DeFi was the shining star of 2020, serving as the first real narrative of the previous market cycle. Its entry into the crypto mainstream is now affectionately known as "DeFi Summer." Anyone who was interested in crypto at the time will recall the restless nights as project after the project was created to ensure short-term success. Yet, 99% of those projects never made it to the end of the year.

While there have been ground-breaking inventions, there have also been thoughtless clones in DeFi. The source of the problem is between the growth of actors focusing on short-term profits and user acquisition/onboarding issues. Permissionless development is a double-edged sword. This article will discuss the next six probable DeFi topics for 2023.

Theme 1: The rise of the DeFi giants.

Although 2022 was a difficult year for DeFi blue chips, these projects continue to dominate their respective markets. Given that value will almost certainly move to the application layer over time, it becomes reasonable to investigate the blue-chip comeback theory. This motif will become much more prominent if and when fundamentals begin to matter.

Uniswap

Despite Uniswap's firm grasp on the DEX market, v3's impetus has faded completely. The token's functionality has been called into doubt due to hesitation in initiating the fee switch and a cabal-like governing structure. UNI has been progressively declining because of a lack of fresh tailwinds.

A fee switch experiment is now being considered by Uniswap's governance. This proposal only affects three pools and does not already transfer fees to UNI holders. The fee switch is expected to be a contentious issue throughout 2023, but it is still a long way off as a means of accruing UNI value.

Source: Substack

The recent introduction of Uniswap's NFT marketplace aggregator signaled the start of Uniswap's horizontal expansion into NFTs. This kind of growth might offer the UNI token genuine benefit while avoiding the perilous fee switch. Uniswap might also expand vertically by purchasing wallet applications and constructing infrastructure to integrate customers directly.

Synthetix

Synthetix may be the most romantic use case of any OG DeFi dApp at first glance. SNX rose to a $4 billion market valuation in early 2021 on the promise of a full-stack, permissionless derivatives platform that democratizes access to the $630 trillion derivatives market. Although progress has halted and hopes have decreased, Synthetix has quietly been cultivating a robust environment of Optimism.

The Synthetix ecosystem pioneered sustainable governance, synthetic assets, cross-asset atomic swaps, and other innovations. Synthetix v3 will include a thorough redesign of the protocol, allowing Synthetix to maintain its leadership as a test-in-progress environment for unique DeFi ideas.

SNX has the most simple value accrual and usefulness of any major DeFi token, being the single form of collateral and beneficiary of platform fees. In 2023, a protracted negative market combined with DEX tailwinds might induce a flight to qualify for tokens like SNX, which have regular cash flows and interesting deliverables.

Aave

The release of Aave v3 in March marked the beginning of a very exciting year for Aave. Aave is once again taking the lead in pushing crypto ahead, with little concern for the token price. The introduction of its institutional DeFi platform Aave Arc, the creation of the decentralized stablecoin GHO, and the development of the decentralized social network Lens Protocol all indicate a concentration on company growth and long-term thinking.

These additions may seem trivial at first, but they will form the basis of Aave's ultimate vision. The AAVE token has the grimmest near-term prognosis of the blue chips described here, but if their intentions are realized, the token will thrive.

Theme 2: Protocols that allow leveraging

In 2023, speculation primitives have plenty of room to grow. For a long time, there has been a dearth of accessible, capital-efficient access to leverage. In order to fully capitalize on chances that need spot leverage, users are compelled to use improvised strategies such as recursive borrowing.

Through its credit accounts, Gearbox enables composable, capital-efficient leveraging. These credit accounts serve as leveraged leverage wallets for authorized procedures. Gearbox v2 improves overall UX and scalability by streamlining liquidations and gas costs. The usefulness of Gearbox will rise tremendously when additional protocols are whitelisted, and new primitives are created. Gearbox may even enable previously unthinkable applications to thrive.

