As decentralized finance gains steam how much of it will depend on Ethereum? Well, it depends on how long Ethereum 2.0 takes to launch.
The number two blockchain hosts the largest number of developers, and thus reports the most activity, according to data from August 2019. Of this activity, “smart contracts, infrastructure, and DeFi ecosystems continue to gain full-time developers.”
Indeed, some of the sharpest minds in blockchain technology are moving to Ethereum to build out the alternative world of finance. This is made clear by the fact that nearly all the dominant DeFi applications are built using Ethereum-based smart contracts.
DeFi Pulse, a site that reports data on the family of DeFi applications, reveals that nine of the top ten DeFi products are built on Ethereum. Bitcoin’s Lightning Network, a layer 2 solution to allow for speedy micro-payments, is the only non-Ethereum application included. It isn’t just the top ten that are thriving either.
At press time, DeFi Pulse indicated that a total of $701.7 million is currently locked up across DeFi applications. That is more than double the amount since January 2019, with some commentators calling 2019 “the year of DeFi.”
— DeFi Pulse 🍇 (@defipulse) January 4, 2020
The term “locked up” in this context refers to the amount of money that has left the fiat world and is gaining interest, being loaned out, or traded in crypto open finance. MakerDAO, for example, DeFi’s most successful credit platform product, makes up just over half of all the funds locked up in the ecosystem.
This swarm of activity hasn’t been lost on big-time investors either.
Venture capitalist Andreessen Horowitz invested $25 million in November 2019 to back Compound, a money market protocol where users are promised high-interest rates to deposit their crypto. Many of these platforms dominate legacy banking interest rates that rarely push beyond the typical 1%.
LoanScan, an analytics aggregator that monitors open finance developments, reports interest rates as high as 8.31% in some cases. These rates will, of course, fluctuate according to an application’s supply and demand.
Still, many are convinced that the DeFi movement is crypto’s best chance of going mainstream. Unfortunately, this chance may be under threat. At least for Ethereum.
Ushering in a Scalable Ethereum
Compared to traditional finance, $700 million locked up in different crypto applications is small change.
Part of making this pie bigger has to do with simply introducing these products to a broad audience. Solving this marketing problem doesn’t solve the technical realities facing most blockchain technologies, however.
No matter the number of interested users each of the DeFi applications onboard, eventually the blockchain that is hosting these applications will come to a grinding halt. At the moment, this blockchain is Ethereum. And like almost every other blockchain, it suffers from scalability issues.
From this perspective, one can see how the promise of DeFi, a future that would allow the world’s unbanked to participate in complex financial products, currently hinges on Ethereum solving this issue. The current title for this solution has been called “Serenity,” or “Ethereum 2.”
It has been laid out as a three-phase process, with Phase 0, Beacon Chain, expected to launch in Q1 of this year. The Beacon Chain is a proof-of-stake (PoS) blockchain that would run in tandem with Ethereum’s current proof-of-work (PoW) model until the two merge into one system. This PoS model would set the table for many security, scalability, and so-called longevity upgrades further down the line too.
The merge from Ethereum to Ethereum 2 also poses problems for large user bases like those found in the DeFi ecosystem. In an interview with Mohamed Fouda, a partner at Token Daily, he told Crypto Briefing that “If DeFi apps cannot migrate easily to ETH2, there will be no activity on the new chain.”
Fouda added that many in the Ethereum space are aware of this challenge too. It is for this reason that Jim McDonald, a managing director of Weald Technology and Ethereum advocate, said that:
“This is undoubtedly the single most important task for Ethereum contributors to focus on in 2020. If 2020 ends without a stable release of phase 0 of Ethereum 2, it will be hard to look at Ethereum 2 as anything other than a failure.”
This failure could mean the end of DeFi as we know it.
The more likely conclusion, however, is that users will simply look to Ethereum competitors. As outlined above, many of the current products are perfectly operable assuming the blockchain has smart contract capabilities. This definition would include projects like Tron, Waves, EOS, and Stellar, to name a few.
While these platforms lack Ethereum’s network activity and brand, they do boast a much higher throughput. One can be sure that investors are watching this competition develop as the space moves through the year.
Jim McDonald highlighted this point in an interview with Crypto Briefing, saying:
“DeFi is heavy on the network effect and as such if Ethereum 2 launches late, with DeFi already moving to another network, that could be problematic for Ethereum 2’s continued use.”
The better question, in this case, is not what Ethereum can do for DeFi, but what DeFi, and the hopes of open finance, can do for Ethereum.