses on exploring the best blockchain projects on a global scale, 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 supporting entrepreneurs who contribute to 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 thesis-driven investment firm that invests in cryptocurrencies, tokens, and blockchain companies reshaping trillion-dollar markets. It manages a hedge fund and several venture funds, investing across both public and private markets.
About 1kx
1kx is a crypto investment firm that specializes in ecosystem growth.
The firm explores the art and science of network building because we care deeply about bringing the best possible version of a decentralized future to life. Powered by software and governed by communities, it believes that token networks have a near-limitless potential to impact the world economy and society itself.
The Past and Present of DeFi
1. Reflecting on the Past: What's Been the Core Driver of DeFi's Growth in the Crypto Market?
OKX Ventures (Esme Zheng): The rise of DeFi can be traced back to 2018, when Ethereum’s founder, Vitalik Buterin, mentioned that finance would be the first pioneering application of blockchain. Between 2018 and 2020, DeFi protocols developed along three main directions: decentralized stablecoins, spot trading, and lending.
First, decentralized stablecoins like DAI, launched by Maker, laid the foundation for the DeFi ecosystem as the native currency and medium of exchange for on-chain economies. The emergence of DEX protocols such as Uniswap and Bancor, which introduced non-custodial peer-to-peer trading through decentralized automated market maker (AMM) mechanisms, marked a significant shift. These protocols allow users to retain control over their funds while conducting transactions without the need for centralized entities or intermediaries. The development of DEXs not only opened new opportunities for cross-border transactions but also paved the way for new financial instruments like synthetic assets and stablecoins.
As demand for DeFi grew, the number of protocols expanded exponentially. Some provided means for users to invest or trade tokens, while others supported lending and staking assets. By this stage, the three core financial primitives of traditional financial markets had been decentralized. Although decentralized liquidity pools were widely used in AMMs and LP tokens, they sparked a chain reaction of innovation within DeFi, DEX token swap functionality faced limitations due to insufficient liquidity, leading to high slippage costs for large transactions. This demand gave rise to liquidity incentives, with Yield Farming and liquidity mining becoming crucial methods for new protocols to attract capital, driving the explosive growth of the DeFi Summer.
Post-2020, DeFi’s second layer began to emerge, integrating mature financial modules from traditional finance into the decentralized world while maintaining similar financial principles but emphasizing concepts like "Code is Law" and the "trustless" and "permissionless" nature of DeFi. This phase saw the rise of platforms like dYdX, offering derivatives trading, futures contracts, options, and structured finance. Moreover, liquid staking protocols, exemplified by Lido, significantly accelerated Ethereum’s staking rate. As on-chain staking volumes increased, we further supported SSV's DVT technology, offering a more decentralized and secure solution for node operations. Subsequently, with the maturity of Layer-2 technology, the launch of numerous Rollups, and the development of ecosystems like Bitcoin, the blockchain world faced increasing liquidity fragmentation issues, driving market demand for secure and scalable cross-chain asset solutions. In this context, we invested in Orbiter and Zeus to promote the development of cross-chain DeFi.
Before 2022, the blockchain landscape resembled a barren land where various financial building blocks were constructed, laying the framework for global financial services. Since 2022, the most significant change in DeFi has been its deepening connection with the real world. Traditional asset management firms like BlackRock have begun entering DeFi, launching tokenized asset funds on Ethereum that offer stable on-chain returns to investors. Simultaneously, discussions about the security of the on-chain economy have increased, with projects like Eigenlayer and Babylon working to address blockchain security and economic efficiency issues. Ecosystem projects like StakeStone and EtherFi have also emerged, enhancing the security and transparency of on-chain financial products and offering investors more choices and higher return potential.
The prosperity of DeFi stems from the pursuit of Open Finance, where the elimination of intermediaries reduces transaction costs. Through smart contracts and blockchain technology, DeFi has improved transaction speed and transparency while enhancing market liquidity. Moreover, DeFi plays a significant role in realizing financial inclusion, enabling more people to participate in and benefit from financial markets.
Multicoin (Kyle Samani): OKX Ventures has provided a detailed explanation, especially in reviewing the development path of DeFi. Here, we’ll focus on a few key reasons why DeFi has thrived.