Source: Medium

In traditional finance, forex is a vast market that is heavily guarded. Despite excellent circumstances, efforts to introduce a currency to DeFi have failed because of limited demand and inadequate design.

Given the existing economic environment, it seems that if FX is to become a reality in DeFi, it will begin to show some potential in 2023. This might happen in one of two ways:

Using the Oracle model to create synthetic assets: Gains Network and GMX provide the most convenient approach to get leveraged exposure to synthetic assets. These projects must use innovative ways to limit tail risk, which comes with a number of negatives. Nonetheless, this approach is simple to implement and already demonstrates the increasing demand for forex in DeFi. In September and October, forex transactions accounted for the vast majority of Gains Network volume. With GMX's significantly bigger user base and the anticipated debut of synthetic assets, Forex volume might skyrocket in 2023.

Stablecoins collateralized by multiple currencies: The composability of collateralized stablecoins inside the larger DeFi ecosystem would benefit them. Existing initiatives have failed owing to the limited value of spot foreign-currency exposure, such as Iron Bank Fixed Forex and Handle.fi. Personal financial use cases are hampered by the absence of convenient ramps, and the inaccessibility of spot leverage forces users to rely on synthetic perps for trading. This is an excellent illustration of the Synthetix and Gearbox value-adds mentioned before. Without synthetic asset liquidity pools, peg stability must be acquired via incentives and arbitrage. Through liquidity pools, Oracle-fed prices for synthetic assets may share this responsibility for Forex stablecoins. Gearbox's credit accounts provide potential usefulness in addition to non-levered trading on Uniswap. With further advancements in related dApps and on/off-ramps, this more organic route to on-chain FX adoption might gain pace.

Theme 3: Undercollateralized money markets.

Throughout the year, there has been a lot of talking about undercollateralized money markets such as Maple Finance, Clearpool, and TrueFi. They support the speculative use case by providing accessible leverage to market makers and hedge funds. They, unlike banks, utilize on-chain holdings to assess an entity's balance sheet health and capacity to repay. Their influence on delivering greater liquidity to the market is clear, but initiatives in this field have yet to find the perfect strategy.

Lenders are effectively making unsecured loans to market makers and hedge funds of "high stature." Not returning their debts is comparable to destroying their whole cryptocurrency reputation. A fund is unlikely to deliberately destroy its reputation for a few million dollars unless they are insolvent and have a true incapacity to repay loans.

However, given the frequency of tail events in crypto, lenders' real risk is likely to be greater than their perceived risk.

Certain forms of hazards are heightened in unsecured money markets such as Maple Finance and Clearpool as compared to overcollateralized money markets such as Aave and Compound.

Given the unsecured nature of these loans, default risk is the clearest. Counterparty and concentration risk come in second and third, respectively. For example, under Maple's concept, a pool delegate selects who gets lender cash. If too much money is transferred to one entity, lenders in that pool face increased counterparty risk. This is especially true for Clearpool, because each pool is exposed to a single borrower and hence has a larger inherent concentration risk.

We won't get into the designs and hazards associated with these procedures since we don't want to waste your time. The main topic of this article is why this might be a significant aspect of DeFi. We can all agree that liquidity is essential to a healthy market. Leverage is a formidable tool when utilized effectively. An unsecured loan is still the simplest approach for professional crypto investors and traders to get capital efficiency.

Market makers are the primary users of unsecured money markets. To execute their role, they need easy access to spot leverage. Traditional banks and financial institutions are unlikely to grant Wintermute, Folkvang, or GSR a substantial loan to sell crypto assets. Even if they did, it would be a time-consuming procedure riddled with the bureaucracy that banks are notorious for. While the appraisal procedure varies per protocol, on-chain undercollateralized loans are often granted using an on-chain balance sheet.

