At the same time, the US authorities will try to strengthen control over the industry. In 2021, the DeFi industry has grown exponentially, and many new decentralized projects have appeared on the crypto market. Even though 2022 has just started, it has also already presented some good opportunities, especially towards the end when the price of bitcoin fell below 40k. Experts predicted what will happen to the industry next year and what risks investors who want to invest in DeFi projects can expect.
The time it all exploded: 2020.
And although Decentralized Finance and Applications appeared earlier, in 2020 the COVID-19 pandemic caused an economic crisis, which led to a general decline in the economy and ultimately affected the growth of DeFi, which became explosive. The crisis also led to a decrease in interest rates on deposits, which in most developed economies were near zero, while DeFi with deposits in USD stablecoins could give on average up 7% per annum, due to which they became an attractive alternative to banks.
In 2020, there are also new trends in decentralized finance that have attracted more users and money to DeFi applications. Profitable farming has become the main trend that has provided an influx of money into DeFi. In June, Balancer and Compound launched programs to distribute governance tokens to liquidity providers.
Further, over the following months, other DeFi protocols launched similar programs. At the same time, some of the tokens distributed by these protocols began to grow rapidly in price, showing 100, 200% and more, in some cases reaching 100,000%, like Yearn Finance, showing such growth in less than 2 months from the launch. As a result, the returns on liquidity supply have also increased and more people are investing in DeFi. So, from June to August 2020, the number of user funds in the accounts of DeFi projects increased by almost 8 times.
Also, the DeFi sphere was significantly affected by the fact that in 2020 large institutional investors began to show interest in cryptocurrencies. The largest cryptocurrency holder in 2020 was the investment company Grayscale Investments, which specializes in investing in cryptocurrency. By the end of 2020, the company was managing five funds for different coins, including Bitcoin and Ethereum, and the total value of assets under the management of Grayscale Investments by the end of the year was $19 billion.
In the outgoing year, the volume of investments in the DeFi area exceeded $200 billion. Experts are confident that this figure will be even higher in 2022. This year gave crypto investors a lot of entry points, giving drawdowns, corrections, and flats. However, 2021 was the year when regulators in different countries flexed their muscles regarding cryptocurrencies. China banned all activity related to this type of asset, India was going to follow in its footsteps, and due to the energy crisis, Iran twice restricted mining.
Against this background, the issue of regulation will become a key issue for this sector in 2022. In particular, the SEC is expected to clarify the legal gray area in the field of cryptocurrencies. 2022 will undoubtedly be an important year in the field of regulation, as interest from various governments, especially the United States, in regulating the crypto space has never been so high.
Over the past few months, some US politicians have openly criticized the DeFi space and also called for its regulation. The latest such statement came from Massachusetts Senator Elizabeth Warren. She stated that the DeFi segment is the most dangerous part of the crypto market. She said that there are a large number of scammers operating in the DeFi space, as well as little to no regulation. In August, the head of the US Securities and Exchange Commission (SEC), Gary Gensler, spoke about the need to regulate the field of decentralized finance. The official also doubted that most of the projects in the industry are really decentralized.
There are two main factors that worry the US financial authorities. The first and most obvious factor is the insecurity of investors since it is not uncommon for smart contracts to be created that are unaudited and contain the possibility of an inconsistent withdrawal of assets. It is also quite common for DeFi projects to be hacked or attacked, which leads to loss of funds, and, in fact, the investor in such a situation is not protected by anything. For example, from the latest, this is a major hack of one of the DeFi projects that occurred on December 13th. Hackers stole $100 million from users of the Vulcan Forged NFT marketplace by gaining access to private keys.
The second reason is the growing role of DeFi products and the more obvious opposition of these solutions to classic banking products such as deposits, lending and other services. The main risk, in this case, is not that over time DeFi projects will force out the classic players from the financial market, but that this could lead to a crisis in the financial and banking sector.
So far, there is no way how the entire DeFi segment can be regulated. If a particular crypto-exchange or a crypto-project can still be put on the rails of regulation, reporting and audit, then it is hardly possible to do this with an entire industry in which new unique projects regularly appear. Governments in the US and other countries will have to go to great lengths to bring DeFi and other crypto products into regulation. We won't see anything like this in the coming years.
Despite this, the total value of assets locked in the Defi reaches $2bn.
Will Ethereum dominate?
