It’s now virtually unarguable that decentralized finance is blockchain’s “killer use case.” Total value locked in DeFi grew by over 3,000% over the year leading up to January 2021. On the DApp Radar rankings, eight of the top 10 DApps on Ethereum are DeFi. Uniswap sees more users than any other application and is set to average $1 billion per day in trading volume for January.
Given the challenges we see with centralized exchanges, the push toward DeFi is hardly surprising. Centralized platforms offer limited lending and staking opportunities, and those that do exist depend on users putting their trust in the exchange. They’re also subject to region blocking and trade censorship, suffer from fragmented liquidity due to a disparity in product offerings, and have a limited range of instruments.
By comparison, DeFi users now have access to a range of on-chain lending and staking options. DeFi is also censorship-resistant, with composable apps that many have dubbed “money Lego” and to have almost limitless possibilities for different types of financial vehicles.
However, DeFi’s biggest Achilles heel is Ethereum. The more apps that pile onto the platform, the more Ethereum starts to show its wear as a dated technology in dire need of upgrades. Ethereum 2.0 shows some promise, but the timeline is distant, with scalability only expected in 2022 or later.
In the meantime, users are left to put up with slow confirmation times and, more importantly, exorbitant fees that limit DeFi participation to big spenders and whales. In January, the average transaction fee was up to over $10. When DeFi transactions rely on more complex smart contract interactions or users engaging in multi-protocol trades, these costs can become prohibitive for many people.
Interest in multi-chain DeFi is growing
Partly driven by Ethereum’s problems, interoperability and second-layer platforms became a significant focus area for many platform developers in 2020, which has recently started to bear fruit with several notable examples.
For instance, Aave’s venture into nonfungible tokens, Aavegotchi, recently decided to migrate to Matic Network from Ethereum, citing high transaction fees as the driver. Late last year, Sam Bankman-Fried, founder of centralized exchange FTX, opted to build his DeFi project, Serum, on the Solana blockchain, following the platform’s launch of an interoperability bridge with the Ethereum blockchain. Elsewhere, Ethereum-based 1inch announced it was expanding to the Near blockchain, which also operates its own bridge connected to Ethereum.
The rationale is clear. DeFi projects want to retain the ability to interoperate with Ethereum, and those platforms that bridge into the Ethereum ecosystem offer that opportunity. But this approach still comes with some critical limitations. Ultimately, it promotes a scenario where multiple blockchains are bridged to Ethereum but not to one another. It’s not a genuinely interoperable blockchain ecosystem.
Furthermore, it will always inherently lack composability because the bridge model depends on two separate platforms running their own blockchain. There still needs to be a bridge transaction in between any two token transactions on either side.
Omni-chain is the only sustainable future of DeFi
Currently, there are only two contenders with a live mainnet — Cosmos and Polkadot. Polkadot shows significant promise and is attracting substantial development from the DeFi community. Projects such as Acala, Equilibrium and Akropolis have ambitious goals to create multifunctional DeFi platforms based on Polkadot.
However, the Polkadot approach to interoperability between the parachains connected to its central Relay Chain involves a technically complex technology called inter-chain messaging among parachains. While this offers great potential for a wide variety of transaction types, the more simple yet elegant inter blockchain communication protocol used by Cosmos focuses on asset transfers between chains. It allows any Cosmos SDK chain to connect to any other.
For this reason, Cosmos lends itself as the ideal platform for DeFi developers. Cosmos SDK chains are 100x more efficient than Ethereum in terms of TPS and block space. Furthermore, the Cosmos Network is reaching an inflection point for its growth, with several notable apps now operational.
These applications include successful DeFi components such as Thorchain’s cross-chain DEX, Kava’s CDP, e-money’s token fiat currency platform, or Terra’s $100 million-plus stablecoin. They each use their own blockchain with their own unique tokenomics model that supports a token with $10M–$100M in market cap.
The Cosmos Network also supports non-DeFi projects with their own token models, such as Althea’s mesh network of internet routers or Persistence’s enterprise blockchain product.
From development to adoption to liquidity
As transactions increase among Cosmos Network tokens, demand for liquidity will rise. The Cosmos Network can support an exponentially larger volume of economic activity than Ethereum while attracting a wider customer base with lower transaction fees. This makes it an optimal basis for processing a massive chunk of on-chain, cross-chain commerce.
Cosmos can support DEXs for swapping assets, but it can also support derivatives like shorts, futures, leverage, perpetual swaps, tokenized interest, liquidity pools, identity management, automated market making and other core aspects of a highly sophisticated centralized market.
Finally, banks and other financial institutions are already showing signs of readiness for blockchain adoption, but they almost certainly won’t use Ethereum. More likely is that they’ll adopt customized solutions. An omni-chain platform that can interact with a wide variety of enterprise networks is, therefore, a must-have in preparing for the point when there’s a demand for trading traditional financial instruments with decentralized digital assets.
2020 was the year that DeFi cemented its place as blockchain’s killer use case, but 2021 will be the year that interoperability starts to become the norm, rather than the exception.
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