The flip side of the coin is that if you think banks have robust risk assessment and review procedures, companies who are unable to get a bank loan will seek less demanding alternatives. This is the heart of the crypto lending market: conventional financial institutions will not lend to them; therefore, they must resort to crypto-native lenders. However, the process of granting loans against verified on-chain assets and monitoring an entity's on-chain balance might operate as a mitigant by assisting lenders/underwriters in determining when to intervene. It's only a question of figuring out the best business strategy to accomplish it all.

You're undoubtedly aware of the failures of institutional lenders such as Celsius, BlockFi, Hodlnaut, and Babel Finance, as well as the impending doomsday for Genesis and others. Traditional lenders operate in the shadows. There is no transparency for lenders in terms of how much and to whom their money is given. Capital providers to these lenders are unable to assess concentration risk to a single borrower, and they are unable to depend on the lending middleman to operate prudently and diligently. Borrower concentration was responsible for the demise of many lending books.

To be sure, unsecured financing via DeFi does not address all of these issues. It would not have necessarily prevented lenders from making large loans to a single hedge fund, but it may have. Lenders may have seen a single business receiving large loans from every possible platform and initiated public dialogue to pressure these platforms to shut off their credit lines. In the example of TrueFi, which utilizes governance to authorize loans, token holders may have begun voting against more credit lines to that entity.

So maybe the music would have ceased sooner and caused much less harm.

The latest event is an example. Auros failed to return a $3 million loan from Maple's platform last week, causing significant alarm. The problem simply got worse from there.

While the concept of undercollateralized lending has the potential to strengthen DeFi markets, there isn't much faith in the models that exist now. In summary, TrueFi has been utilizing token governance to authorize loan issuance (this may change soon), Maple gives pool delegates a lot of authority (thus centralizing loan issuance), and Clearpool has borrower-specific pools that do not enable lenders to diversify their risk.

Unsecured DeFi systems, on the other hand, provide the simplest means for market makers and hedge funds to get spot leverage. Customer deposits were utilized by centralized operations such as BlockFi and Celsius to lend funds to institutions. Similar DeFi solutions accomplish the same thing, but lenders can see their risk profile and where their cash is being deployed. The key difference is gaining more openness — and, ideally, the capacity to demand specific measures in the future.

While counterparty, concentration, and default risks exist in any unsecured loan market, DeFi systems provide unparalleled transparency. As a result, these platforms are serious rivals to companies such as BlockFi, Nexo, Crypto.com, and other institutional loan providers.

When the crypto market recovers, there will be a significant increase in volume for both on-chain and off-chain trading venues. Platforms that provide institutions with leverage at a predictable cost of capital may prove to be an essential element of market infrastructure. In a time of high demand for leverage, unsecured on-chain lending protocols might offer potential users competitive returns vs their centralized counterparts as crypto users want to invest cash into passive (but not risk-free) options.

To play the devil's advocate, it's feasible that the efficiency gains from this paradigm aren't worth the dangers. Perhaps DeFi should stop attempting to imitate TradFi and instead concentrate on its fundamental objective of trustless and decentralized financial infrastructure. While unsecured credit indirectly enriches markets and on-chain versions of these products improve loan book transparency, decentralizing these platforms is proving tough.

Theme 4: Improving Passive LP and Enhancing Delta Neutrality

The demise of SushiSwap and Uniswap v3 signaled the end of incentivized LP staking. Charm and Visor LP management systems have done nothing to demystify concentrated liquidity provision for passive users. DOVs took advantage of the AMM's failure to protect LPs, but they still pose a significant risk over lengthy periods of time. Liquidity providers have limited choices for securely chasing significant profits, but 2023 will bring a new generation of DeFi initiatives catering to neglected LPs.

Lyra Finance's Avalon upgrade introduced DeFi to the first delta-hedged AMM. Since its inception, the capacity of an AMM to hedge its obligations has been a game changer for LPs. Delta hedging is exceedingly difficult to deploy; however, more delta-neutral AMMs and projects with sustainable yields are emerging.

