Backfired by DeFi, Ethereum fights back from the brink
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Backfired by DeFi, Ethereum fights back from the brink
Compared to the wild market movements of DeFi on Ethereum, ETH has been stuck in place for a long time.
Navigating Web3 tides with focused insightsEthereum finally surged!
Over the past two days, Ethereum has risen by 12%.
Investors can finally breathe a sigh of relief. But it still seems far from enough—compared to the explosive DeFi market on Ethereum, ETH has been stagnant for a long time.
No doubt countless questions are swirling in investors' minds right now. This article will focus on the following key concerns:
Why did DeFi-related tokens surge while ETH remained flat for so long?
Why is DeFi becoming a burden to the Ethereum network?
Has the "Fat Protocol," once revered as gospel in the blockchain world, become outdated?
Why did Ethereum suddenly surge? Where does its future opportunity lie?
DeFi Is Drifting Away From Ethereum
Why did ETH's price remain stagnant despite the DeFi boom?
In short, DeFi protocols on Ethereum are becoming less and less dependent on ETH.
In the early days, MakerDAO—the dominant lending protocol—only accepted ETH as collateral to generate Dai. Even after Compound and Aave launched, ETH served as the base currency in the DeFi market for a period of time.
As the DeFi market flourished, more and more tokens emerged as native assets.
On November 18, 2019, MakerDAO officially launched multi-collateral Dai, allowing tokens like BAT, USDC, WBTC, KNC, and ZRX to be used as collateral alongside ETH to mint stablecoins—diminishing ETH’s influence to some extent.
Soon, multi-asset collateral became mainstream, leading to platforms like Synthetix.
Unlike most DeFi applications built on Ethereum’s base layer, Synthetix does not use ETH as collateral. Instead, it only accepts its native token SNX to back synthetic asset issuance.
Meanwhile, the lending protocol Aave launched uncollateralized peer-to-peer loans in July.
Financial innovations have gradually distanced DeFi from ETH—especially yield farming, the key innovation that propelled DeFi’s takeoff.
On June 15, 2020, Compound initiated liquidity mining to distribute its governance token COMP—marking the beginning of DeFi’s golden era.
Shortly after, Balancer, Curve, Bancor, Thorchain, mStable, bZx, Kava—and many others—followed suit with their own liquidity mining programs.
To chase these token rewards, investors actively provided liquidity to DeFi protocols, sending DeFi into rocket-like growth.
As more DeFi protocols issued governance tokens and distributed them to liquidity providers, a new meme—"Yield Farming"—was born in the crypto community.
"Yield" means return or earnings, and "Farming" refers to cultivation.
Literally, it describes crypto investors deploying funds across various DeFi protocols to maximize returns. These investors call themselves "Yield Farmers"—a concept better understood in Chinese as "shearing wool" or being part of the "wool-grabbing mob."
Yield farming further pushed DeFi away from ETH—and even harmed ETH.
Yield Farmers aim to earn more speculative tokens—such as COMP or BAL—through liquidity mining.
From an economic standpoint, using BAT, ZRX, USDT, USDC, and DAI for mining is more attractive than using ETH.
Take the highly popular Compound as an example: BAT whales once dominated COMP mining, prompting the team to urgently revise the token distribution mechanism. Stablecoins then became the main battleground, while ETH remained lukewarm.
Currently, in Compound’s lending pools, ETH accounts for only 19.15% of total deposits and 2.45% of total borrowings.
In liquidity mining, ETH’s role is largely limited to paying gas fees.
However, this doesn’t necessarily create significant new demand for ETH. Most DeFi users are also ETH holders who can use their existing ETH to cover transaction costs.
Unlike the 2017 ICO frenzy, where every project raised funds in ETH—directly fueling explosive demand and driving ETH’s price up over tenfold—DeFi hasn’t recreated that miracle for Ethereum.
DeFi has not brought Ethereum’s revival.
William, chief researcher at OKEx Research, believes that for ETH to benefit from DeFi, DeFi must grow large enough to significantly drive ETH demand. For instance, the 2017 ICO wave pulled ETH demand to new heights, pushing its price to $1,300.