DeFi has prospered over the last few years because it offers a few unique value propositions that CeFi can’t offer:
The ability to trade, borrow/lend, etc. while maintaining self-custody of assets
The ability to tap into long tail assets before CeFi exchanges list those assets
The ability to trade NFTs. NFTs have effectively 0 volume on CeFi
1kx (Mikey 0x): The first use case that drove DeFi adoption was spot token trading. MakerDAO and Uniswap, both built before 2020, helped serve the main onchain use case of buying and selling tokens. Uniswap also created a new type of user within trading, namely the passive market maker. Uniswap V2 was particularly interesting because no liquidity provider had a pricing edge and everyone had to offer prices on the same curve. DeFi served new types of tokens, which led to increased volumes, and benefitted from regulatory arbitrage.
The second use case was protocols that optimized for yield, or the perception of returns. In 2020, Yearn Finance helped pioneer the DeFi farming era, which allowed users to earn passive yield that came from token inflation. These native token inflows, which were the result of people wanting to stake it and earn yield, led to price increases, which led to more attention, and the flywheel eventually continued. Then came DeFi 2.0, which further fueled price speculation, larger promised yields, and tons of liquidity.
The third reason why DeFi has really taken off in the past few years is advancements in onchain trading mechanisms, namely V3, and onchain orderbooks. CowSwap* has pioneered a model that prioritizes the user. Uniswap V3 resembles traditional orderbooks more than V2, as any liquidity provider can customize their price ranges. It also allowed for concentrated liquidity, which created better onchain price execution, therefore making it more appealing to trade onchain. Perpetual trading venues such as dydx and now Hyperliquid create an environment where the UI/UX is more friendly than before, while the path to full decentralization is actively being worked on. Another interesting protocol that pioneered the pooled perps model is GMX, which also allowed passive liquidity providers to earn trading fees and counterparty profits from platform users.
Overall, the growth of L2s has helped grow the pure number of users in the space. Uniswap’s average traded amount per transaction has gone from 5 figures in the early DeFi days to now under 100 dollars, which is a clear indication of retail users coming into the space en masse.
2. Major Challenges Facing the DeFi Sector
OKX Ventures (Esme): We believe that the current development of DeFi faces three main issues:
Firstly, infrastructure is still lagging compared to traditional finance. Although the DeFi market and user base are relatively more mature compared to other sectors within the crypto industry, its infrastructure remains underdeveloped compared to traditional finance. For example, in payment scenarios, traditional financial systems have branches, ATMs, and a broad financial network to provide more convenient services. In contrast, crypto payments still face issues related to usability and efficiency. Therefore, infrastructure improvements that enhance the user experience and lower the barrier for first-time users, such as account abstraction and smart account integration, are worth focusing on.
Secondly, there’s the issue of liquidity fragmentation. Currently, on-chain assets and trading volumes are dispersed across different ecosystems, with liquidity within the same ecosystem concentrated in the pools of different leading protocols. This fragmentation of liquidity leads to increased on-chain transaction costs, slower transaction speeds, and reduced leverage opportunities, thereby affecting the trading experience for users. While some highly interoperable and composable protocols can amplify liquidity efficiency, differing standards among financial protocols (such as risk management) and varying levels of security unintentionally increase systemic risks within the DeFi ecosystem.
Finally, there’s the challenge of low protocol governance efficiency. Currently, DeFi protocol governance primarily relies on a static manual approach, and smart contracts require complex and trusted infrastructure to handle external data. Single trusted APIs struggle to ensure data accuracy. Thus, many protocols face the challenge of how to separate logic and dependencies from foundational primitives, create more robust high-level service markets, and unify liquidity while reducing attack vectors and introducing responsive, dynamic protocol design.
Multicoin (Kyle Samani): The first DeFi era was focused on defining and building out foundational finance primitives. Those elements are in place — spot trading, borrow/lend, and bridging — which allows DeFi to build more sophisticated products. The next major opportunity for DeFi is around derivatives: perpetual contracts and options. The biggest challenge for derivatives has been performance during volatility. DeFi derivatives are complex systems that are very technically demanding. DeFi is just now getting to the point where it can reliably power on-chain derivatives trading. The most notable example of this is Drift, which is built natively on Solana, a high-performance chain explicitly designed to host DeFi applications like perpetual contracts.
