Decentralized finance (DeFi) has a problem. We set out to build a financial alternative, driven by the shortcomings of opaque businesses that often put their interests over those of their customers. The goal was a decentralized, self-governed economy that was transparent and largely independent from external influences.
Instead, crypto markets today hang on Federal Reserve Chair Jerome Powell’s every word, run almost entirely on centralized stablecoins and are onboarding real-world bonds as collateral assets.
This article is part of “Staking Week.” Conor Ryder is the head of research and data at Ethena Labs.
While I’m fully aligned with a pragmatic approach — making short-term sacrifices that give us a better chance of reaching an end goal — the time has come to accept that DeFi as it stands today is not so decentralized. Blockchain finance might be a better term.
But crypto native staking yields can help bring us back to DeFi.
How have we got to this point?
Stablecoins
Many previous attempts at decentralized stablecoins have fallen by the wayside. In short, this is because they either have struggled to scale and compete with their centralized counterparts, or they scaled too quickly based on fundamentally flawed designs.
Decentralized stablecoins are the holy grail, but we have seen a lack of innovation in the space since the collapse of Terra. Novel approaches are dismissed immediately if they dare suggest anything but an overcollateralized approach. DeFi was left scarred and shaken after Terra, and an emphasis since then has been placed on security, at the expense of innovation.
Centralized stablecoins power DeFi today, with more than a 95% market share of on-chain volumes versus their more decentralized counterparts. Web2 incumbents like PayPal entering the stablecoin space will only exacerbate this trend. Centralized stablecoins are built to get into as many hands as possible and have spread quickly throughout DeFi as a result. On the other hand, overcollateralized stablecoins, constrained by their design, have lagged behind and failed to achieve the same level of adoption.
While it’s positive to see stablecoin adoption, regardless of who issues them, it’s important for DeFi to offer a competitive decentralized stablecoin that can stand on its own two feet and put the “De” back in DeFi.
Yields
Second, the rise of U.S. bond yields has shifted the real risk-free rate to 5%, leaving crypto collateral assets that earn little to no passive income facing a competitive mountain to climb. If you are a struggling crypto protocol, where decentralization isn’t your first priority, moving your collateral into a risk-free asset earning 5% yield makes a lot of sense. However, this hasn’t just been struggling protocols onboarding real world assets (RWAs) in search of higher yield — some of DeFi’s biggest blue chips have shifted a large portion of their assets into RWAs. According to rwa.xyz, tokenized treasuries are up from $100 million at the start of 2023 to over $600 million today.
The speed and rate of adoption of U.S. Treasuries and RWA’s should make us question the industry’s commitment to decentralization. To be clear, it’s fine if we have other goals, like moving finance on the blockchain à la PayPal USD or Visa settling transactions via USDC on Solana. But let’s be honest about the state of DeFi today: it’s Blockchain Finance running on U.S Treasuries and centralized stablecoins. That may modernize finance and bring more users onto crypto rails, but we need to start building out solutions that serve as decentralizing forces to the space to provide viable options for holding money outside the banking system.
Where do we go from here?
Enter crypto staking yields, or more specifically, “post-Shapella” staking yields. Since the Shapella upgrade of the Ethereum network, users can stake and unstake their ether (ETH) at will, significantly de-risking staked ETH from a liquidity standpoint. This has been reflected in the staked ether, or stETH, discount to ETH, barely dipping past 30 bps since Ethereum’s last major upgrade. Before the Shapella upgrade, stETH was a poor collateral asset due to its illiquidity and discount volatility. Now that stETH has been derisked, we have seen it overtake ETH as the primary collateral asset throughout DeFi.
See also: Crypto Staking 101: What Is Staking?
This means that DeFi now has a yield-bearing collateral asset that is native to crypto as well as being decentralized. StETH yields rival bond yields at 4%-5% and give protocols another option without the censorship risk profile of bonds. This will only help decentralize DeFi as protocols and stablecoins can now build on top of stETH rather than RWA’s and evolve independently of the traditional banking system.
An interesting addendum is that we are quite likely at the top of a rate cycle for bond yields and interest rates, meaning that in a few years’ time we could see staked ETH yields outpace bond yields. In that scenario, the decision to hold RWA’s for crypto protocols would be difficult to justify. At that point, we might just see DeFi become truly self-sufficient, built upon crypto-native, yield-bearing collateral.
