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3 Critical Flaws That Toppled DeFi Protocols This Bear Cycle

2 mins
Updated by Kyle Baird
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In Brief

  • Risk, revenue, and leverage are key factors for DeFi protocols.
  • 2022 was a year of DeFi exploits, hacks, scams, and rug pulls.
  • Lido has become the leading DeFi protocol by market share.
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Decentralized finance (DeFi) is in the doldrums. The hype of the past couple of years has waned, and several protocols have failed to gain traction.

DeFi collateral has tanked by 77.6% since its all-time high in December 2021. The decline is greater than the 71% that crypto markets have fallen.

Furthermore, many of the hundreds of newly launched protocols have simply collapsed. According to researchers, there are three main reasons why this has happened.

On Jan. 10, DeFi analyst ‘CyrilXBT’ suggested three critical flaws weighed down DeFi protocols this cycle.

Risk, Revenue, and Leverage

“Most Defi protocols have poor risk management, insufficient revenue, and the overuse of leverage,” he stated.

Systemic risk mitigation is a key factor for the success of a DeFi platform. 2022 saw countless hacks, exploits, cross-chain bridge attacks, compromised smart contracts, and rug pulls.

According to a recent report, crypto and DeFi losses hit $3.9 billion last year. Poor risk management is a fast track to failure for any DeFi protocol.

The ability to generate revenue and remain profitable is another critical factor. The researcher noted:

“One of the most frequently cited reasons for DeFi protocols struggling is their inability to generate sustainable income that adds meaningful value to the platform’s ecosystem.”

DeFi decentralized finance

Poorly designed tokenomics with high inflation rates are a red flag. High inflation increases token supply, so liquidity leaves the ecosystem if the token value is not maintained.

The third critical factor is over-exposure to leverage. Protocols that had tokens that could be used as an asset to borrow loans got trapped by users taking over-leveraged positions

Leverage has also been the cause of some of last year’s major meltdowns, such as Celsius and Three Arrows Capital (3AC).

DeFi will come back stronger, but only the fittest protocols without exposure to these three critical flaws are likely to survive.

Lido Becomes New DeFi King

There has been a shakeup at the top of the DeFi pile. Liquid staking platform Lido has toppled stablecoin pioneer MakerDAO.

According to DeFiLlama, Lido has the largest market share of all DeFi protocols at 13.8%. Furthermore, it has a total value locked of $6.6 billion, which is just above Maker’s $6.4 billion.

Lido has been on a roll recently as liquid staking derivatives gather momentum ahead of Ethereum’s Shanghai upgrade.

Curve Finance is the third largest DeFi protocol with $4.3 billion in collateral locked. Furthermore, the total for the entire ecosystem is $47.6 billion, a decline of 74% over the past 12 months.

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Martin Young
Martin Young is a seasoned cryptocurrency journalist and editor with over 7 years of experience covering the latest news and trends in the digital asset space. He is passionate about making complex blockchain, fintech, and macroeconomics concepts understandable for mainstream audiences.   Martin has been featured in top finance, technology, and crypto publications including BeInCrypto, CoinTelegraph, NewsBTC, FX Empire, and Asia Times. His articles provide an in-depth analysis of...
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