Ethereum is a cryptocurrency that appeared in 2015. It immediately attracted the attention of many investors and organizers. In a couple of months, it has grown tenfold, which earned it trust. Ether and bitcoin have a lot in common, they are two digital currencies that are used to make various transactions. The only difference is that Ethereum is more affordable in terms of price, which means that in some cases it is more profitable to purchase.
The current situation on the crypto market suggests an increase in the exchange rate of bitcoin and digital currencies in general. In the first quarter of 2022, the price of the main coin will be subject to bullish dynamics, it may update its historical maximum and exceed $70,000. The main reason for the increase will be fiat money inflation, which forces investors to look for alternative investment instruments. In addition, the number of institutional market participants is increasing, including against the backdrop of the launch by banks and companies of products based on cryptocurrencies, such as exchange-traded investment funds.
Now there is a widespread interest of the corporate sector and even states in placing reserves in digital assets. This is a powerful factor in the demand and increase in the price of bitcoin. The bullish trend will likely continue in 2022 and the year may be no less successful for the market than 2021. At the same time, the price of the main cryptocurrency can exceed $100 thousand, and the cost of Ethereum can be $5.8–6 thousand.
In the second half of the year, the capitalization of the sector is predicted to reach $4 trillion due to the active expansion of the DeFi, GameFi, NFT and metaverse segments. Such an increase will lead to a boost in the rate of Ethereum, which is the most popular platform for decentralized finance and NFT projects. Ethereum may become more investment attractive than bitcoin.
Major DeFi Uses Will Swallow Traditional Markets
The segment of decentralized finance imposes today the highest liquidity and investment attractiveness. The prospects for the DeFi sector will remain at a high level even in the moments of a bearish trend in the crypto market.
There are already fundamental opportunities in DeFi such as landing, AMM, yield farming, staking, algorithmic stablecoins, etc., but there are still many problems in the DeFi sector in the following areas. The sector needs experts from the traditional financial industry to create more sophisticated financial instruments such as bonds, fixed income, interest rate swaps, asset management, and so on. It also needs to continue increasing liquidity and capital efficiency. The collateral ratio in DeFi 1.0 is very low and the LP risk is quite high. A good attempt to solve this problem in DeFi 2.0 is the concept of liquidity-as-a-service.
SocialFi and GameFi will be key drivers of the new DeFi. In 2022, the social and gaming sectors of the industry began the massive adoption of cryptocurrency. These sectors will introduce new opportunities in DeFi, such as NFT+DeFi, NFT fragmentation, NFT leasing, etc. The growth of the DeFi segment will continue for many years to come, as stablecoins are the main driving force behind the industry. In the case of another cryptocurrency trend of recent years, NFT, does not have such a stable basis and the NFT market is more subject to investor sentiment and manipulation.
The decentralized finance segment will only grow and develop in the future. It is based on DeFi projects that the entire financial system of the world will change.
Tokens with great growth potential
Here are promising projects that can show high returns next year:
Cardano (ADA). In essence, the project is an improved Ethereum platform, the developers of which took into account all the disadvantages and problems inherent in the creation of Ethereum and were also able to integrate the most promising proposals that exist among the crypto developers of such platforms. To date, the token is best suited for smart contracts and decentralized games. It is a matter of time before the community manages to win back a significant market share from its ideological inspirer and, perhaps, then become the number two cryptocurrency in terms of capitalization.
Solana (SOL). This cryptocurrency bills itself as an Ethereum killer. And is there a reason for that? For example, faster and cheaper transactions, strong community support and active participation of developers in the implementation of improvements. In 2021, the Solana token has grown by more than 100 times, taking 5th place in the ranking of cryptocurrencies by capitalization. At the same time, the growth potential of the coin has not yet been exhausted. This blockchain uses the Rust language, which is more flexible and has more support in the development environment than Solidity, which is used in Ethereum.
Elrond (EGLD). The project is also an advanced Ethereum technology, however, the platform developers have focused on performance by implementing the Secure Proof-of-Stake (SPoS) consensus model. In fact, this allows the blockchain to process about 1000 times more transactions per second than Ethereum. The project is not so popular yet, although the prospects for Elrond are high, it is worth taking a closer look at the token.
