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The decentralized finance (DeFi) space has seen renewed interest over the past few weeks, partly due to mild recovery in the crypto sector and bullish protocol-specific developments. For context, the total value locked (TVL) across all protocols contracted significantly in 2022 from $202 billion at the start to $44.78 billion, data from TVL aggregator DeFi Llama shows.
“DeFi […] experienced a sharp drop in TVL following exogenous market events and a challenging macro environment. More and more users have engaged in the ‘flight to quality',” Binance Research analysts wrote in a report summing up last year's biggest events.
In the first two weeks of January, this figure recovered slightly to $53 billion thanks to recovering prices in the crypto market. An increased level of innovation in DeFi projects and related offerings has further supported this rebound.
Last week, DeFi Protocol Ondo Finance launched three offerings that give stablecoin holders direct exposure to bonds and US Treasury. The new DeFi projects have yields between 4.62% and 8%, which compare well to yield rates of popular DeFi protocols that invest in liquidity pools belonging to projects based on blockchain ecosystems like Ethereum.
DeFi was the cradle of vulnerabilities and attacks in 2022
The revived focus on available offerings has perceptibly resulted in increased activity on decentralized platforms, despite the pains in the industry. Still, though DeFi has generally seen a decent start, existing gaps and glaring flaws in the space remain a concern. A report compiled by the Blockchain Security Alliance on crypto crime and Web3 security found that DeFi protocols were the most attacked of all crypto-related projects last year, accounting for more than two third – 113 out of 167 reported major exploits. Bridge exploits, in particular, accounted for six of the largest exploits – ranked by funds in question – recorded across the year, cumulating to roughly $1.4 billion.
In its end-year update on the security incidents afflicting the industry, blockchain security platform CertiK reported that exploiters, hackers and scammers stole more than $62.2 million from victims in December. This figure indicated an 89.5% decline relative to November's numbers while representing the lowest monthly value of stolen funds throughout the year. Though CertiK's update implied a deceleration in reported thefts, recent incidents have sucked up any hopes of a relief or change in the trend.
Bridge hacks, exit scams, and flash loans will continue staining the space
Barely three weeks into the new year, the industry has already flashed early signs of attacks manifesting. Blockchain security experts concur with this inference, having already forewarned that malicious actors are set to act sophisticatedly and aggressively. DeFi lending and borrowing platform Midas Capital reported a hit on its protocol on Jan 15, which resulted in the halting of borrowing on the affected pool- Jarvis Polygon.
The attacker manipulated the WMATIC-stMATIC Curve LP using a flash loan to borrow more than 663,101 MATIC ($660,000 at current prices) before the exploit was detected. In a postmortem update, Midas Capital acknowledged their fault, i.e., failure to address all security concerns when adding the affected collateral token to the pool.
“The lessons here are many, one of them being that being too eager to expand protocol capabilities and being too certain about the due diligence can lead the big oversights and loss of funds […] we did not consider putting borrow limits on a (newly added) collateral, or having a cooldown period before enabling the asset,” the team wrote.
Last week, CertiK alerted that 1200 Ether tokens associated with the Nomad bridge exploit, which saw about $190 million drained due to a smart contract vulnerability, had been moved to crypto mixer Tornado Cash.
Mango Markets hack
The Mango Markets security incident in which the actor, one Avraham Eisenberg, manipulated prices as well has resurfaced in recent days after the involvement of authorities escalated the matter. Eisenberg, who justified his actions as ‘a highly profitable trading strategy', was charged by the Commodity Futures Trading Commission (CTFC) last Monday following his apprehension by the US Department of Justice in December. Magistrate Judge Bruce McGiverin of the US District Court for Puerto Rico heard and determined that Eisenberg be detained pending trial.
What could 2023 present in decentralized finance?
The spike in illicit activity within the DeFi space has drawn even more attention from regulatory agencies. The SEC has hinted that it aims to push crypto entities to comply with long-running securities laws. Proper regulatory oversight is expected to work in favor of institutional DeFi, courtesy of the improved credibility. Major banks such as Standard Chartered, BlackRock & Chase, and Citigroup have made inroads into decentralized finance.
Consumer security flaws to beget DeFi losses this year
Industry experts caution that the majority of security incidents expected this year would capitalize on existing shortcomings in managing private keys as opposed to what has been prominent – brute force attacks on wallets. Blockchain security and intelligence firm Chainalysis compiled a Jan 12 report that a total of $20.1 billion was hacked in 2022, the record highest figure culminating from a three-year run of consecutive increases.
