The financial world has long been familiar with the concept of lending, encompassing various forms such as mortgages, lines of credit, and personal loans. However, with the advent of web3 and the rise of cryptocurrencies, a new paradigm of lending has emerged. Lending and borrowing have become crucial strategies for enthusiasts to gain exposure to digital assets, generate passive income, and strengthen their portfolios.
At its core, lending is a digital adaptation of traditional credit and loan systems within the web3 space. Borrowers can secure loans by offering their cryptocurrency holdings as collateral. Conversely, lenders can offer their assets to borrowers in exchange for interest, similar to the interest earned from traditional savings accounts in banks.
Lending has emerged as the 2nd largest sector within DeFi , showcasing remarkable growth and solidifying its importance.
Since October 2023, the total value locked (TVL) in DeFi lending protocols has experienced a significant surge, growing from $14 billion to an impressive $33 billion by May 2024. This rapid growth trajectory suggests a robust recovery and a strong potential to reach the all-time high (ATH) TVL of $50 billion, last seen at the end of 2021 and early 2022.
The current crypto environment, marked by the acceptance of Bitcoin ETFs and increased mainstream attention, has acted as a powerful catalyst for this remarkable growth in DeFi lending. The institutional validation and wider adoption brought about by these developments have bolstered confidence in the crypto market, driving more users to explore and invest in DeFi platforms.
As a result, the lending sector within DeFi is poised to continue its upward trend, fueled by enhanced accessibility, investor interest, and the innovative nature of decentralized financial services.
Growth Horizons
Market Opportunity
The blockchain industry is still growing, with DeFi at its heart. Within this space, the DeFi lending market has reached $10.3 billion. However, compared to the enormous $10.5 trillion global lending market, crypto lending makes up only 0.1% of the total. This huge difference shows how new the crypto lending market is and how much room there is for growth.
Most of the top players in the crypto lending market, like Aave, Compound, Kamino, and MarginFi, etc, use a peer-to-pool lending model. In this model, lenders put their assets into a pool, and borrowers can take loans from this pool. This system helps manage capital well and has been key to the early success of DeFi.
Despite the benefits, peer-to-pool lending has a big problem: floating interest rates. These rates change based on how much of the pool is being used. When the pool is heavily used, rates go up quickly to reduce usage. However, this system isn't very effective and usually just keeps usage at an optimal level.
The issues with floating interest rates in peer-to-pool lending models create unacceptable rate spreads that hinder the development of a mature financial system. Even if large institutional liquidity were available, there would still be significant slippage on large loans. To enable DeFi to go mainstream and fully realize its potential, it is crucial to address and fix these rate spread problems. Otherwise, the crypto lending market is missing out on tapping into the huge $10.5 trillion global lending market.
Demand of Fixed Interest Rate
Fixed-rate lending can address these issues by providing a stable and predictable rate environment. This stability is crucial for attracting institutional-sized liquidity, which requires reliability and precision in financial planning. With fixed rates, DeFi can offer more appealing and understandable products, making it easier for new users to enter the market and for existing users to plan their financial strategies effectively.
The introduction and traction of fixed-rate lending in DeFi can remedy the problematic rate spreads, establishing a legitimate yield curve. This foundational change is necessary for the development of more complex financial derivatives and applications. Yield derivatives, for instance, hold exciting potential within the crypto space but require a healthy and stable interest rate foundation to thrive.
Fixed interest rates can create a more mature and efficient DeFi ecosystem. They will enable better risk management, improve user confidence, and facilitate the creation of advanced financial products. As DeFi continues to grow, the demand for fixed interest rates will become increasingly critical in shaping a sustainable and integrated financial future.
Demand of innovative products for LSTs
In 2023, Ethereum's liquid staking market experienced significant growth, primarily driven by the Shapella upgrade, allowing withdrawals from the Beacon Chain. This led to a rise in staked ETH, reaching 28.6 million ETH by December 2023. The adoption of liquid staking derivatives (LSDs) also surged, with approximately 44% of all staked ETH now held in these protocols. This expansion has been fueled by yield-seeking ETH holders and the increasing utility of LSDs within the DeFi ecosystem.
Additionally, Solana's liquid staking market saw Marinade initially dominate, but Jito emerged as a strong competitor, particularly in Q4. Jito's success was partly attributed to the distribution of Jito points, which led to a significant airdrop event. The lowest tier of users received 4931 JTO tokens each, estimated to be worth ~$10K on the day of the airdrop. Additionally, BlazeStake, a newcomer, offers token-incentivized rewards for staking, successfully providing bSOL holders with additional yield opportunities.
As liquid staking brings a wave of innovation to the DeFi product stack, the demand for new and innovative financial products continues to rise. One of the most exciting developments in this area is the concept of LSDfi, which has started to gain traction as the next big thing. Leveraging liquid staked tokens (LSTs) has become a necessity for several reasons.
The ability to lend and borrow LSTs natively within DeFi platforms can significantly enhance liquidity and capital efficiency. By allowing these assets to be used as collateral or for earning yields, DeFi platforms can attract more users and increase the overall utility of staked ETH. This native lending and borrowing capability can serve as a major catalyst for growth within both the liquid staking and lending markets.
Demand of cross-chain product
The current DeFi landscape is characterized by a plethora of blockchain networks, each with its unique features and ecosystems. While this diversity fosters innovation, it also leads to fragmentation, where assets and liquidity are confined within individual chains. This siloed approach restricts users' ability to fully leverage their holdings, as they are often unable to seamlessly move assets between different platforms
Liquid staking derivatives (LSDs) are a prime example of how cross-chain functionality can enhance DeFi. In both the Ethereum and Solana ecosystems, LSDs have emerged as vital tools for providing liquidity to staked assets. However, the benefits of LSDs can be significantly amplified through cross-chain integration. For instance, liquid staked ETH and SOL could be utilized across multiple DeFi platforms, regardless of the underlying blockchain, thereby increasing their utility and yield opportunities.
The adoption of cross-chain solutions is inevitable as the DeFi ecosystem continues to expand. A connected ecosystem, where assets can move freely between chains, will unlock new possibilities for innovation and growth. Users will benefit from increased liquidity, enhanced yield opportunities, and a more seamless DeFi experience.
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