Four ‘breakout’ DeFi trends that will define crypto’s coming bull market

DeFi was crypto’s primary growth driver last year as it had twice as many users who completed over 100 transactions than any other crypto market sector.

This growth was fuelled by an increase in transaction activity on Ethereum layer 2 blockchains like Arbitrum and Optimism, and the return of Solana post-FTX collapse.

That trend is expected to continue this year amid a possible bull run with trading on decentralised exchanges and yield farming expected to be the most dominant on-chain activity in 2024.

That’s according to a new on-chain crypto user report by blockchain data platform Flipside Crypto.”Significant regulatory, institutional, and financial announcements emerged every month,” of 2023, the report said. “These developments set the stage for a breakout 2024.”

Driving that growth lately: EigenLayer, an Ethereum liquid restaking protocol.

Staking in DeFi means to lock a token in a blockchain network or DeFi protocol, usually in exchange for yield.

Locked tokens are typically unusable but some protocols like Lido offer liquid staking where a liquid staking token or LST is given in exchange for the locked crypto, as well as the opportunity to earn yield.

“Novel DeFi like EigenLayer will rise in prominence and adoption among web3 native audiences,” Flipside said.

Liquid staking has the advantage of giving users access to their locked coins in the form of the LSTs which they can deploy on other DeFi protocols to earn compounded gains.Flipside highlighted four other trends to watch:

Restaking staked crypto

Liquid restaking is an expansion of the DeFi liquid staking primitive. It allows users to restake their LSTs to earn more yield and another token called a liquid restaking token, or LRT.

There are even protocols like Pendle that will accept an already yield-bearing LRT deposit from a user and provide them with another yield-bearing token, taking the compounded yield potential further.

Flipside’s prediction of a liquid restaking boom this coming year may already be showing signs of becoming a possibility. The new DeFi sector is already a $600 million market — a market growth driven not only by the compounded yield frenzy but also the possibility of airdrops.

Novel DeFi niches like liquid restaking come with the expectation of airdrops for early participants. Such expectations have been boosted by majors like EigenLayer offering a points system for depositors as points have become a bellwether for possible airdrops.

Despite its growth potential, Flipside does not envisage a bubble emerging because of liquid staking this year.

“We’re still a ways away from the 2021 frenzy, where anyone could simply fork a project and slap on 10,000% APY inflation tokens to attract users,” Flipside data scientist Carlos Mercado told DL News.

Instead, Mercado identified the lack of client diversity among Ethereum stakers and validators as a possible cause for concern. More than 80% of Ethereum validators run Geth, an execution client responsible for processing transactions and deploying smart contracts.

This dependence of Geth makes it a supermajority client in Ethereum and any problems with Geth could cause system-wide failures in Ethereum.

Given the possible scale of the problem, Mercado said he expects stakeholders to diversify to other clients.

“The good thing is that these staking methods compete directly with other on-chain opportunities, so there’s natural pushback against it becoming “too big to fail” — as the yields fall with more participants,” Mercado said.

Multi-chain engagement

Flipside’s report only covers eight blockchains — Bitcoin, Ethereum, Arbitrum, Optimism, Polygon, Base, Solana, Avalanche — all but Bitcoin and Solana are EVM networks.

EVM networks run on the Ethereum Virtual Machine and use the same smart contract logic for their applications. This compatibility also makes for easier liquidity migration via protocols called bridges that allow users to send crypto across different blockchains.

Last year, however, only a small percentage of users interacted with at least two EVM chains. But Flipside expects a change this year with greater multi-chain engagement among DeFi users, especially those looking to capitalise on yield and airdrop opportunities across different blockchains.

Greater multi-chain engagement will mean flexible liquidity migration and an uptick in the volume of crypto flowing across bridges. Bridge protocols have historically been targets for hackers leading to some of crypto’s biggest thefts including the $125 million that disappeared from cross-chain bridge Multichain last year.

Mercado noted that bridge security is a big deal while adding that market participants are gravitating towards more secure solutions for cross-chain crypto transactions.

“The lock and mint mechanism prevalent throughout 2021-2022, which left a honeypot of tokens that hackers eyed, has faced significant competition from order book or routing bridges that are more efficient in volume transferred per value locked, and canonical bridges like USDC’s Cross Chain Transfer Protocol,” Mercado said.

Competing layer 2 blockchains

Three of the blockchains covered in the Flipside report — Arbitrum Optimism, and Base — are Ethereum layer 2. These are networks created to scale Ethereum by processing transactions away from the mainnet but still rely on Ethereum’s security for finality.

Polygon is also an Ethereum scaling blockchain but is technically not a layer 2, but rather, a side-chain.

Ethereum layer 2s have experienced a Cambrian explosion in the past 18 months, bloating the EVM blockchain market. With limited investor liquidity, the report predicts greater competition among incumbents especially in lowering transaction costs and offering a smoother user experience.

Ethereum, itself stands to gain from the rivalry among its layer 2 networks as increased network activity means more money for validators.

This struggle for market share dominance among Ethereum layer 2 networks may also affect the value of their respective native tokens, the report said.

Booming infrastructure and chain specialisation

Apart from Ethereum layer 2 networks, crypto’s overall infrastructure stack expanded last year and Flipside is predicting an even greater boom in 2024.

The report pointed to significant gains in the likes of zero-knowledge technology and data availability solutions like Celestia as reasons for such expectation.

Newer entrants like scaling blockchain Monad and Berachain are also expected to contribute to this growth, the report said.

Ultimately, the report expects that developers will optimise for their respective technological strengths leading to specialised blockchains rather than the general-purpose blockchain networks currently available.

Osato Avan-Nomayo is our Nigeria-based DeFi correspondent. He covers DeFi and tech. To share tips or information about stories, please contact him at osato@dlnews.com.