This is a discussion about the current status of the DeFi market as a whole.

At the beginning of 2023, the global crypto market bounced back along with the overall economy. Of course, this has been boosted by a reduction in inflation, the reopening of China and strong demand. Total cryptocurrency market capitalization has reached the $1 trillion threshold once again. Despite this, it is still considerably lower than the all-time high of approximately $3 trillion recorded in late 2021. 

The DeFi sector has also experienced a similar rise. Contributing to the expansion of the DeFi market are several significant advancements from the past month, alongside various macroeconomic factors.

Consensys has produced a report analyzing in detail the status of the DeFi space.

What is DeFi?

Firstly, DeFi stands for ‘decentralized finance’. It is a sector in the finance industry aiming to create an open and transparent financial system using blockchain technology. DeFi is designed to remove intermediaries. Additionally, it seeks to enable peer-to-peer transactions, automated market making, lending, borrowing and trading without resorting to traditional financial institutions. 

DeFi market cap

As of December 2022, the DeFi market cap was recorded at $29.9 billion, indicating a continued downturn in the industry. However, in January 2023, the market cap experienced a substantial recovery, reaching $44.8 billion. This represents a remarkable 50% increase in just one month. Nonetheless, despite this impressive rebound, the current DeFi market cap is 60% lower than the figure recorded in January 2022.

Cryptocurrencies and DeFi tokens

Bitcoin (BTC), the most prominent digital currency, gained considerable momentum in January. At the beginning of the year, BTC was priced at $16,500. By January 30th, its value had risen by 45% to approximately $23,955. This surge in price resulted in a sense of optimism among investors regarding the future of the industry.

Also, Ethereum's (ETH) price has rebounded to around $1,600, which is similar to the levels seen prior to FTX’s fallout. On the other hand, DeFi market tokens have experienced pronounced price fluctuations. DeFi dominance, which measures the market capitalization of DeFi tokens relative to global crypto market capitalization, has risen to 1.2%. This indicates a more significant surge in prices compared to the overall industry.

What’s more, in January, many tokens experienced significant growth, with most of them posting double-digit gains and reaching multi-month highs. Additionally, there was a 93% year-on-year decrease in losses from DeFi market exploits and hacks over the same period.

As February began, the top 100 DeFi tokens sustained their bullish momentum. This led to a total value locked of nearly $50 billion in DeFi protocols. Along with this, many tokens recorded yet another weekly price surge.

A significant development contributing to this upward DeFi market trend is the upcoming Ethereum Shanghai upgrade. This upgrade is scheduled to take place in March. It will allow validators to unlock their staked ETH tokens, thereby reducing the liquidity risk associated with staking ETH. Liquid staking providers offer staking services to individuals who do not meet the validator minimum of 32 ETH. Understandably, such providers have experienced substantial increases in their native tokens over the past month. 

Decentralized Exchanges 

As part of our exploration of the DeFi market, the next area to consider is decentralized exchanges (DEXs).

In January, trading volume on DEXs increased by 27% compared to the previous month, reaching $56 billion. This is the first monthly volume increase since May 2022, excluding the rise seen in November following the FTX fallout. However, the surge in volume was not evenly spread across all DEXs. In fact, DeFi market activity is becoming more concentrated across a few exchanges. The top five exchanges on Ethereum, for example, accounted for 91% of total activity, up from 73% a year earlier. 

Uniswap was particularly dominant, contributing to 58% of activity in January, up from 50% in December. One reason for Uniswap's increased dominance in the DeFi market is its ambitious expansion plan. Uniswap has launched its DEX on multiple Layer 2 chains, including Arbitrum, Optimism and Polygon. Not only that, but it has captured almost 50% of Polygon’s market share. 

DEXs are likely to capture a more substantial share of volume in future market cycles as opposed to centralized exchanges. This will be facilitated by an improvement in DeFi's user experience (UX) and features and by regulatory guidelines becoming clearer. 

Lending and the DeFi market

In January, the DeFi lending sector also saw a surge in activity. Aave is leading the charge in terms of DeFi market share. Indeed, daily borrowing data indicates that Aave is capturing more market share than its competitors MakerDAO and Compound. Of course, a major contributor to Aave's growth is the deployment of the highly anticipated Aave v3 on Ethereum. This was launched on January 27th, bringing several new features to the platform. These features aim to reduce costs and increase capital efficiency. 

UX and Regulations

Notably, there have been significant UX and regulatory advancements within the DeFi market in recent months. Circle, the issuer of USDC stablecoins, has announced the imminent launch of its Cross-Chain Transfer Protocol. This is a permissionless protocol that will allow users to transfer USDC across blockchains. The new protocol is expected to potentially improve security and also offer more features than standard cross-chain bridges.

Stablecoins play a crucial role in introducing traditional financial activity into the DeFi market.

Furthermore, on the regulatory front, EU policymakers have proposed a comprehensive framework for regulating digital assets. The Markets in Crypto-Assets Regulation aims to attract a significant portion of the crypto market to the EU. It is viewed as one of the most comprehensive guidelines to date and is pending final approval in April.

Conclusions

In summary, the DeFi market has kicked off the year with a strong start, buoyed by a wider market rebound. Additionally, DeFi's value proposition is being strengthened by the potential for clearer regulation and Ethereum's upcoming Shanghai upgrade. It is being helped by continued innovation from key players in the ecosystem too. Macroeconomic conditions are likely to remain a significant factor in overall activity. Despite this, the structure of the DeFi market is showing signs of change.

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