Source: Lyra finance

GammaSwap enables users to bet or hedge against impermanent loss by seeking volatility. LPs on XYK AMMs are basically long volatility and short volume. The volatility that exceeds the rewards from trading fees results in a temporary loss. Because AMMs do not enable liquidity borrowing, longing for impermanent loss is not as simple as shorting spot tokens through money markets. GammaSwap is developing a user - AMM intermediate layer that will enable LP token manipulation.

Users may borrow an LP stake and split the tokens using GammaSwap, obtaining positive exposure to temporary loss. In all circumstances, liquidity borrowers pay a funding rate to GammaSwap LPs, resulting in a payout structure that outperforms the vanilla LP position.

Rage Trade is seeking to alleviate some of the previous concerns with vAMMs while also providing LPs with stacking yield through recycled liquidity. Users may deposit LP tokens into several 80-20 vaults using Rage Trade. On the original platform, 80% of the TVL is unaltered. The remaining 20% supports Rage Trade's ETH perpetual market by collateralizing concentrated LP holdings on a Uniswap vAMM. The payment is similar to the initial yield plus a Uniswap v2 ETH-USDC LP position.

The fact that these new initiatives provide tangible gains over the status quo is a recurring topic. LPs are still vulnerable to short-term losses and drawdowns, but they benefit from additional income by fueling creative new products.

Theme 5: A fresh wind for UX Aggregators: A DeFi Front End

The present state of crypto's user experience is far from optimal. Currently, the typical process flow is as follows: plugging in a piece of hardware, using a browser extension to regulate the flow of cash, and accessing a variety of different websites to perform one's activities. Reading that, traditional tech UX designers lost a chunk of their spirit.

It is difficult to use crypto. And the longer it persists, the greater the distance between this sector and popular acceptance.

What does the UX of conventional finance look like when we zoom in on financial services? It varies depending on the individual. However, you would normally have one app for your brokerage (investments), one or more banking apps, one or more payments applications (Apple Pay/Google Pay), and maybe an aggregator of some type to assist in aggregating information and payoff various credit card bills from a single interface. The typical individual generally uses 4-5 financial applications to get everything done.

But how come this is the case? Different banks, on the other hand, operate on their own infrastructure and provide excellent gatekeeping features. Only some feature sets, such as credit card payments, may be aggregated by aggregation applications. For the most part, you must utilize a bank's website/app. Or, much worse, go to a branch.

DeFi is built on a foundation of transparent infrastructure legos. These basic layers include Ethereum, Solana, Avalanche, and Arbitrum, to name a few. These networks are home to non-custodial networks, with smart contract custody being the greatest level of custody. Even so, each user has discretion over when they may deposit/withdraw funds.

As a result, we no longer need to live in a world where users must travel to the Uniswap front end to access swaps or the Aave front end to get profit on idle assets. We can build UX aggregators that serve as a single front interface for all of DeFi.

To begin with, unlike banks and brokerages, crypto users seldom visit a single app. It makes no difference whether you use a Charles Schwab brokerage account or a TD Ameritrade account to purchase Apple shares. In either case, your order is sent to the NYSE orderbook. However, there is no central trade venue in DeFi. There are hundreds, if not thousands, of DEXs with liquidity where assets may be traded. Depending on the amount of your deal, you will see varying execution prices for a coin you wish to buy on Uniswap, Curve, 0x, Bancor, SushiSwap, and other exchanges.

This is fixed by liquidity aggregators. Protocols such as Matcha, 1inch, and ParaSwap aggregate quotations from many DEXs to provide consumers with the lowest execution price. A logical user would go to one of these liquidity aggregators rather than visiting many front ends to obtain the best price or remain loyal to a single trading venue.

DEXs have seen the most product-market fit so far. As a result, DEX aggregators have achieved success. We predict liquidity aggregation to develop faster than DEXs in the future as DeFi expands. Borrowing, lending (or yield in general), options, perpetual swaps, and other products will inevitably emerge. This is necessary due to the enormous number of protocols that facilitate each of these actions.