Spark (FLR). Developers from Flare Finance have decided to introduce virtual machine technology from Ethereum (EVM) to the Ripple (XRP) token-enabled network in order to implement smart contracts. That is, in the short term, holders of XRP, a token considered the future of international banking, will be able to enjoy all the innovations of the DeFi industry.
Terra (LUNA). The project is a stablecoin that is regulated by algorithms, not by a centralized organization. On the one hand, this adds the risks of artificial manipulations, but in the perspective of community growth, the technology offered by Terra can replace the existing principles of securing stablecoins.
Crypto lending and collateral
Landing is the process of blocking cryptocurrencies in exchange for interest payments - it will become perhaps the most important trend of the coming year. An increasing number of investors in digital assets are gaining confidence in the future and are comfortable with this asset class. Now they are looking for different ways to make money on their crypto investments. It can be staking, landing, deposits.
The most popular projects offering lenders to earn money on cryptocurrency landings:
First to be mentioned is Maker DAO. This is the undisputed leader and perhaps the most famous of the DAO projects in the DeFi market. It is an Ethereum based crypto lending platform created back in 2015. The model works in such a way that when collateral is deposited, usually Ethereum, new stablecoins are created in a certain ratio. For Maker DAO, it's 2:1. This was until September 2020. Users can pledge in ETH tokens in return for DAI tokens, the world's first stablecoin. MakerDAO is governed by voting using a different token, MKR. MKR holders vote on platform updates, and the weight of the vote is proportional to the number of tokens held.
Decentralized networks offer hybrid protocols that combine cryptocurrency and traditional assets. And one of these protocols is MakerDAO, which uses a set of algorithms to ensure that the DAI stablecoin is tied to the US dollar. But MakerDAO in September added to the list of infamous projects that, due to the growing demand of investors for DeFi products and yield farming, threatened the stability of the DAI token.
As a result, the platform was unable to contain the volatility and the DAI jumped 10% of the dollar price. In a matter of hours, capitalization fell by more than 99%, although the project ranked second in the DeFi market with $1.26 billion.
Other popular examples of such projects are Aave (AAVE) and Compound (COMP). Aave tokens showed record growth. In just 4 months, the price of LEND cryptocurrency increased almost 40 times from, which made it one of the fastest-growing projects. The developers of the Aave token recently announced plans to develop a mobile cryptocurrency wallet. In his opinion, this will help the creators of the altcoin to significantly increase the number of token holders. In the future, this will contribute to its rise in price, the analyst predicted.
Last year, the Aave token went up by 182%. On January 4, it is trading at $262.5, and its capitalization is $3.5 billion. The asset occupies the 52nd position in the list of the largest cryptocurrencies by capitalization.
YFI, Compound and others. However, in August 2020, a DeFi project appeared that surpassed all previous platforms in this category by providing a new governance system. It is about Yearn.Finance. The YFI token has risen in price by more than 125,000% and rose above $40,000 in almost a month, bypassing the cost of Bitcoin several times.
Yearn.Finance serves as a liquidity aggregator for crypto lending platforms such as Aave, Compound, Fulcrum, and more. The main task of YFI is to select the optimal loan product for borrowers based on the analysis of proposals.
There are several important things to know about staking cryptocurrencies. Firstly, it is impossible to earn Bitcoin in this way due to the BTC mining algorithm. But the ether is possible. If the developers' plans do not change, then next year simply holding Ethereum on the wallet will bring from 5% to 10% per annum.
Secondly, when staking, the tokens will be frozen. In this case, the investor will not be able to sell them instantly if the exchange rate falls or there is an urgent need for working capital. Landing is generally questionable for US investors due to regulatory uncertainty. Therefore, before placing investments under this scheme, it is first worth delving into the study of the issue.
At the center of the entire ecosystem is ChainLink, whose oracles use the above platforms. Oracles form a solid foundation for DeFi since applications are directly dependent on the validity and accuracy of external data. Moreover, the more blockchain providers deliver data, the less likely it is that the protocol will incorrectly calculate data that may affect, for example, the actual cost of loans issued.
In November, there was a hard-to-believable headline from Bloomberg saying that the new DeFi derivatives platform DyDx had surpassed Coinbase in nominal trading volumes. Although the project was helped by a stimulus program, it is a new network that has deprived American users of access to the platform.