1kx (Mikey 0x): There are tons of exciting developments within all aspects of the DeFi market, whether it be spot trading, perpetuals, lending, policy frameworks, MEV, or payments.
The biggest recurring theme among all these aspects is the attempt to vertically integrate. Perpetual platforms are trying to launch memecoin launchpads, some are even launching entire chain ecosystems, and others have built their own stablecoin. There’s a natural incentive to do so, and at the end of the day, owning the user is what matters. DeFi projects that create sticky ecosystems will have strong moats that will be tough to break. This verticalization incentive is also driven by increasingly available infrastructure. For example, Fastlane, Sorella, and Semantic are all trying to re-distribute MEV from sophisticated technical actors to those further up in the stack, whether it be the protocol, the users swapping, or the liquidity providers.
On the Core DeFi primitive side, it almost feels like there’s a “DeFi 3.0” wave coming, as many are optimizing for maximum composability and efficiency. Within lending, Morpho has introduced a new actor through vault managers, making it more of a marketplace, meanwhile, Euler is launching its v2 soon and is also focused on catering to long-tail. Unsiwap v4 is extremely exciting because there are so many more “if, then” statements that can be baked into the way liquidity is provided. There will be many interesting long-tail applications being built on Uniswap beyond just the major crypto swaps use case, whether it be options, perpetuals, or even prediction markets.
The main challenge that remains is creating a favorable user experience that matches centralized exchanges, as well as getting users to onboard into DeFi in the first place. DEX to CEX spot volumes have hovered in low digit percentages for quite some time, and this ratio is even smaller for perpetuals. This is a lot harder to accomplish because everything needs to eventually interact with a blockchain compared to centralized exchange data bases. Things like account abstraction (ERC-4337) and smart accounts powered by projects such as Safe* and Rhinestone* are taking the space in the right direction.
II. The "State" of DeFi in the New Cycle
1. What Role Will DeFi Play Going Forward?
OKX Ventures (Esme): Most of the surviving DeFi projects have demonstrated more stability. Although they may lack the speculative short-term narratives and concepts seen in many other areas, they show a stronger correlation between token prices, fundamentals, and business revenue, giving them a blue-chip character. The current cycle mainly revolves around ETH and BTC re-staking, as well as several new Layer 1 (L1) and Layer 2 (L2) solutions, which are competing for a small pool of existing users. DeFi's current phase is dominated by major trends. Protocols are shifting from overall structures to smaller, more granular primitives. Developers in this phase will benefit from new and unique ecosystems.
As early as the DeFi Summer of 2020, Ethereum firmly dominated the DeFi space, accounting for over 95% of all network Total Value Locked (TVL). This has now decreased to around 60%. Nearly one-third of the total TVL is now divided among competing Layer 1 networks and various Layer 2 networks. We have also seen Bitcoin’s share of the TVL rise to nearly 1%. The emergence of token standards like Ordinals and Runes has introduced DEXs on Bitcoin, creating new markets for Bitcoin NFTs and memecoins.
Yield has also become the new normal. The latest DeFi narratives — native yield and re-staking — are highly popular. In the first six months of 2024, EigenLayer’s TVL soared from $1.3 billion to $20 billion, making EigenLayer the world’s second-largest DeFi protocol, after Lido. Undoubtedly, liquid staking protocols, re-staking, native yield, and Real World Asset (RWA) tokenization are creating a more active DeFi ecosystem in the current cycle.
Multicoin (Kyle Samani): A new meta emerges with every new cycle. The last meta was all about NFTs. This cycle’s meta is all about memecoins. Almost all memecoin trading activity takes place on DeFi on Solana. This isn't a coincidence. Solana enables fast and cheap transactions that reduce the barrier to onboarding and trading. Furthermore, all memecoins are natively launched using on-chain liquidity.
1kx (Mikey 0x): On the crypto-native side: DeFi will play the same role that it always has. Users can access protocols that allow them to leverage, trade, lend, borrow, and earn yield. Innovations in the space make it more efficient and cheaper for users to engage in these use cases. For memecoins particularly, it’s been interesting to see the skew towards deploying them on V2 vs V3, presumably because liquidity is a lot easier to handle.