Highlighting the need for better on-chain transparency, the Chainalysis team penned that although blockchains possess innate transparency, there is still room for growth. There are possibilities to integrate off-chain data on liabilities with on-chain data to offer improved visibility. The report authors also remarked that on-chain transparency of all transactions in DeFi is a benchmark that all crypto platforms should aim to attain. As the value transferred to the blockchain increases, all potential threats will become visible, thereby, even better discernability.
DeFi Market overview
The total value locked in all protocols has reclaimed the $50 billion mark for the first time since Nov 15. DeFi aggregator platform DeFi Llama shows that the top 10 projects based on TVL ranking have had a volatile and bullish month, with all virtually in the green across 7-day and 30-day timelines. The decentralized exchange (Dexes) category makes for an interesting watch as it is the kingpin of DeFi protocols. This category has more than 670 projects boasting a combined total value locked of almost $18 billion. Curve Finance leads Dexes rankings with a TVL of $4.98 billion, followed by Uniswap, which is sixth overall, with $3.69 billion. BNB chain-native PancakeSwap sits third with $3.43 billion in total value locked.
Staking rewards platform Convex Finance had the most significant TVL change, alongside Lido, in the 7-day and 30-day periods among the top five protocols at writing, followed by Curve, whose TVL has swollen by 16% in this period. Uniswap has fared well in other statistics that assess a network's performance. More than 480,000 unique active wallets have interacted with dapp‘s smart contracts on Uniswap V3 in the last 30 days – the highest of any decentralized exchange, according to data from DappRadar.
To learn more about Uniswap, visit our Investing in Uniswap guide.
Lido's popularity and growth
Liquid staking protocol Lido Finance has, on its end, seen significant benefits derived from the Ethereum Merge last year. This has been reflected in its TVL change and overall ranking. The liquid staking solution currently sits atop all decentralized finance protocols with $7.88 billion in TVL ahead of MakerDAO's collateralized debt position (CDP) product which has an equivalent figure of $7.06 billion as per Defi Llama data. In the past 7-days, the total value locked on the Lido protocol has increased by nearly 20%, only bettered albeit slightly by lending protocol JustLend. Lido has stamped its dominance in liquid staking derivatives as Beacon Chain depositors anticipate the Shanghai upgrade tentatively queued for March.
Demand for staking products propels Lido past MakerDAO
A December report from blockchain analytics firm Nansen noted that there had been an increase in the demand for staking solutions since Ethereum switched to a proof-of-stake (PoS) consensus. The report shed light on how Merge's introduction of staked ETH as a way to earn yield-bearing has proven to be more successful than collateralized yield-bearing products. Particularly eye-grabbing is the popularity of Ether liquid staking, where Lido has so-dominantly established its status.
The rankings have, however, been challenged by MakerGrowth, which asserted a fortnight ago that Defi Llama “excludes a number of different collateral options that account for more than $1 billion of TVL.” Lido's TVL only recently surpassed MakerDAO, recently guided by the buzz around Ethereum's staking plans in Q1.
To learn more about Lido, visit our Investing in Lido guide.
Polygon partners with Uniswap to provide a low-gas fee alternative
Despite the lull in crypto last year, Polygon spared no effort in closing deals with mainstream brands. The scaler network has sought to address the limitations of DEXs owing to its low transaction fees. This advantage has proved crucial in facilitating the integration of more services on Uniswap, thereby attracting more traders to the DeFi platform. The increased usage of the network has contributed to a growth in total value locked thanks to the attractive DeFi ecosystem conceived by the collaboration.
Decentralized exchanges have historically been constrained by the trade-off between security on the Ethereum network and low transaction fees on less secure or decentralized blockchains. The integration of scaling solutions, such as Polygon, enables DEXs to attain low fees while maintaining security. Polygon network's low transaction fees, coupled with its compatibility with Ethereum's security features, provide an optimal solution for these exchanges to scale their operations. It is likely that more DeFi projects will migrate to alternative scaling solutions, especially as the crypto market returns to a bullish trend and DEXs see high trading volumes again.
To learn more about Polygon, visit our Investing in Polygon guide.
DEX and Lending Protocol Tokens Thrive on Recent Proposals – Uniswap, Mango Markets, SushiSwap, and Aave Updates
Sam is a financial content specialist with a keen interest in the blockchain space. He has worked with several firms and media outlets in the Finance and Cybersecurity fields.