Is Ethereum a DeFi?

Ethereum as a market leader.

Ethereum is not a DeFi; instead, it is a DeFi industry enabler as it is the most popular smart contract platform that supports DeFi applications. Ethereum created the conditions for explosive growth in the DeFi space by offering a trustless, decentralized infrastructure with Ethereum’s blockchain serving as the settlement layer.

Unlike Bitcoin, the first modern-day cryptocurrency to enter the mainstream spotlight and attract institutional interest, Ethereum slowly developed into an industry leader thanks to its ability to increase digital blockchain utility. The differentiating factor between Bitcoin and Ethereum is Ethereum’s capacity to create programmable smart contracts that are executed on the blockchain.

Conferring Ethereum developers the opportunity to decentralize financial processes under DeFi removed dependency on third parties, allowing for increased access to more complex financial services. In 2020, Ethereum’s smart contract capabilities ignited the first wave of DeFi applications which were considered part of the DeFi summer of 2020.

In 2020, all DeFi applications were built on Ethereum, and platforms such as Curve or AAVE have created new DeFi mechanisms to provide financial services for the unbanked.

Ethereum’s first-mover advantage, major ecosystem support, and extensive developer community make it the clear market leader in the smart contract space and increased the value of the cryptocurrency.

Ethereum’s dominance in the cryptocurrency market is further reinforced because most DeFi applications are built on Ethereum.

Ethereum’s shortcomings

Ethereum’s TVL dominance started to decline at the start of 2021. According to DeFiLlama, Ethereum’s TVL currently stands at $13.81B, which is 58.67% of the total DeFi TVL. By contrast, Ethereum held 95% of the TVL in early 2021.

In mid-2021, at the peak of the DeFi bubble, Ethereum accounted for over 800,000 daily transactions on DeFi platforms, putting a strain on the network’s ability to cope with the growing demand. The main problem with Ethereum is its scalability. Ethereum can only handle a few transactions per second, limiting its use cases. Ethereum is also very expensive to use, and ETH gas fees can be quite high.

While new DeFi products such as lending, stablecoins, borrowing, swapping, and asset management were gaining popularity, Ethereum was losing ground simply because it could not handle the network load. One of the main issues with Ethereum was its inability to keep transaction fees low as more users interacted with the protocol.

The network’s proof-of-work consensus mechanism made DeFi inaccessible to most users. It also created frustration among Ethereum miners and developers as Ethereum started implementing the controversial EIP-1559, which reduced miners’ rewards, yet it did not solve the issue of high network fees.

Ethereum’s answer to network congestion is a shift to a proof-of-stake consensus called ETH 2.0 and is working hard to address them. Ethereum’s developers are working on several solutions, including scaling solutions like Ethereum’s Plasma and Sharding. Additionally, they are exploring new ways to make Ethereum more efficient and cheaper. 

Its shortcomings gave way to new protocols called “Ethereum-killers’ to challenge its cryptocurrency market dominance.