It is undoubtedly that DeFi is a powerful tool that can shape the digital economy. However, the current DeFi ecosystem still has a long way to go and there are some critical problems and limitations around growth & value that are worthy of discussion.

Accessibility

DeFi is in a place now where there is no apparent influx of new users. This can attribute to several factors, the major one is the difficult onboarding experience. For those who know very little about crypto or those who are typically traditional consumers of financial products, DeFi is too complicated. Most DeFi today are accessed via wallets that are browser extensions, and secured by a seed phrase. It generally takes users a learning curve on seed phrase/private key and it is fatal for them to understand the importance of it as well.

There is another major barrier in the DeFi ecosystem — how partitioned it is. If a user wants to perform a task, it usually requires navigating to several DeFi protocols. Novices normally have no interest to invest the time or effort thus more integrated solutions are needed if DeFi wants to attract the mainstream audience.

Take yield farming as an example, users earn interest on their money when they provide liquidity to DeFi platforms. This is alluring compared to the traditional legacy system because of its more attractive interest rates. If a user wants to start off with a low-fee chain, let us use Polygon as an example of what it takes to deposit on DeFi platforms, a user must:

Look for appropriate bridge protocol, and find out which assets are acceptable to bridge from Bridge said crypto asset via a bridge protocol and swap into some Matic Deposit the asset into a lending protocol

Many crypto beginners would abandon at the first or second step, some might abandon before starting because they wouldn’t even know where to begin with. If DeFi can’t make any change on this matter of usability then it will never attract a wide audience beyond a niche community.

Security

Today, DeFi projects have a total market cap of $45 billion, and the large amount of value invested in DeFi raises great awareness for security.

DeFi works by using smart contracts to fulfill orders placed by traders. If DeFi projects don’t go through complete security testing before going live, they can be very vulnerable to exploits. Simply, if there is a flaw in the smart contract, it is almost certain that some parties with malicious intentions will attempt to exploit it.

Another issue that emerges among security risks in DeFi would refer to stolen or leaked private keys. Anyone with access to an account’s private key can generate digital signatures and transactions on behalf of that account. A leaked seed phrase/private key can result in the loss of cryptocurrency and abuse of the account's permissions on DeFi contracts.

Concerns of Liquidity

Liquidity is a critical factor in DeFi-based projects. On a decentralized exchange, liquidity correlates directly with the amount of tokens locked in a liquidity pool. If a token lacks liquidity, holders may not be able to sell their tokens when they wish. If a DeFi platform lacks liquidity, it means that there is no interest in cryptocurrency people invest and there is no arena for people to trade it.

Low liquidity also leads to higher price volatility. If a token’s liquidity pool has only $10,000 in locked value, and someone sells $2,000 worth of the token into the pool, it could impact the price by nearly 20%. Automated market makers can determine how many tokens are being purchased from the pool, and adjust the price accordingly for large sales and buys.

Decentralized but only “to some extent” How decentralized is DeFi? A project is considered decentralized when it’s controlled by lots of people. For example, a project with a thousand people with a vote over its future would be less decentralized than one with ten thousand people with a say. That said, in practical terms, many DeFi projects are controlled by a few people with most of the tokens. Those DeFi projects have teams behind them, which essentially act like boards or development groups, holding meetings and making key decisions to determine their direction.

Fortunately, there is a rising number of DeFi projects started to focus on “true decentralization”. This has significant implications, a more decentralized project means it will less likely to suffer if they lose a key figure or decision maker.

Risk mitigation tool

It is perceived to be unsafe that current DeFi users do not have any guardrails in case of errors. That’s why useful risk mitigation measures need to go hand-in-hand with improved user experience. However, reversing a transaction shouldn’t be counted as one of the measures. Sure that reversibility would make it much easier to recover stolen and fraudulently obtained funds, but theoretically speaking, there is no recourse unless a legal system gets involved, which is totally against crypto’s nature of anti-supervision or third-party’s intervention.

To better help with risk mitigation, current DeFi protocols could develop safer front ends and better phishing detection tools. Safer front ends could offer users an option of enabling slower finality while more advanced users or users willing to take on more risks can access the faster, unguarded mode. A phishing detection tool can also make a huge change. Phishing detection and response functionality allow users to identify and remediate phishing threats before attacks can cause any damage.

Bottom Line

The future of DeFi is exciting. The global decentralized finance market is expected to reach $230 billion by 2030, This means more capital, more opportunities, more innovative DeFi projects and hopefully more new users to enter this space. As DeFi matures and as future projects gradually tackle the challenges above, DeFi will broaden its appeal and set the stage for future successes.

