The threats to DeFi’s sustainability — and how to fix them

With insane interest rates and yield farmers endlessly jumping from one protocol to another, fears are growing that DeFi isn’t sustainable — and change is needed.

In the space of 12 months, DeFi has become a $15 billion industry — spawning governance tokens that are now worth even more than Bitcoin.

But the rapid explosion of protocols has brought considerable growing pains… and concerns that the sector is not on a sustainable footing. When interest rates in conventional savings accounts stand at a fraction of a percent, while yield farming generates triple-digit returns, it’s inevitable that questions will emerge about whether this is a bubble that’s fit to burst.

As Ethereum co-founder Vitalik Buterin recently pointed out on a podcast with Ryan Sean Adams, such sky-high interest rates are “just a temporary promotion that was created by printing a bunch of compound tokens, and you just can’t keep printing compound tokens forver.”

SEBA, a regulated crypto bank in Switzerland, hit the nail on the head in September when it released a report that asks this: “What happens when the music stops?”

Its analysts warned that the current yield farming trend in DeFi is not sustainable — and went on to predict that only a small handful of protocols would survive in the long-term. Indeed, Yearn.finance has already embarked on a plethora of mergers in recent weeks designed to bolster development resources and expand its liquidity pool.

Although SEBA went to great lengths to stress that not all yield farming lacks merit, the company added: “Yield farmers made money by hopping from one protocol to another. As long as there are buyers for new protocol tokens, yield farmers can continue jumping among protocols. When buyers stop accepting the other side of the trade, this deranged activity will be arrested. Clearly, this trend is not sustainable.”

It pointed to SushiSwap, a fork of Uniswap, as an example. Following its launch, a myriad of other food-themed forks emerged. “When markets took a bad turn, all except SUSHI corrected by more than 99% and became almost worthless,” SEBA’s analysts wrote.

The bank ultimately drew parallels with the dizzying ICO boom seen in 2017 and 2018 — where most ambitious projects failed to stand the test of time.  

Siloed protocols

Unfortunately, headaches in the DeFi space don’t end here. This year, Ethereum has established dominance as the main blockchain where protocols are based — and according to DappRadar, this network held 96% of total transaction volume in the DeFi ecosystem in the third quarter of 2020.

As reported by Cointelegraph in September, this led to alarm bells being raised over Ethereum’s scalability issues — with transaction fees surging to an all-time high. Although it is hoped that Eth2 will dramatically increase the network’s capacity, experts warn it could be years before the transition to proof-of-stake is complete… and by then, the industry may have had little choice but to look for alternative blockchains.

The research company BraveNewCoin touched upon these challenges in a recent report, where it identified 18 serious non-financial risks facing the DeFi sector.

“Scalability risk is also the risk that Ethereum itself will not scale properly for DeFi protocols to be able to function sustainably over time. If network activity is too high (as it has been recently) it deters smaller investors and removes the ‘accessible’ aspect of DeFi — because smaller investors are earning rewards that are less than the fees required to obtain them. Not only does scalability risk impact investors, but it also impacts protocols,” BNC wrote.

And all of this is before we mention the countless smart contract vulnerabilities that have led to millions of dollars in capital from being sucked out of the DeFi ecosystem by malicious actors. High-profile incidents appear to happen on an almost weekly basis — affecting investor confidence and jeopardizing the industry’s long-term potential.

Finding the answers

According to Unifi — which has already launched on five different blockchains — change is needed if the sector has any prospect of establishing a meaningful presence in the crypto industry into the 2020s and beyond.

At present, the team behind this protocol believe the space is deeply flawed. On most DeFi platforms, those who make the most rewards are those who leave a platform first and move on to the next thing — creating distrust and causing confidence to evaporate. Resultantly, the top-ranking protocols with the highest total value locked are constantly changing.

“Unifi is custom built to be an efficient, rewarding, and sustainable system. Capitalizing on the strengths of each blockchain Unifi is on, we have created a system where all chains contribute together to form a complete tokenomics model, ensuring the success of the entire protocol,” Unifi CEO Juliun Brabon said. 

Unifi says it isn’t a clone of any existing protocol — and instead, the project says it delivers a sustainable tokenomics system that is more akin to a blockchain than a conventional DeFi protocol. This is demonstrated by their governance token, UNFI, which incorporates proof-of-stake into its model. Unifi offers loyalty rewards to liquidity providers and traders, encouraging a sense of community instead of being a race to be the first out. 

The protocol adds that its multi-chain approach results in an ever-increasing audience with each new blockchain supported — with Ethereum, Tron, Ontology, Harmony and the Binance Smartchain united through the use of base tokens. In the last quarter of 2020 and continuing through 2021, Unifi is set to launch on additional blockchains — and new DeFi services, such as cross-chains swaps and a lending platform, will be released.

In order to gain cross-industry support, Unifi says it has received investment from over 20 blockchain venture capital firms, including four major exchanges — Binance, MXC, Bibox and HBTC. Unifi’s governance token, UNFI was recently featured on Binance Launchpool.

As 2021 begins, all eyes will be on DeFi to see whether it can maintain its current size — let alone build on the astronomical growth that was seen in 2020. Sustainability is shaping up to be crucial in making this happen, and encouraging user loyalty could be the key to success.

[…]
Learn more