Problems In DeFi

DeFi, short for Decentralized Finance, has been one of the most transformative and revolutionary aspects of the blockchain industry. It has paved the way for a decentralized and inclusive financial ecosystem, enabling users to access financial services without the need for intermediaries such as banks or traditional financial institutions.
The evolution of DeFi can be categorized into different stages or versions. DeFi 1.0 refers to the initial phase, characterized by the development of basic decentralized applications (dApps) like decentralized exchanges (DEXs) and lending platforms. These platforms allowed users to trade digital assets, provide liquidity, and earn interest on their holdings in a trustless and transparent manner. However, DeFi 1.0 faced several challenges, including scalability issues and limited interoperability.
Here are some of the important challenges users are facing in a DeFi space today:
  1. 1.
    High gas fees on top chains: This problem is prevalent in many DeFi platforms, particularly those on Ethereum, where transaction costs can be prohibitively expensive. These high fees can severely impact the profitability of yield farming, particularly for smaller investors.
  2. 2.
    Yield discovery is a struggle: With an increasing number of DeFi projects available, finding the best yield opportunities has become increasingly complex and time-consuming. This abundance of choice can lead to decision fatigue and missed opportunities.
  3. 3.
    Yield market is too fragmented: The yield market is divided among numerous blockchain platforms, creating friction for users wanting to move their assets across chains. This fragmentation can hinder efficient capital allocation and limit users' ability to exploit yield opportunities across different chains.
  4. 4.
    Yields are variable and keep changing: The dynamic nature of DeFi yields can make portfolio management a challenging task. The constant fluctuations in returns require frequent monitoring and rebalancing, which can be laborious and stressful for many investors.
  5. 5.
    UX is sub-optimal: The user experience in DeFi is often less than ideal, with complex interfaces and jargon that can be off-putting to newcomers. This complexity can act as a barrier to wider adoption of DeFi.
  6. 6.
    A lot of hidden risks: DeFi carries numerous risks, including smart contract bugs, flash loan attacks, and impermanent loss. These risks may not always be apparent to users, making it difficult for them to fully understand the potential downsides of their investments.
Problems in DeFi today
On several of them, we'd like to elaborate in more detail:

UX and gas fees

Despite Ethereum network switching to PoS, the gas fee optimization has not changed much. Recent activity around PEPE and other meme tokens increased gas fees on Ethereum by a factor of x2 – x5, making it extremely costly and causing many DeFi protocols to be more inactive.
Ethereum Average Gas Price Chart
Gas fee optimization has become a crucial area of focus in the blockchain industry, as high fees can hinder user adoption and limit the scalability of decentralized applications. Fortunately, various solutions have emerged to address this challenge, and two notable examples are Arbitrum and Blur.
Arbitrum is a layer 2 scaling solution built on Ethereum that aims to improve scalability and reduce transaction costs. By leveraging off-chain computation and only settling the final results on the Ethereum mainnet, Arbitrum can significantly increase transaction throughput and lower gas fees. It achieves this by batching multiple transactions into a single proof and submitting it to Ethereum as a single transaction. This approach enables more efficient use of network resources and reduces congestion on the mainnet, resulting in lower fees for users.
Blur is an aggregation service that primarily targets pro-traders. A common theme among the pros is that they usually prefer to “sweep” NFT projects. They purchase multiple or a bunch of NFTs from any project at their floor price. Blur allows creators and collectors to do this via their inbuilt tools across multiple projects.
Both projects used transactional fee saving as one of the major features to be marketed.
However, the idea that the high gas fees problem can be solved by simply moving to cheaper networks is not optimal. No network is even close to the TVL of Ethereum, which represents almost 60% of the entire space TVL attributed to DeFi protocols.
TVL Per Chain Based on DeFiLlama
Low gas fees on other networks is a great myth as well. Of course, Ethereum tops the amount of actual money needed for gas fees. However, other networks such as Polygon, BNB Chain, Avalanche are not cheap to the point where transactional fees can be completely irrelevant.
𝑇𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛𝐹𝑒𝑒(𝑖𝑛𝑁𝑎𝑡𝑖𝑣𝑒𝐶𝑜𝑖𝑛)=𝑇𝑜𝑡𝑎𝑙𝐺𝑎𝑠×𝐺𝑎𝑠𝑃𝑟𝑖𝑐𝑒𝑇𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛 𝐹𝑒𝑒 (𝑖𝑛 𝑁𝑎𝑡𝑖𝑣𝑒 𝐶𝑜𝑖𝑛) = 𝑇𝑜𝑡𝑎𝑙 𝐺𝑎𝑠 × 𝐺𝑎𝑠 𝑃𝑟𝑖𝑐𝑒
𝑇𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛𝐹𝑒𝑒(𝑖𝑛𝑈𝑆𝐷)=𝑇𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛𝐹𝑒𝑒(𝑖𝑛𝑁𝑎𝑡𝑖𝑣𝑒𝐶𝑜𝑖𝑛)×𝐶𝑜𝑖𝑛𝑀𝑎𝑟𝑘𝑒𝑡𝑃𝑟𝑖𝑐𝑒𝑇𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛 𝐹𝑒𝑒 (𝑖𝑛 𝑈𝑆𝐷) = 𝑇𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛 𝐹𝑒𝑒 (𝑖𝑛 𝑁𝑎𝑡𝑖𝑣𝑒 𝐶𝑜𝑖𝑛) × 𝐶𝑜𝑖𝑛 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒

Multichain fragmentation

The decision of whether to participate in the larger Ethereum ecosystem or explore opportunities on other blockchain networks is a crucial one for DeFi participants. Ethereum has established itself as the dominant blockchain for decentralized finance, with a significant portion of Total Value Locked (TVL) residing on its network. However, there are other emerging blockchain platforms that offer unique advantages and a more specialized environment for specific use cases.
The analogy of being a small fish in a huge pond or a big fish in a small pond is relevant when considering the trade-offs between Ethereum's network effects and the potential for greater visibility and prominence on smaller blockchain networks. Being a small fish in a huge pond implies that although the competition and noise might be high, there is a vast user base and established infrastructure to tap into. On the other hand, being a big fish in a small pond suggests that while the user base and infrastructure may be smaller, there may be opportunities for greater recognition, influence, and potential early mover advantages.
However, it's important to note that the decision doesn't have to be an either-or scenario. By leveraging bridging partners, it is possible to have a presence and benefit from both the Ethereum ecosystem and other blockchain networks. Bridging solutions facilitate interoperability between different chains, allowing users to access assets and liquidity across multiple platforms.