But, if we have liquidity aggregators for each DeFi sector, does it imply customers would have to visit various aggregator front ends for each of their needs? Who will aggregate aggregation?

UX aggregators lay on top of all of these liquidity aggregators, combining all of their functions into one interface. Imagine accessing a single front end, linking your wallets, and quickly finding the finest venues for a particular swap, yield-bearing possibilities, borrowing rates, perpetual futures execution, the lowest option premiums (or the most costly for potential sellers), and more.

Even for power users, UX aggregators provide a significant improvement in the ease of use of these programs. Products like these don't always appeal to new users who are unfamiliar with the sector — a point we'll return to later in this study. Given that users will still need to utilize hardware wallets and browser wallet extensions, the primary buyers for pure UX aggregators are those who are already familiar with these tools. However, making life simpler for the present user base is not something to be done lightly. Every move toward making DeFi easier to use is a step in the right direction.

UX aggregators provide some interesting advantages to newbie crypto users that trade using their own wallets. To begin, access is restricted to protocols judged "safe" from rug danger. Zapper is unlikely to incorporate a new farm with a 4-digit APY and a significant chance of the team pulling a rug. More smart users who realize the hazards of these farms will have no qualms with visiting a different front end on occasion to satisfy their inner degenerate. However, since the whole experience is non-custodial, there is a lot of freedom. For example, one might still use a UX or liquidity aggregator to switch to high-risk tokens by ignoring the warning that appears. You're warned, and that's the end of it. Nobody can prevent you from accomplishing anything.

Source: zapper

Importantly, since they are the layers with which users engage, UX aggregators will control the consumers. This may lead one to believe that these are excellent businesses to buy, but monetization is not that straightforward.

This isn't Web2, where Facebook can spam consumers with ads. There are currently several UX aggregators, such as Zapper, Zerion, and DeBank, and since a user owns their data through their on-chain addresses, switching costs are quite minimal. If one UX aggregator seeks to commercialize via advertising, which is frowned upon by most crypto supporters, the user's cost of switching to a different UX aggregator is insignificant.

Overall, we think that UX aggregators are poised to become DeFi's principal user-facing layer. The timing of this depends on when they release the kinds of feature sets that customers demand. Given the amount of active on-chain users, Zapper, Zerion, and DeBank already have quite large user bases. It's now only an issue of devising a fresh monetization technique that doesn't compromise usability.

Theme 6: veTokens will still dominate, but there should be an alternative.

At the tail end of DeFi Summer, VeTokenomics exploded into the scene with Curve's yield farming frenzy. Curve's position as DeFi's liquidity moat was strengthened by the subsequent Curve wars. Hundreds of more projects are also using veToken ideas. Over $10 billion TVL is currently invested in projects that have adopted or intend to use some kind of veTokenomics.

At their foundation, veTokens are meant to reduce sell pressure from aggressive liquidity-mining systems by introducing market inefficiencies (tying illiquidity to optimum yield).

Source: Medium

Typically, mature veToken structures like CRV, CVX, FRAX, and BAL result in the locking of around 50% of the token supply - an evident advantage for token holders. When appropriate, steep emissions charge token holders who provide no value to the project a financing rate. Long-term thinking by ve-lockers, in theory, generates more value. This value diminishes when individual users are surpassed by aggregators, who further isolate incentives.

Convex developed a liquid wrapper named cvxCRV after launching veCRV. Convex lets users stake their Curve LP tokens for higher returns without committing to the veCRV. Individual users tended to avoid the unneeded sunk cost, which increased Convex's accumulation of veCRV. Users who froze CVX for 16 weeks in return for vlCVX had control over Convex's veCRV gauge votes and prevented the linear decline. Because of the separation of veCRV's usefulness, vlCVX has huge voting power, with 1 vlCVX controlling over 5 veCRV. Individual veCRV holders are diluted, and the benefit of veCRV is distributed too thin in comparison.