In the early months of 2022, the industry was blooming and seemed to reach the “peak”, the commercials were everywhere — on TV, on bus stops, and even on the super bowl fields; all kinds of digital assets prices were hitting all-time highs, people were making irrational amounts of money; we also saw a number of celebrities openly talking about and were in support of Cryptocurrencies. It seemed like the industry has become mainstream and has suddenly had everyone’s attention, even people who weren’t deeply into crypto before.

However, the downturn soon come, starting with the Federal Reserve's decision to raise the interest rate to fight against high inflation, then a string of failures started when 2022 reached its halfway point. Terra, Three-arrow capital, and FTX fell like dominoes only in a few months apart. The ‘crypto winter’ has finally come, many individual investors suffered staggering losses and started to lose confidence for the industry as a whole.

Nevertheless, 2022 has also given us a few positive developments. Ethereum had a good year despite ETH’s weak price performance, as “the merge” finally shipped, and we also saw governments worldwide acknowledge crypto’s value and potential. Hong Kong has been actively working toward establishing a well-thought regulatory groundwork for the crypto market and UK’s prime minister Rishi Sunak was a vocal advocate of crypto and outlined a grand plan aiming to make the country a global crypto hub.

It’s been a good & bad year. With that context, let’s take a closer look at the seven most important events that shaped the year and what you should know about.

Hackers steal $625M from Ronin network

The first big bomb of the year, in the month of March 2022, was that the makers of the extremely popular blockchain NFT game Axie infinity, Ronin Network, fell victim to one of the single largest Defi hacks to date. The attackers were able to steal and get away with approximately 173,600 ETH and 25.5 million USDC, amounting to a staggering total of $625 million as of the day of the hack.

It certainly wasn’t the end. In June, Harmony One’s Horizon Bridge lost over $100 million in an attack. In August, another 200 million was lost from the Nomad Bridge as a consequence of an exploit of a vulnerability in its underlying technology — smart contracts.

In total, The crypto auditing company Chainalysis estimates that over $2 billion worth of digital assets have been stolen from blockchain bridges in 2022 alone. This figure accounts for approximately 70% of all stolen crypto funds in the year.

That has raised our awareness of cyberattacks on cross-chain bridges.

Blockchain cross-chain bridges — a tool designed to solve the challenge of interoperability, in plain language, it aims to solve the problem that blockchains usually operate alone and cannot communicate with each other.

Due to the limitation of the bridge’s characteristics, they can still be vulnerable to exploits. Simply, if there is a flaw in the smart contract, it is almost certain that some parties with malicious intentions will attempt to exploit it. As a user, it is vital for us to do our own due diligence before interacting with any bridging ecosystem.

Terra’s collapse

Just before May 2022, Terra blockchain’s main token Luna was one of the world’s biggest cryptocurrencies by market capitalization. However, it crashed from $83 to $0.002, in just two days.

How did this crypto disaster happen?

Well, unlike most stablecoins, UST(Terra’s stablecoin) was not fully collateralized, it relied on an algorithmic mechanism to stay on par with the US dollar. Luna, which is the sister coin of UST, is backing up the target peg. That is to say, to create UST we have to burn luna. For UST to retain its peg, one UST could be changed to $1 worth of Luna at any time. If UST slipped, traders could make money from buying UST and then exchanging it for Luna, but both Luna and UST will crash once UST lost its peg to the dollar.

UST seems risky because it wasn’t backed by cash or any other cryptocurrencies, but why did so many people buy the concept of algorithmic stablecoins? Well, UST was a particularly alluring option because of Anchor Protocol, a lending platform on Terra that provided a 20% yield on UST lending. As market participants flocked to UST to take advantage of the yield, they increasingly burned LUNA, sending its price higher.

On May 7th, there was a huge selloff that brought down the price of UST from $ 1 to $0.91, and once a large amount of UST had been offloaded, the stablecoin started to depeg. In a panic, more people sold off UST, which led to the minting of more Luna and an increase in the circulating supply of Luna. Luna’s price plunged at a surprising speed.

The Luna meltdown impacted the entire cryptocurrency market, which was already highly volatile and experiencing difficulty at the time. It’s estimated that the Luna crash ended up tanking the price of bitcoin and causing an estimated loss of $300 billion in value across the entire cryptocurrency space. Many people therefore lost their life savings and suffered financial hardships due to the Luna crypto crash.

The downfall of 3AC

The Singapore-based crypto hedge fund Three-arrow capital was founded in 2012 by Su Zhu

and Kyle Davis. Over the years, 3AC rose to become one of the top players in the industry with numerous successful investments, including Aave, Avalanche, and Solana. As it grew, the company began to take riskier bets, and when Luna collapsed in May, it set off a chain reaction of events that ultimately led to its collapse.