Currently, ETH’s circulating supply is 111 million, while DeFi’s total value locked (TVL) stands at just 4 million—contributing little to ETH demand—hence ETH’s lackluster performance.
The More Successful DeFi, The More Dangerous for Ethereum
Not only has DeFi failed to revive Ethereum, it has also made the network more congested and transaction fees more expensive. Rising transfer fees may even be driving away real DeFi users.
According to a report by Coin Metrics, DeFi has driven Ethereum transaction fees to their highest levels since 2018—and is now threatening the security of the Ethereum network.
On July 22, Ethereum co-founder Vitalik Buterin warned on Twitter that unless measures are taken, high fees could undermine network security.
He cited a Princeton University paper indicating that miners are increasingly reliant on transaction fees, which could incentivize selfish mining behavior—miners might manipulate transaction processing for higher profits. Therefore, Vitalik called for reform of cryptocurrency fee mechanisms to safeguard network security.
Jan Xie, chief architect of Nervos, believes the more successful DeFi becomes on Ethereum, the more dangerous it is for Ethereum.
“Ethereum faces a unique challenge we call the ‘heavy asset problem.’ Ethereum pays miners in ETH to secure consensus and protect network security. However, many different tokens operate on Ethereum and benefit from its security without contributing to it. Meanwhile, ETH holders bear the ongoing storage cost—by creating new ETH to pay miners.”
In his view, the more successful non-ETH tokens become (like DeFi tokens), the greater the incentive for attackers to target Ethereum. Yet, network security does not scale proportionally with the total value of all tokens stored on the network.
Is the Fat Protocol Theory Outdated?
In August 2016, Joel Monegro from U.S. investment fund USV published an article titled “Fat Protocols,” which gained widespread attention in the Chinese-speaking world as the “Fat Protocol” theory.
The “Fat Protocol” theory sparked broad discussion and was once considered gospel in the blockchain world—even partially explaining the bull run in public chain investments.
The theory argues that blockchain captures value differently from the internet. In the internet era, value is mostly captured at the application layer—companies like Google, Facebook, Amazon, Alibaba, and Tencent. Underlying protocols such as TCP/IP and HTTP that support the internet cannot capture value.
In contrast, in the blockchain era, value concentrates at the shared protocol layer, with only a small portion flowing to the application layer. Thus emerged the terms “fat protocols” and “thin applications.”
According to the Fat Protocol theory, the success of applications drives speculation in the underlying protocol. As a result, the protocol’s market cap grows faster than the combined value of all applications built on it. Therefore, foundational protocols like Ethereum should grow much faster in value than application-layer projects like DeFi.
But in reality, DeFi tokens have outperformed ETH in value growth. The total market cap of all existing ERC20 tokens has already surpassed Ethereum’s market cap.
In his article “Aggregation Theory, Thin Protocols, and Recentralization: Augur Edition,” Kyle Samani of Multicoin Capital used Augur to illustrate a point—that applications can steal value from protocols, and protocols struggle to prevent it.
When an application captures most of a protocol’s traffic but must pay substantial fees to the protocol, it may fork the protocol to capture more value.
William, chief researcher at OKEx Research, believes the analytical framework of the “Fat Protocol” theory is no longer applicable.
“The ‘Fat Protocol’ theory attributes the protocol’s ‘fattening’ and the application’s ‘thinning’ to two factors: data sharing at the protocol layer and the introduction of protocol-level tokens. But now we clearly see that data sharing doesn’t imply traffic sharing—application-layer projects differ greatly in functionality and operations, making true traffic sharing impossible.”
Secondly, there is a growing decoupling between the application and protocol layers in terms of users and capital.
The theory assumes that application success brings in new users, who then increase demand for the protocol’s token, while existing investors hold due to price expectations—thus limiting supply. For example, the 2017 ICO boom attracted massive new users and drove up demand for ETH, boosting its market cap.
