The History of DeFi
Level 3 - Virgin DeFi Analyst
Welcome Avatar! At this point, most people seem to have an idea of what DeFi is or at least heard of it. What most people don’t know is how DeFi was born and the major developments that got us here today.
Today we’ll cover the history of DeFi. Strap in.
The History of DeFi
Orange Coin Good: Bitcoin
First off, there is no crypto or DeFi without Bitcoin. A lot of new people have entered the crypto industry, but many still have not studied Bitcoin adequately.
For those who don’t know, Bitcoin was invented in 2009. If you’ve never read it before, we highly suggest reading the 2008 Bitcoin whitepaper published here.
Vitamin Butane: Ethereum
Four years after the inception of Bitcoin, Vitalik Buterin released the whitepaper for Ethereum, paving the way for the development of DeFi, NFTs and many of the innovations in crypto you see today.
You can check out the Ethereum whitepaper here.
It took almost two years from the release of the whitepaper to Ethereum’s genesis block in July 2015.
Around that time period, one of the pioneers of DeFi was also being built.
In Sergey We Trust: Chainlink
Chainlink was founded in 2014 and went live in 2017. Originally designed as a centralized oracle system, Chainlink has become a decentralized oracle network that provides off-chain data to smart contract platforms on-chain.
Participants in the Chainlink network operate nodes to obtain and deliver the data and get compensated in LINK tokens.
Chainlink today secures over $60 billion in DeFi through its price feeds and is integrated with over 1,100 projects. For a list of Chainlink users, check out https://data.chain.link/users.
DeFi’s Granddaddy: MakerDAO
In March of 2015, Rune Christensen released MakerDAO with a stablecoin named “eDollar” on Ethereum’s testnet. You can check out his reddit post here.
eDollar eventually launched on mainnet in December 2017 as SAI, or Single-Collateral DAI, which allowed users to mint a USD stablecoin against ETH. In November 2019, SAI was phased out for Multi-Collateral DAI, or simply DAI, which allows users to mint DAI against a variety of cryptoassets.
You can read our deep dive on MakerDAO below.
The First Decentralized Exchange (DEX)
While Uniswap is the most well known DEX, the first DEX on Ethereum was actually OasisDEX in 2016. Oasis allowed users to swap between Wrapped ETH, Single-Collateral DAI and MKR tokens.
Oasis was a MakerDAO project until spinning off in June 2021 as part of the dissolution of the Maker Foundation.
Money Markets & The Granddaddy of Yield Farms: Compound Finance
Compound Finance, founded by Robert Leshner and Geoffrey Hayes, launched in November 2019. Compound allowed for borrowing and lending of collateral in a decentralized way with interest rates being set algorithmically based on supply and demand.
In June 2020, Compound launched the COMP token, a governance token distributed over time to liquidity providers on Compound. COMP rewards boosted yield farming rewards big time, and kicked off what’s now known as “DeFi Summer.”
Yield farming, also known as liquidity mining, continues to be a core facet of DeFi today for new projects to incentivize liquidity.
Automated Market Makers (AMM)
Automated market makers (AMM) are DEXs that pool liquidity from users and price the assets within the pool using algorithms. The concept was proposed by Vitalik in 2016.
One of the first AMMs was Bancor, launched in 2017 in a $150M+ ICO. Uniswap, now the most popular and market dominant AMM, launched in November 2018.
You can read our post on Uniswap here:
AMMs allow for anyone to spin up liquidity on any assets regardless of regulations, KYC, deposits, etc. They are on-chain permissionless exchanges.
Curve Finance, an AMM specializing in stablecoin swaps, launched in Q1 of 2020.
Fair Launch: Yearn Finance
Yearn Finance launched in July 2020, with all YFI governance tokens being issued to liquidity providers and none being set aside for the team, advisors or other insiders (a “fair launch” as it is now called). The project was founded by Andre Cronje, who had built Yearn for his personal use to automate his yield farming activities.
Today, Yearn is a DeFi powerhouse with a $900 million market cap and close to $4 billion in Total Value Locked.
Vampire Attack: Sushiswap
Sushiswap forked Uniswap in September 2020 and incentivized Uniswap liquidity providers to migrate their LP tokens to Sushiswap with SUSHI token rewards. This not only allowed Sushiswap to absorb over $1B in liquidity, it also drove Uniswap to launch its own token (UNI) which was airdropped to users retroactively.
The Sushi protocol has since undergone a number of organizational changes and issues, which we covered in detail below.
Q1 2021: Golden Bull Run
Despite the brief DeFi winter in Q4 2020, all of crypto experienced a massive boom in Q1 2021 on the back of BTC’s run from $10K to $60K in 7 months, crossing the threshold of being a trillion dollar asset. During this time period, Ethereum gas fees started to increase significantly.
