The current state of DeFi one year after the crypto bubble burst

Last Friday was the one year anniversary of the collapse of the Terra Luna Stablecoin. This event marked the end of the 2020-2022 crypto bull market and started a chain of events that would lead to the high-profile collapse of corporate crypto exchanges such as FTX, BlockFi, Celsius and Voyager.

As the irrational exuberance of the 2020-2022 crypto bull market cycle has subsided, the one-year anniversary of the Terra Luna collapse provides many opportunities to reflect on the current state of the crypto industry. However, for today’s article, I want to focus on the outlook for DeFi protocols one year after the crypto bubble burst.

For those unfamiliar with DeFi, a DeFi protocol is code built on top of an existing blockchain (such as Ethereum) that is designed to provide a specific financial product or service (e.g. crypto trading, crypto lending, crypto insurance, etc. ). DeFi code performs transactions without traditional financial intermediaries between parties. Major changes to DeFi protocols can usually only be made if the majority of the community votes for the change.

Over the past 12 months, despite all the headlines surrounding corporate crypto exchange bankruptcies and regulatory actions in the US, the leading DeFi protocols have largely continued to run smoothly and function as expected. In fact, headlines about regulatory uncertainty in the US only seem to be fueling interest in DeFi services.

It is also important to understand the global nature of DeFi. Because DeFi protocols are not traditional financial companies tied to a specific jurisdiction, DeFi services can usually be accessed with a few clicks of a button from almost anywhere in the world with an internet connection. The use of cryptocurrency is strongest in countries in the developing world, where weak rule of law, unstable currencies and unreliable financial institutions motivate the use of crypto and DeFi.

However, DeFi is not a monolith. To broadly generalize, there are five types of DeFi that are most relevant to the average consumer: DeFi Lending, DeFi Trading, DeFi Asset Management, DeFi Payments and DeFi insurance. And not all types of DeFi have thrived in the past year or so. I worked with research and consulting firm Corporate Insight to write a detailed study on the DeFi ecosystem in honor of this anniversary – DeFi 2030 report. According to Corporate Insight CEO Michael Ellison, “the end of the 2020-2022 crypto bull market saw a marked decline in both consumer and venture capital activity in the crypto space. Therefore, the last twelve months have revealed the real prospects of different types of DeFi. For example, DeFi lending and DeFi trading have performed relatively well, while DeFi asset management and DeFi payments are still nascent but have shown potential. On the other hand, some DeFi concepts do not yet appear to have meaningful traction.”

Today, let’s examine one of the five DeFi verticals that generally doesn’t get as much attention as other areas of DeFi – DeFi insurance. There are about 20 different DeFi projects that offer some sort of insurance for the crypto ecosystem. These protocols provide insurance against crypto theft, hacks or failures. While none of these insurance protocols have the traction or scale seen with other types of DeFi protocols, pooling of cryptoassets is already common in the cryptoecosystem. Therefore, the P2P pooling of cryptoassets to provide insurance against cryptocurrency hacks or bugs seems likely to succeed in the long term. As long as the overall crypto ecosystem continues to grow during the 2020s, “winners” will emerge and DeFi crypto insurance is likely to grow and achieve scale.

When it comes to DeFi insurance for real-world assets, however, the outlook is much less clear. Several projects that used to offer some form of DeFi insurance for real-world assets have turned around and changed their business model in the last twelve months. Despite some initial hype around DeFi insurance for real-world assets, there does not appear to be any DeFi protocol selling insurance for real-world assets with meaningful traction.

DeFi insurance for real-world assets faces several challenges, and DeFi’s ability to handle things like large-scale insurance fraud is unproven and unproven. Insurance is also a highly regulated industry in many jurisdictions, and regulators can force DeFi protocols that attempt to offer real-world insurance products to act in a less decentralized manner. According to Michael Beck, project manager of DeFi insurance protocol UNION Finance, “Properly executed, DeFi protection protocols do not have actuaries, underwriters or adjusters. Instead, they use the market’s expectations of risk and return to inform price and oracles or token holders vote on claims. Decentralized protection protocols can be used to address some of the shortcomings of the traditional insurance industry, but being a protocol and a regulated insurer are two very different things.”

In the long term, DeFi can offer event-related insurance (eg weather-related insurance, flight delay insurance, etc.) as this type of insurance does not require a manual and/or personal claims review process. However, at this stage, it is unclear whether DeFi protocols will be able to disrupt traditional insurance companies that sell home, life and auto insurance to consumers.

That said, as the crypto industry grows, DeFi protocols that have achieved scale can expand and start developing more traditional insurance products for real-world assets. In addition, some projects specifically highlight their long-term plans to offer traditional insurance products on the blockchain. For example, the Nexus Mutual website highlights that the firm plans to offer real-life insurance in the future. The next crypto bull market may see another attempt to develop DeFi insurance for real-world assets.

Of course, DeFi insurance is just one of many types of DeFi services, and arguably has the lowest levels of traction of the five types of DeFi protocols discussed earlier. DeFi protocols like Aave ($5.2B), Curve Finance ($4.2B) and Uniswap ($4.1B) all manage billions of dollars based on code. According to Kevin Goldstein, co-founder and managing partner of Kee Global Advisors, “the past 12 months have proven that DeFi protocols are here to stay. Although not all DeFi concepts will succeed, DeFi as a whole will fundamentally challenge the established financial industry.”

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