What Will Drive Crypto’s Likely Bull Run in 2024?

Decentralized finance (DeFi) has experienced tremendous growth since its inception, expanding by more than 1,200% in 2021 in total value locked (TVL) and exceeding $240 billion in invested assets. While DeFi has since fallen to around $60 billion TVL as a result of broader macroeconomic trends, such as rising inflation, the seeds are in place for DeFi to reconfigure the foundations of our financial infrastructure when the next market cycle arrives.

Historically, the return to a bull market develops over a four-year path. This time, a recovery in 2024 is very feasible due to the maturing of monetary policy and easing of regulatory headwinds, which could allow reduced interest rates and enable the flow of funding back into the space.

That bull market is likely driven by four factors: the taming of global inflation, renewed confidence in the sustainability of DeFi business models, the migration of at least 50 million crypto holders from the world of centralized exchanges to the world of decentralized applications (there are more than 300 million crypto holders over worldwide today, mostly via exchanges), and potentially the next change in Bitcoin (BTC) mining difficulty.

Everyone is wondering where users and developers should turn next for opportunities. Will the next cycle repeat the “DeFi summer” of 2020, only bigger and with more users?

A shift to economic sustainability

Startup entrepreneurs can no longer rely on “magic internet money.” What this means is that the market is unlikely to return to the levels of trust that allowed DeFi protocol founders to reward early adopters with large amounts of protocol-generated tokens, thus subsidizing annual returns of more than 100% or even 1000% on invested capital.

While DeFi protocol tokens will continue to have a role to play, the minting of these tokens will come under increased scrutiny. Market participants will question whether the protocol is capable of generating enough fees to fund the treasury and ultimately retain (or invest) more value than it distributes to end users via inflation or rewards.

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Of course, this does not mean that DeFi protocols are expected to be profitable from day 1. Web3 entrepreneurs must consider the concept of unit economy, borrowed from Web2 and Silicon Valley. This will allow a technology-enabled business model to generate free cash flow that exceeds operating and user acquisition costs when oversized early-stage investments are no longer required.

In the world of DeFi, the concept of unit economy translates into an imperative to achieve capital efficiency for liquidity providers and market makers. Simply put, this means that a DeFi protocol must eventually be able to generate enough transaction fees to reward liquidity providers when it can no longer rely on arbitrary protocol token inflation.

What this means for decentralized exchanges

Decentralized exchanges (DEX), also called automated market makers, have always been at the forefront of DeFi. For example, SushiSwap pioneered the concept of protocol-sponsored rewards for early adopters and “vampire attacks” to incentivize liquidity providers to move away from Uniswap.

DEXs have historically not been capital efficient, requiring large amounts of liquidity from liquidity providers to operate every dollar of daily trading volume in a decentralized manner. As liquidity pools generate low fees per dollar of liquidity locked in, they relied on protocol-generated tokens to generate sufficient rewards for liquidity providers.

We are now seeing the rise of more capital efficient DEXs in a trend that is likely to be followed by every other DeFi vertical.

For example, Uniswap v3 allows liquidity providers to concentrate their capital to enable trading only between specific price ranges. This allows one dollar of liquidity to enable many more dollars in daily trading volume, as long as prices stay within that range, thereby capturing more transaction fees per dollar invested in liquidity without relying on protocol-generated token inflation.

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Another example is dYdX, a decentralized derivatives platform. As dYdX uses an order book to match buy and sell orders, it does not require ordinary users to commit liquidity to liquidity pools and instead relies on much more efficient professional market participants to act as counterparties to end users.

Capital efficiency is the name of the game

The next wave of DeFi innovation will come from founders who are able to design decentralized business models that generate sustainable unit economics for liquidity providers and market makers.

The startups that will create these business models may not even exist today. As a result, we are seeing a proliferation of early Web3 startup accelerators looking for the “next big thing” (for example Cronos, Outlier Ventures or BitDAO).

For DeFi to continue to accelerate its growth among the next generation of Web3 users, founders and projects will need to continue to build a variety of options with different risk and reward profiles. With an increasing number of interoperable blockchains offering high throughput and low transaction speeds, developers are given a multitude of options to further develop DeFi and ROI-generating decentralized applications. As Web3 moves towards a multi-chain future, competition will help drive innovation to deliver the best products for end users.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.