The recent events in the encryption market have once again confirmed the value proposition of decentralized finance (DeFi), which is one of the core cornerstones of the future of digital assets. However, DeFi space is also affected by market changes, because many top players in DeFi have actually disappeared. In some aspects, the challenges faced by central financial institutions (CeFi) should be conducive to the adoption of DeFi protocol. DeFi should be a key component in the next phase of the encryption market, but it is likely to require major changes in the industry.

The recent changes in the composition of the encryption market have resulted in the total value locked (TVL) of some agreements being at a low point for many years, and activities in some DeFi ecosystems actually do not exist. Nevertheless, the DeFi protocol has remained incredibly resilient to a large extent, and some of the largest central institutions in the encryption field have completely collapsed.

The encryption market is relatively small, and CeFi and DeFi are intertwined in an almost contradictory way. Although the DeFi infrastructure can withstand the recent market impact, the collapse of CeFi institutions has brought great pressure to the DeFi agreement. In short, DeFi is thriving in a market that no longer exists. In order to give full play to its potential in the new reality of cryptocurrencies, DeFi needs to continue to develop. This development can translate into great opportunities. To find its position as the foundation of financial services in the encryption field, DeFi needs to improve in several key areas:

Capital efficiency

The first generation of DeFi primitives, which dominated the market, embodied the principle of democratizing programmable financial services, but they were at the cost of capital efficiency. Automated market makers (AMMs) are an incredible innovation to promote transparency in financial markets, but they lack the efficiency of centralized order books. Excessive mortgage lending has spawned amazing innovations such as flash loans - but this is the textbook definition of capital inefficiency.

Building a new wave of DeFi protocols with a strong capital efficiency base is critical to simplifying the adoption of DeFi. The idea of a hybrid decentralized exchange (DEX) that combines the order book with the AMM mechanism or semi mortgage/low mortgage lending agreements may release some value in this field.

credit

The crypto credit market has been under pressure in the past few months. Many of the market leaders in the area of free lending have failed or are unable to operate. Therefore, establishing a new credit mechanism in a transparent way has become one of the most attractive opportunities in the encryption market.

The way to improve credit in DeFi is to establish new forms of insufficient mortgage or semi mortgage lending. Although there have been some attempts in this field, they are difficult to be considered as DeFi and suffer from the inherent risk of lending to market makers. In this area, alternatives to lending to parties with predictable activities on the chain, such as stake providers, miners or DeFi agreements, may be worth exploring.

New financial primitive

Today, most activities in DeFi are dominated by two main protocol primitives: market making and lending. Although these factors are of course important, they are not enough to establish an effective financial market. DeFi urgently needs new financial instruments to reach the traction level experienced by AMMs and loan agreements.

In DeFi, derivatives seem to be an obvious place to expand the collection of DeFi financial primitives, because they play a role in capital efficiency and risk management. The DeFi derivatives field has been growing steadily, and agreements such as Ribbon or GMX have undoubtedly demonstrated the potential of this field. However, most DeFi derivative agreements have not been adopted meaningfully, and more innovation is definitely needed in this field.

Risk management and insurance

The risk form in DeFi is very different from that in traditional markets, so a new form of risk management technology is needed. The initial risk management work in DeFi focused on the development of technology smart contracts. Although this is important, it is only a part of the risks faced by investors when participating in DeFi.

Economic risk management is one of the biggest opportunities for institutions to adopt DeFi. Solutions for managing economic risk conditions (such as composition of capital pool, decoupling scheme, slip point, whale impact, and many other situations) are required to establish large capital market institutions. DeFi is required to be adopted on a large scale. One of the most interesting forms of risk management is insurance products. The economic insurance in DeFi is still a largely unsolved problem, which limits the choice of creating complex institutional structured products on the DeFi track.

TradFi Bridge and Real Utility

In the past two years, DeFi has been an encryption to encryption market, with very limited contact with offline applications. Although encryption centric dynamics are key to accelerating innovation in this area, they limit the sustainability of DeFi as a financial market. For example, the sustainable income of the financial market not only comes from the asymmetry of the market, but also from the utility created for enterprises in reality. DeFi needs to recreate a similar dynamic.

Building a bridge between traditional financial (TradFi) applications can bring a new wave of practical tools to DeFi and transform them into new ways of financial activities. Agreements like MakerDAO have been experimenting with ideas in this area by providing loans to financial institutions.

Deliberate regulation

When it comes to DeFi, few topics are as polarized as the discussion on regulation. No matter which side of the regulatory debate, it is hard to deny the fact that the recent changes in the composition of the encryption market have catalyzed a more positive regulatory agenda and will touch DeFi at some time.

Regulation will certainly be harmful to the innovation occurring in DeFi, but if properly implemented, it provides an interesting opportunity for institutions to adopt this space. Many regulated financial institutions are trying to coordinate the financial returns and opportunities of DeFi with the regulatory uncertainties in this field. The agreement in the form of regulatory control can certainly fill this vacuum.

Most of the initial efforts to enforce the "Know Your Customer" (KYC) procedure on the DeFi agreement have been limited, but it is still interesting to use the data on the chain for regulatory evaluation of the agreement. Strong regulation may be very harmful to DeFi, but deliberate regulatory controls may open the door to a new round of institutional adoption.

conclusion

From a philosophical point of view, DeFi is a movement that contains the true spirit of decentralization, resistance to censorship and financial inclusion. The recent DeFi rush has both huge innovations in protocols and an disproportionate wave of artificial incentives, which incite unsustainable gains and attract the participation of some of the largest companies in the encryption field.