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Decentralized Finance (DeFi)
Overview
Decentralized Finance or DeFi comprises peer-to-peer financial services that use blockchain technology and eliminate intermediaries such as banks that make up the traditional financial system (TradFi). It has several advantages over TradFi, such as faster transactions, greater transparency, and streamlined cross-border transactions, among others.
The Ethereum blockchain is home to the most number of DeFi projects, contributing to nearly 56% of the total value locked (TVL) in DeFi as of March 2024. Developments in blockchain technology have allowed for the creation of decentralized apps using smart contracts, which have, in turn, enabled DeFi. However, a high volume of activity has strained Ethereum, resulting in slower processing times and steep transaction fees. Planned upgrades to the chain, along with new blockchains emerging with innovative processes and interchain compatibility, are set to bring about more efficiencies in the space.
The search for high yields is the primary driving factor for this sector, as investors seek to generate returns that have consistently outperformed traditional investments like treasuries. In addition, a sizable underbanked population and difficulties faced by SMEs in obtaining credit are likely to drive demand for credit through DeFi applications.
Industry Updates
Market Sizing
The US protocol revenue for DeFi projects could reach USD 10.9 billion–20.5 billion by 2028
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Market Mapping
Most startups in the DeFi space operate in the borrowing and lending segment, while much of the incumbent activity is seen in the marketplaces, wallets, and infrastructure segments. The incumbents are mostly established cryptocurrency exchanges as most DeFi projects also operate in the same blockchains as major cryptocurrencies. These incumbents mostly have internally developed solutions to expand their existing marketplace and wallet offerings to support DeFi protocols, enabling access to tokens from DeFi projects, such as Compound, from the borrowing and lending segment.
While limited, the infrastructure segment is also seeing activity from traditional banks, as they experiment with blockchain technology in their own internal processes or to trial DeFi projects. Another notable incumbent is the Ethereum Foundation (a non-profit dedicated to supporting the Ethereum blockchain), home to the most number of DeFi projects. Startups in the infrastructure segment have garnered the most funding as Ethereum challengers emerge, offering high performance at a lower cost.
Most disruptors operate as decentralized autonomous organizations (DAOs), a non-hierarchical governance structure where holders of the DeFi project’s native token are able to vote on strategic and operational matters of the DAO. Further, given the relatively young age of the disruptors (and the industry itself), most DeFi startups are at an minimum viable product/go-to-market stage.
Borrowing and Lending
Decentralized Insurance
Investment Platforms
DeFi Marketplaces
DeFi Wallets
Financial NFTs
Infrastructure
The Disruptors
Most startups in the DeFi space are involved in the borrowing and lending segment and are built on existing blockchains such as Ethereum. The blockchain landscape and cryptocurrencies, in general, have seen phenomenal growth from 2020 to 2024. The DeFi sphere has been no different, with around 90% of the key startups in this space being established after 2020.
Blockchain infrastructure and asset tokenization company Fireblocks is the largest active disruptor in this space, having closed its Series E round of USD 550 million in January 2022. However, companies in the borrowing and lending space have raked in the highest total funding, with institutional borrowing and lending platform Anchorage leading the pack with over USD 487 million in funding, as of March 2023.
While established investors such as Andreessen Horowitz have amassed a notable portfolio in this space, most DeFi projects, given their DAO structure, also see significant retail participation in their coin offerings, in some cases attracting thousands of investors for a single offering.
Funding History
Competitive Analysis
Incumbents
Cryptocurrency exchanges see DeFi as a natural extension of their offerings; traditional banks still testing the waters
As most DeFi projects are based on the same blockchain as popular cryptocurrencies (such as Ethereum), established cryptocurrency exchanges such as Coinbase and Binance can expand their offerings to cover DeFi-related projects with relative ease. These exchanges are using their existing marketplace offerings to allow users to swap DeFi-related tokens, hold them using the same wallets as their crypto, and even provide direct access to deposit their tokens into yield-generating tokens like DAI from MakerDAO.
Traditional banks are yet to fully break into this space, as they are restricted by their internal compliance measures and an overall risk-averse approach to innovation. However, large international banks (such as JPMorgan and ING) are taking steps like experimenting with blockchain in their internal processes, working on building the infrastructure to develop apps on top of it, and testing tokenized versions of real-world assets in regulatory sandboxes.
Notable Investors