In William’s view, today there is a clear decoupling between the application and protocol layers: “People can issue stablecoins on Ethereum, raise funds in lending markets, or trade on DEXs—all without significantly increasing demand for ETH. This disconnect results in the application layer’s market cap exceeding that of the protocol layer.”
Analyst Mike disagrees with concluding that the “Fat Protocol” theory is obsolete based solely on the “DeFi craze.” Just as FCoin’s “trade-to-mine” model once led the trend but eventually failed, it remains to be seen whether DeFi, fueled by innovations like liquidity mining, will become the next FCoin.
He believes that in the long run, DeFi is already in a bubble, while the value of the protocol layer has not yet been fully realized—for example, Ethereum itself hasn’t truly unleashed its potential.
Ethereum Strikes Back With Its Killer Moves
Faced with the backlash from DeFi, Ethereum won’t sit idle. It has unveiled its killer weapons—EIP-1559 and ETH 2.0.
In his July 22 tweet, Vitalik Buterin not only expressed concern about high fees undermining network security—he also proposed a solution: EIP-1559.
EIP-1559 changes Ethereum’s current transaction fee structure into two components:
Base Fee (BASEFEE): The highlight is that this fee is not rewarded to miners—it is burned. This prevents inflation and may even reduce supply.
Tip (GAS_PREMIUM): This rewards miners. In low congestion, a small tip (e.g., 1 Gwei) suffices to compensate for uncle block risks. During congestion, users can increase tips under a first-price auction model to get faster inclusion.
EIP-1559 uses a difficulty-adjustment-like mechanism to dynamically adjust the BASEFEE. When demand is high, the base fee increases—and rises faster during congestion.
Moreover, before EIP-1559, transaction fees technically didn’t have to be paid in ETH. If users could pay fees in any token (e.g., stablecoins), it would threaten ETH’s status as reserve currency and erode its monetary premium. Under EIP-1559, the BASEFEE portion of every transaction is denominated in ETH and permanently burned.
In summary, EIP-1559 achieves two major things:
Establishes a market-driven pricing mechanism for block space.
Mandates ETH for fees and burns most of the ETH paid in transaction fees.
This will reshape Ethereum’s economic ecosystem.
Previously, the rise of stablecoins, the DeFi liquidity mining craze, or even Ponzi schemes on Ethereum did not enrich the Ethereum protocol layer. Some even threatened Ethereum’s security—leading to the situation where “the more successful DeFi, the more dangerous for Ethereum.”
EIP-1559 changes all that.
Burning the BASEFEE is equivalent to paying value back to the entire Ethereum network—benefiting all ETH holders. By increasing ETH scarcity, EIP-1559 internalizes externalities and solves the “tragedy of the commons” on Ethereum.
EIP-1559 acts like a tax system for Ethereum’s economy—ensuring that all citizens (ETH holders) automatically benefit from Ethereum’s value creation. Whether participating in staking, DeFi, gaming, or even speculative schemes, every use case on Ethereum increases ETH scarcity and strengthens the protocol layer’s value.
Of course, whether EIP-1559 will ultimately be adopted remains uncertain. According to Vitalik’s message in a WeChat group, a testnet for EIP-1559 already exists, and Ethereum 2.0’s first phase includes EIP-1559.
Additionally, the highly anticipated Ethereum 2.0 is imminent.
On July 23, the Ethereum Foundation announced that the next multi-client testnet, Medalla, will launch at 9 PM Beijing time on August 4—marking the final step before the Ethereum 2.0 mainnet goes live.
Previously, Ethereum Foundation researcher Justin Drake suggested Phase 0 of Ethereum 2.0 might go live in 2021, but Vitalik denied this, saying Phase 0 will launch much earlier—possibly by the end of 2020.
This is widely seen as the main reason behind Ethereum’s recent price surge. Ethereum 2.0 and EIP-1559 will revolutionize Ethereum’s economic system. Whether shifting from PoW to PoS, requiring at least 32 ETH for staking “mining,” or burning transaction fees, all will positively impact ETH’s price.
This will be Ethereum’s “last stand” comeback!
References:
Fixing the Ethereum Fee Market (EIP-1559). David Hoffman
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