Given the exuberance present in the altcoin market at the time, many users and developers migrated or expanded to Binance Smart Chain (BSC). BSC is effectively a centralized Ethereum fork, allowing for nearly free and very fast transactions. Given the similarities to Ethereum, many coins were launched on this chain as simple copy and pastes. Pancakeswap, the leading BSC DEX, was the biggest winner during this time, dominating on-chain swaps on BSC.
The BSC era gave a glance into a multichain world.
DeFi 2.0
Ah, DeFi 2.0. Perhaps the most controversial DeFi term ever popularized. DeFi 2.0 was in reference to a new set of DeFi protocols that prioritized interoperability and partnerships in comparison to their “DeFi 1.0” counterparts. They also placed an emphasis on managing and improving liquidity. Naturally, this was a marketing effort to push certain narratives to the forefront (don’t hate the player!).
These protocols include OlympusDAO, Alchemix, Tokemak, and some others. In hindsight, DeFi 2.0 involved an arbitrary selection of a handful of protocols and the narrative was driven by the exuberance resulting from OHM’s success at the time. In 2022, we will get to see if this narrative will be backed by real product delivery.
The Curve Wars
The vote-escrowed model invented by Curve Finance has resulted in a competition by various DAOs to direct CRV token rewards towards specific pools to enhance stablecoin liquidity and improve the strength of the stablecoin’s peg. Curve has over $20 billion in TVL, making it the largest DeFi protocol by TVL. We covered the Curve Wars in detail in a free post.
The vote-escrowed token model is now being contemplated by other DeFi protocols in an attempt to improve the performance of their tokens and better align incentives with long-term participants. You can read about how we are thinking about these tokens from an investment perspective in our veDeFi post.
Curve Finance is the reason many stablecoins with the goal of decentralization are maintaining their peg. It also serves as a source of yield for the broader DeFi ecosystem. With the growth experienced by stablecoin operators, it’s no surprise the Curve protocol became a critical part of DeFi in 2021.
Alt-L1 Season
Despite a slow Summer 2021 in the altcoin market, continued congestion on Ethereum, technological progress and specific applications on alternative L1s such as Avalanche and Solana drove alt-L1 activity through the roof. During this time period, the tokens of the market leading Ethereum-based DeFi applications underperformed significantly as new users to crypto were not interested in spending $50-$200 per transaction in gas fees. Alt-L1 season and DeFi 2.0 closed out the bull run of Q3-Q4 2021.
Looking Forward: Cross Chain Liquidity and Interoperability
Ethereum’s gas fees are simply too high. In one sense, this can be considered a positive (signs of adoption and usage of Ethereum). In another sense, this creates problems (competitive pressure from less secure chains, slower growth of crypto overall).
Regardless of your perspective, Ethereum congestion is unlikely to go away in the near term. The Eth2.0 merge is not expected to reduce fees and sharding is at least one year away.
Gas fees may hurt adoption of Ethereum, but they do not stop innovation in crypto overall. There are some great projects being built on Ethereum Layer 2s. There are also burgeoning ecosystems on other chains such as Avalanche, Cosmos and Solana. Applications built in these ecosystems require cross chain liquidity and interoperability.
The future of DeFi will include the expansion of:
Ethereum DeFi
Ethereum Layer 2 DeFi
Alt-L1 DeFi
Until Ethereum resolves its congestion issues, innovation will expand horizontally to other chains. We remain confident that most innovation will occur on Ethereum, as it has historically. But the future is increasingly multichain. That’s why we have partnered with Synapse Protocol, a cross chain liquidity provider and bridge, in assisting with their growth strategy and helping them become the market dominant cross-chain bridge in the industry (more to come!).
More broadly, we think 2022 will be an important year for the development of infrastructure to support crypto activity as a whole.
That wraps up the brief history of DeFi. As you can see, the industry is extremely young and many of the important innovations are happening right in front of us.
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Until next time..
Disclaimer: None of this is to be deemed legal or financial advice of any kind. These are opinions from an anonymous group of cartoon animals with Wall Street and Software backgrounds.
One of the best post of the Substack - thank you to all the DeFi team members
Can't wait to see what 2022 will be made of
Sorry if this is not allowed here, but I have yet to see any discussion on here about the PulseChain project which is going copy over the entire ETH system state and airdropping nearly 10,000 erc20 tokens with it -- in addition I saw that they are launching a Dex (PulseX ?) as well which is a copy of Uniswap. It has been said it is beating ETH 2.0 to market, is proof of stake and will be wildly inexpensive to use when compared to ETH - Can you fine folks share some color on this? Seems like it will be the first fully loaded chain at launch if I'm looking into it correctly.