On the institutional side: DeFi will help legitimize the space due to the growing use cases that banks and financial institutions are currently working on. On the RWA side, lots of traction has been partly led by players such as Blackrock and Franklin Templeton. Key crypto-native players include Ondo and Superstate*. As of the time of writing, there are almost $2B of tokenized onchain U.S. treasuries.
Lots of teams are building frameworks or entirely new chains to comply with the existing American laws around AML and KYC. Two players that come to mind are Aethos and Sphere.
2. In the New Cycle, What Directions Will DeFi Innovations Take?
OKX Ventures (Esme): The first phase of DeFi was primarily driven by financial incentives, but the next phase should focus on practicality, organic growth, and simplicity to validate its viability as a parallel financial system to traditional finance. Key infrastructure needed to onboard new users — such as fiat on-ramps, smart accounts, and account abstraction — must see significant improvements to attract the next wave of millions of Web3 users. Protocols like Infinex (created by the founder of Synthetix), Gnosis Pay, and others are addressing these issues.
To enhance user experience and facilitate mass adoption, current DeFi applications (such as trading, cross-chain, and wallets) can be redesigned around the concept of "intent." Intent-based bridges, for example, could become major winners. Protocols like Across and Connext are shifting from existing relay bridge designs to intent-driven models. Additionally, UniswapX is working on some intent-based innovations, while some perpetual protocols are experimenting with intent-driven approaches similar to Symmio but find it challenging to attract market makers to complete all transactions.
To achieve "universal intent," some infrastructure projects are starting to build an intent layer aimed at providing the necessary conditions for DApps to fulfill specific intents. This approach will streamline the on-chain user experience to be as smooth as using traditional apps. Processes that previously required complex operations across multiple chains (such as opening cross-chain bridges, signing assets for cross-chain, paying cross-chain fees, switching networks to interact with DApps, and paying transaction fees) can now be simplified to a single step where users only need to sign once for the desired transaction.
The future of DeFi will inevitably be layered, combining more granular and composable financial primitives to enable developers to create new protocols, provide robust financial services for institutions, and improve the user experience, thereby removing barriers to retail adoption. For instance, modular lending solves fundamental layer functionality logic and abstraction layers, ensuring accessibility and user-friendliness. While blockchain itself is very inefficient compared to centralized databases and services, its permissionless access, composability, and the ability to choose between self-custody or trusted service providers make up for the costs and troubles faced by users. If better ways to execute these primitives are found, most top-level protocols and service providers will be able to quickly migrate users to new primitives as more advanced services are designed to be modular. For example, Uniswap is moving towards modular AMMs, eventually transforming into a native liquidity layer upon which many liquidity and currency markets will be built. Uniswap is evolving towards an Ethereum Rollup-centric approach, viewing Hooks as a place for innovation, while keeping the core protocol simple. Version 5 (v5) may eventually lead Uniswap towards application chains.
1kx (Mikey 0x): As mentioned previously, the main trend is around protocols verticalizing to capture value. It will be interesting to see how verticalization leads to liquidity fragmentation, and consequentially user churn. While it seems plausible that chain abstraction tools and gas abstraction will make it easier to move capital across rollups and ecosystems, protocols get discoverability benefits when they are part of an ecosystem. For example, lots of teams in the Berachain ecosystems were able to raise simply due to the fact that they were launching on Berachain.
There’s also an opportunity for the non-EVM ecosystems to capture significant market share in the upcoming year.
III. Iteration of Opportunities and Corresponding Investment Logic
OKX Ventures (Esme): In our view, practicality will become the most compelling narrative for DeFi, and DeFi itself is already a trend. We firmly believe that being first to market isn’t the key — the true long-term winners are those who achieve product-market fit first.
Currently, key use cases revolve around ETH and BTC re-staking and AVS (Active Verification Service) protected by re-staking protocols. Additionally, new Layer 1 networks, such as Berachain, are bringing significant economic transformations and could give rise to DeFi primitives that are difficult to achieve on other chains.