3AC held a significant position in both Luna & UST, worth roughly $560 million at its peak and about $600 after the price crashed in a matter of days to almost zero, and 3AC finally filed for bankruptcy in early July.

On July 22, Su Zhu finally broke his silence and had an interview with Bloomberg, according to him, people had become too comfortable in the prolonged bull market, with too much sense of security. He claimed that this led to complacency, and the market turmoil following LUNA’s collapse was too much for 3AC to handle.

US Treasury sanctions Tornado Cash

Tornado Cash is a privacy protocol for concealing the origins of cryptocurrency transactions. On August 8th 2022, the US treasury announced that it had placed Tornado Cash on its sanctions list. The agency claimed that cyber criminals used the tool as a vehicle for money laundering.

The sanctions specifically include the following:

Assets currently sitting in Tornado Cash are frozen.

Transactions to and from Tornado Cash are prohibited.

Tornado Cash code is banned (though it’s essentially impossible to shut down the technology)

The ban soon outraged the crypto community. Critics of the sanctions are worried about their implications for crypto users’ privacy and potential future shutdowns. It also raised concern about Ethereum’s ability to remain censorship resistant.

Accordingly, the crypto community soon took various initiatives to fight back against the decision. Coinbase was funding a lawsuit against the US treasury over the sanction and the outcome of the case could have a huge impact on crypto’s future, as it will determine where the US government will have the power to sanction other crypto projects.

Ethereum Merge

2022 has been a cruel year, but Ethereum brought some relief to the crypto space. Ethereum’s long-awaited Proof-of-Stake upgrade has been in discussion for as long as the blockchains existed, so the crowd was thrilled when the September launch was finalized.

ETH soared over 100% from its June bottom, as the hope for the merge was enough that people believed it would lift the market out of despair and a 99% energy efficiency improvement could also help crypto flip bullish.

In the end, even though ETH’s price wasn’t affected too much after the merge and it seemed like the merge was just a “sell the news” event, it was still considered a big success and hailed as crypto’s biggest technological update.

FTX’s “Lehman moment”

In about a week’s time, beginning a few days into the month of November 2022 — the world’s third-largest crypto exchange by trading volumes, FTX filed for bankruptcy.

The collapse began with the publication of a few internal documents from FTX exchange’s sister company Alameda Research which was involved in a crypto trading business. The documents showed that the firm was highly overleveraged on its own crypto tokens, FTT, and Alameda’s investment foundation was also in FTT, not a fiat currency or other cryptocurrencies. Soon Binance announced that it would sell its entire position in FTT tokens and by the next day FTX was already experiencing a liquidity crisis. FTX founder Sam Bankman-Fried attempted to reassure FTX investors that its assets were stable while at the same time reaching out to Binance for help and acquisition.

The promise of rescue was short-lived, as Binance backed out of the deal a day later. The exchange said that it would cancel the FTX deal after they learned about the FTX’s mishandling of customers’ funds and some other issues.

On Nov 11th, FTX finally filed for bankruptcy after SBF apologized for the liquidity crisis and admitted on Twitter that FTX had insufficient funds to meet customer needs. He soon “resigned” as CEO of FTX and was replaced by John J. Ray, a man who has made a career out of overseeing the dissolution of failing companies. Ray testified in writing to the court regarding FTX’s downfall:

“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”

Yuga Labs glorious year

Yuga labs definitely won at NFTs in 2021 and it kept its winning streak in 2022, with its own collection Bored Apes topping the sales charts after garnering more than $3.75 billion. In March 2022, it acquired CryptoPunks and Meebits, which sealed yuga’s crown as the world’s top NFT company. Then Yuga labs soon leveraged its brands to create a Metaverse platform, Otherside.

Otherside launch was the most anticipated NFT drop of the year. Bored Apes prices were soaring and the demand for the virtual land was so high that only those who could afford to pay thousands of dollars on the gas fee made the transaction through. However, due to the general market weakness, NFTs crashed as well but we would believe that once the market comes back, Yuga labs will still be at the leading place.

In the future, 2022 may be regarded as the turning point for the world of virtual currencies, or it may simply be remembered as a stretch of excruciating growing pains for an industry that is still in its early stage.

Regardless, 2022 has made one memorable year in the crypto history books.

We are still in the bear market, and though many people are questioning whether crypto would pull through, those watching the space closet have no doubts that crypto is here to stay, and not just here to stay, after the events of last year, the foundations should be stronger than ever in 2023 and beyond.