Because Convex needs users to lock CVX in order for vlCVX to direct gauge voting and earn bribes, an extra liquid wrapper is required. Pirex from the Redacted Cartel produces liquid wrappers for locked-token systems like vlCVX. Pirex enables the automatic compounding of rewards as well as the tokenization of future voting events. It will eventually include GMX, as well as, strangely, its native revenue-locked BTRFLY.

Bribe marketplaces like Votium and Redacted Cartel's Hidden Hand enable users to trade governance votes for money. With the market for veTokens expected to grow in 2023, the market for voting boutiques that oppose these designs in favor of equilibrium might gain greatly. Votium presently leads the Convex market, with approximately $200 million in bribes paid on the site.

Bribers were able to direct over $5 in CRV emissions for $1 spent on bribery during Votium's early rounds. This arrangement is especially advantageous for projects like as Frax, which owns a considerable amount of CRV and CVX and uses bribery to divert emissions into its pools. As Frax effectively pays themselves, vlCVX ownership provides a refund for bribe expenditures. Emissions per dollar spent on bribes are now about $1.40 and will most likely remain at or around $1.

While emissions per dollar fall, the proportion of mercenary voters is expected to stay unchanged or rise. Since its beginning, vlCVX delegation has stayed consistent at roughly 80%. Users don't lock veTokens to rule; they lock them to profit financially. This is confirmed further by the fact that just 18% of veCRV holders have voted in Curve governance. Votium's losing market share is most likely due to a poor bribe-claiming UX rather than a decreased desire for bribes. Pirex's partnership with Llama Airforce addresses this problem with uCVX, which automatically compounds profits into pxCVX.

Users will prefer the outermost layer over comprehending the confusing jumble of unlocking schedules and who controls who when higher aggregation levels develop. Because NAV will be made up of unconnected businesses, Frax-like ownership at the meta-governance layer will be less practical. As the more transactional shadow market is pushed to the back end, bribe markets will approach native token dumping as a service. The market will suck all it can out of these high FDV gauge tokens to maintain constrained yields, as we are now seeing with sustainable yield and principal-protected contracts.

The veToken design was created specifically for Curve's business. It works as well as it always has for Curve. Currently, projects are utilizing veTokenomics as a leveraged liquidity-mining program with no specific goals or KPIs. The frenetic copycat phase of adoption, including pool 2s, Ohm forks, and LUNA clones, tends to exhaust the market demand for tokenomics fads. What remains are just the fundamentals. The fundamentals of veTokens are just additional layers of red tape supporting on-chain feudalism.

VeTokenomics aren't necessarily evil; they're simply useless. There's a lot more to cryptocurrency than token unlocks times. The growth of veTokens is a sign of DeFi's general sluggishness over the last year. Inefficiencies in the market will ultimately be eroded and abstracted away from view. All pathways ultimately lead to another alternative. Meanwhile, there is a lot of value to be harvested when approaching this equilibrium. Playing this narrative right might be quite profitable.

Conclusion

We could discuss a number of additional themes that we feel will influence the industry. The necessity for payment rails improved on and off-ramps for crypto > fiat, the advent of DeFi app chains, the consequences of apps controlling their infra layer, and many other issues are at the forefront of our thoughts. Furthermore, the DeFi bull case and how durable it has been in the face of recent market volatility are front of mind.

There is plenty to be enthused about. DeFi is on the verge of some of the most exciting potential (and difficulties) in the financial industry's history. We think that decentralizing the financial system and enabling permissionless access to a diverse range of financial products will be critical initiatives during the next decade. The most apparent difficulty is regulation, particularly given the prominence of U.S. regulators' attitudes and the existence of groups with a strong interest in squashing DeFi.

Disclaimer:
This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.

The six key themes for DeFi in 2023