We believe that the concept of shared economic security is crucial at this stage. By optimizing financial commitments on PoS (Proof-of-Stake) chains to enhance network security and increase attack costs, projects like EigenLayer and Babylon are driving this direction. EigenLayer releases liquidity in the ecosystem through its re-staking mechanism, while Babylon provides an additional security layer through checkpoints. These mechanisms not only enhance security but also reduce the demand for AVS expansion validation nodes and shorten the unbonding time for stakers. As economic incentives and technological iterations of operational networks evolve, we’ll witness different solutions exploring shared economic security.
Economic models and revenue models will also undergo transformation. DeFi will gradually shift towards real yield models, rewarding users with actual income rather than token incentives. For instance, Aave’s new token economic model reduces $AAVE's selling pressure and emissions through protocol revenue and increases value capture through buybacks. Aave also introduced a new security module, Umbrella, which isolates risks of different assets, enhancing system security. For DeFi, the future could involve either Ponzi-like speculation or real yield-driven protocols that reduce dependence on governance tokens and achieve sustainable growth. We have the opportunity to witness the specialization of Farming as a Service, making it easier for ordinary investors to participate and profit, thereby increasing DeFi’s attractiveness and adoption.
Technological iterations are addressing existing issues. For example, combining ZK (Zero-Knowledge) privacy technology can ensure that users aren’t on regulated criminal blacklists while protecting their privacy. Governance inefficiencies will also improve through more automated dynamic governance reliant on data and machine learning. In terms of protocol design, protocols will have vested interests in recognizing user behavior and making corresponding adjustments. For instance, personalized credit and interest rate adjustments will be achieved through credit scoring systems, where well-behaved users enjoy lower credit or collateral rates, increasing user engagement and loyalty. Additionally, innovative protocols will dynamically adjust interest rates and collateral requirements, refine risk management, enhance security, and manage user risks more effectively.
The future development of DeFi will inevitably evolve from speculative trading to practical applications. Building on past iterative results, the focus will be on integrating scaling solutions, new token paradigms, zero-knowledge proofs, and AI technologies to create a safer and more interconnected ecosystem, leveraging the latest infrastructure advancements to drive application transformation. By addressing past limitations and introducing more sustainable economic models, the aim is to fundamentally transform user experience and accessibility, offering lower fees and more intuitive interfaces.
Multicoin (Kyle Samani): The single most important opportunity is onchain derivatives. We have yet to even scratch the surface of what’s possible with perpetual derivatives and onchain options. They have the potential to radically expand financial markets inclusion, bring new asset classes onchain, and unlock better ways to hedge, lever, and express investment views. Per my comments above, we are spending most of our time here and believe that Drift is currently the best positioned DeFi protocol to capture this opportunity.
1kx (Mikey 0x): At 1kx, we take an investment approach that focuses on long-term growth prospects rather than short-term ones. However, from a pure trader perspective, we understand how interesting opportunities might exist when looking into the right narratives.
From a narrative perspective, RWAs probably attract the most eyes and capital. After all, we must rely on institutions if DeFi were to 100x in the next decade. The value proposition should become clearer over time: an open, transparent, and composable ledger that helps decrease intermediary costs exponentially.
Another narrative that Hyperliquid has been able to spearhead is the “Onchain CEX” one. While perpetuals are a big part of exchanges’ business, they have many other revenue streams including indirect products they lead customers to, such as their chain. The same can be said for Hyperliquid’s vision, which started with perpetuals then branched out to spot and a token launchpad, and is now building an ecosystem around those two products.
The most important part about investing in a relatively mature market such as DeFi is finding a team that has a unique wedge when it comes to distribution and go-to-market. At this point, innovations around core mechanisms won’t move the needle alone, and I believe the true 0-1s are likely past us.
As the space grows and more protocols launch within DeFi, investing based on fundamentals will become a key theme: the incremental incoming fund managers want to see real cash flows and growth prospects. Currently, the market is pricing in extreme growth across the DeFi stack (based on basic metrics like P/E ratios), which is certainly attainable, but potentially on a longer time horizon than all of us think.
Disclaimers:
For OKX Ventures: Please read the full disclaimer at OKX Disclaimer.
For Multicoin Capital: Please read the full disclaimer at Multicoin Capital Disclosures.
For 1kx: Please refer to 1kx Important Disclosures.
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