Opinion by: Marc Boiron, Chief Executive Officer of Polygon Labs
Decentralized finance (DeFi) is at a crossroads, and it’s time for a reality check. For years, DeFi protocols have pursued growth through token emissions that offer tantalizing annual percentage yields (APYs), only to see liquidity vanish once those incentives disappear. The current state of DeFi is overly reliant on mercenary capital, which creates artificial ecosystems that are destined to collapse.
The industry is stuck in a damaging cycle: Launch a governance token, distribute it liberally to liquidity providers to boost total value locked (TVL), celebrate growth metrics, and then watch helplessly as yield farmers withdraw their capital and chase the next hot protocol. This model fails to create lasting value and instead produces fleeting illusions of success.
DeFi needs a more sustainable approach to value creation and capital efficiency. The current emission-driven yield model is undermined by three critical flaws.
Inflationary Emissions
Most yields in DeFi are driven by inflationary token emissions rather than sustainable revenue streams. When protocols distribute native tokens as rewards, they dilute their token value to support short-term growth. This creates a precarious situation where early adopters extract value while subsequent users are left holding devalued assets.
Capital Flight
DeFi liquidity is predominantly controlled by mercenary capital. Without structural incentives for long-term commitment, capital flows to whichever protocol offers the highest temporary yield. This liquidity lacks loyalty, following opportunistic routes rather than intrinsic value, leaving protocols susceptible to sudden capital flight.
Misaligned Incentives
Misaligned incentives hinder protocols from developing sustainable treasuries. When governance tokens are primarily used to attract liquidity through emissions, protocols fail to capture value for themselves, making it challenging to invest in long-term development and security.
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The industry has witnessed these issues repeatedly across multiple DeFi cycles. The “DeFi summer” of 2020, the yield farming boom of 2021, and subsequent crashes all follow a similar pattern: unsustainable growth followed by drastic contractions.
Protocol-Owned Liquidity
How can this be addressed? The solution involves transitioning from extractive to regenerative economic models, with protocol-owned liquidity representing a promising approach. Instead of renting liquidity through emissions, protocols can build permanent capital bases that generate sustainable returns.
When protocols own their liquidity, they gain several advantages. They become resistant to capital flight during market downturns, can generate consistent fee revenue that benefits the protocol rather than temporary liquidity providers, and most importantly, they can create sustainable yield derived from genuine economic activity rather than token inflation.
Utilizing Bridged Assets for Yield Generation
Staking bridged assets offers another path toward sustainability. Typically, bridged assets remain idle and don’t significantly contribute to the liquidity potential of connected blockchains. By staking the bridge, these assets can be redeployed into low-risk, yield-bearing strategies on Ethereum, which can then be used to support boosted yields. This approach enables protocols to align participant incentives with long-term health and enhances capital efficiency.
For DeFi to evolve, protocols must prioritize real yield — returns generated from actual revenue instead of token emissions. This requires developing products and services that offer true user value and capture a portion of that value for the protocol and its long-term stakeholders.
While sustainable yield models typically yield lower initial returns than emissions-based approaches, these returns are more sustainable. Protocols that embrace this shift will build resilient foundations rather than chasing vanity metrics.
The alternative is to continue a cycle of boom-and-bust that undermines credibility and hampers mainstream adoption. DeFi cannot fulfill its promise of revolutionizing finance while relying on unsustainable economic models.
Protocols that succeed in this endeavor will amass treasuries designed to withstand market cycles rather than deplete during downturns. They will generate yield from providing real utility rather than merely printing tokens.
This evolution necessitates a collective mindset shift among DeFi participants. Investors need to discern between sustainable and unsustainable yield. Builders must design tokenomics that reward long-term alignment rather than short-term speculation. Users should understand the true source of their returns.
The future of DeFi hinges on getting these fundamentals right. It’s time to rectify our flawed yield model to avoid repeating past mistakes.
Opinion by: Marc Boiron, Chief Executive Officer of Polygon Labs.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Source: Cointelegraph