Trading volumes on derivatives markets dominate spot volumes on centralized exchanges and it is likely that what is happening in DeFi will not be an exception. The biggest breakthrough for decentralized derivatives exchanges this year was the launch of L2 solutions. Due to slow settlements and high commissions, these exchanges were simply out of place at the core level of Ethereum. The native token of the trading platform is another representative of the decentralized trading platforms on the list.
DyDx prospects talk about bans on cryptocurrencies and crypto exchanges. Although this will hit the crypto world, it will send investors to decentralized platforms at the same time. In the issue of the crypto ban, it is important to keep an eye on the Chinese market, which is a huge market. DyDx has the option to trade with leverage and futures. Also, more and more users will switch to DEX. Decentralized sites are becoming convenient, they are unprecedentedly better than centralized competitors in terms of security.
Compound is in some way responsible for the DeFi farming craze and the bull market of the last 18 months. While sending $160 million worth of tokens to users this fall during a normal protocol upgrade and then trying to get the tokens back through a series of compensation offers didn’t add credibility to them, the community got a lot of money back.
Uniswap, in turn, came under fire for a $20 million unconditional grant to a DeFi education fund, leading to an immediate sale of 50% of UNI for USDC. The community does not want to be drained of tokens, even if the money goes to really important political work, as was generally intended, given that politicians from Washington still prefer dollars.
For now, suffice it to say that many in the community are bullish about the governance infrastructure, improvements in the deployment of protocol treasuries, and current DAO distribution models that pay users, individual members, other businesses, and the same DAO. These are the foundations of the tools that will lead to DAOs replacing most companies.
NFT, GameFi and the Metaverse
Investors' attention will be mainly focused on gaming applications and projects related to the metaverse where NFT is used, which will become an additional growth driver for the segment. The largest companies and famous brands rushed to create their own NFTs in collaboration with various developers in order not to stay away from the metaverse trend. It seems that 2022 will be the year of exploring new virtual territories, where, with the help of NFT, their own economy and a new life in general, will be built, not least thanks to play-to-earn (P2E) games.
Nothing particularly sinister is happening yet, just the serious guys are scratching their heads over how to make decentralized operations less terrible. We haven't found many management bugs yet, but it has a fair amount of problems, such as contract bugs, front-running, and manipulation of instant loans.
User funds are often at risk, even in so-called secure browser wallets. Exchanges are hacked, keys are lost, SIM cards are duplicated. Protocols break. The risks are exacerbated by the fact that the systems are complex.
At the same time, users usually do not come to crypto for a risk-free rate. Technical risk is part of the risk-reward that users deliberately take. The hacks serve a purpose and help bolster the security immune system of the entire crypto ecosystem, which is important while we are still operating on the fringes with riskier end users.
Now is the best time to become a security developer or insurance agent. In smart contracts across various protocols, the total locked value (TVL) is more than $250 billion, so there is something to profit from. Ethereum security developers have done enough work already, but now high fees force risky assets to move to new networks where security is sometimes lame, so TVL in Ethereum has dropped from almost 100 to less than 70%.
It is important to follow the news on-air about Etereum 2.0. But in general, for the hold strategy, the news does not play such an important role as the fundamental value of the project. Do your own research and invest only in those projects that you understand, this will definitely bring X in 2022.
With so many projects coming up, there is always a risk, so it's worth weighing the pros and cons of whatever platform or protocol you're going to use. DeFi is still a new market where rules and standards have not yet been established. At the same time, investors should understand that since the market is very young, the opportunities to hit the jackpot are huge.
The volume of DeFi projects that are being squeezed out of the market suggests that many of them have remained unverified, which has already led to noticeable consequences. New projects, at least those that learn from the mistakes of outsiders, create more technically robust protocols that don't run into the same problems.
What matters is dominance and control over tokens. You need to know how much of a given supply of tokens is controlled by whales - funds, founders, venture capitalists, etc. It is important to know their coin lockings, position sizes and targets. But the concentration of positions in certain networks is not unambiguously negative.
There are also things to watch out for in 2022 so you don't miss out on the opportunity to make money. For example, insurance of smart contracts. In this way, Nexus became the first crypto-insurance unicorn, but probably not the last. Libraries of proven secure smart contracts and security as a service may become another trend. Pay attention to bullish optimism towards smart contract security researchers.
People have more confidence in VCs as professionals who sell on the rise, rather than panicking retail investors who sell-off at the bottom. It is worth paying more attention to well-distributed tokens, as well as where there are large, long-term-oriented sponsors.