Source: Cointelegraph Original: "{title}"
Opinion by Marc Boiron, CEO of Polygon Labs
Decentralized finance (DeFi) needs a reality check. For years, various protocols have chased growth through token issuance, promising eye-popping annual percentage yields (APY), but when incentives dry up, liquidity evaporates. The current state of DeFi is too driven by speculative capital, which is creating artificial ecosystems destined to collapse.
The industry is caught in a destructive cycle: launching a governance token, generously distributing it to liquidity providers to boost total value locked (TVL), celebrating growth metrics, and then helplessly watching yield farmers withdraw their funds and move on to the next hot protocol. This model fails to create lasting value and only produces a temporary illusion of success.
DeFi should adopt better methods to create value and enhance capital efficiency. The current emission-driven yield model has three fatal flaws that continue to undermine the industry's potential.
Most of DeFi's yields come from inflationary token emissions rather than sustainable income. When protocols distribute native tokens as rewards, they dilute token value to subsidize short-term growth. This creates an unsustainable dynamic where early participants capture value while later users are left holding depreciated assets.
Employed capital dominates DeFi's liquidity. Due to a lack of structurally incentivized long-term commitments, capital freely flows to any protocol that can offer the highest temporary returns. This liquidity is not loyal—it follows an opportunistic path rather than fundamental value, making protocols vulnerable to sudden capital flight.
Misaligned incentive mechanisms hinder protocols from building sustainable treasuries. When governance tokens are primarily used to attract liquidity through emissions, protocols cannot capture value for themselves, preventing them from investing in long-term development and security.
Recently: The European Commission plans to hold four more cryptocurrency roundtables on issues such as trading, custody, tokenization, and DeFi.
These issues have recurred across multiple DeFi cycles. The "DeFi Summer" of 2020, the yield farming boom of 2021, and the subsequent collapse all displayed the same pattern: unsustainable growth followed by devastating contraction.
How can this problem be addressed? To solve this issue, a shift from an extractive economic model to a regenerative economic model is necessary, and protocol-owned liquidity is one of the most promising ways to achieve this. Instead of leasing liquidity through emissions, protocols can establish a permanent capital base that generates sustainable returns.
When protocols own their liquidity, they gain multiple advantages. They can withstand capital flight during market downturns. They can generate ongoing fee income that flows back into the protocol rather than to temporary liquidity providers. Most importantly, they can create sustainable yields derived from actual economic activity rather than symbolic inflation.
Collateralized bridging assets provide another pathway to sustainability. Typically, bridged assets sit idly, contributing little to the liquidity potential of the connected blockchains. By locking up bridged assets, they can be redeployed into low-risk, yield-generating strategies on Ethereum, which are used to fund yield enhancement. This allows protocols to align participant incentives with long-term healthy development while also improving capital efficiency.
To mature DeFi, protocols must prioritize actual yields, meaning returns generated from real income rather than token emissions. This means developing products and services that create genuine user value and capturing a portion of that value for the protocol and its long-term stakeholders.
While the initial returns generated by sustainable yield models are often lower than those based on emissions, these returns are sustainable. Protocols that embrace this shift will build resilient foundations rather than chase vanity metrics.
The alternative is to continue the cycle of booms and busts, which undermines credibility and hinders mainstream adoption. By relying on unsustainable economic models, DeFi cannot fulfill its promise of innovating finance.
Protocols capable of achieving this will accumulate treasury bonds designed to withstand market cycles rather than depleting them during economic downturns. They will generate returns by providing actual utility rather than printing tokens.
This evolution requires a collective shift in mindset among DeFi participants. Investors need to recognize the difference between sustainable and unsustainable yields. Builders need to design token markets that reward long-term alignment rather than short-term speculation. Users need to understand the true sources of their returns.
The future of DeFi hinges on whether these fundamental elements are addressed correctly. Before we repeat past mistakes, it is time to fix our broken yield models.
Author: Marc Boiron, CEO of Polygon Labs.
This article is for general informational purposes only and is not intended and should not be construed as legal or investment advice. The views, thoughts, and opinions expressed in this article are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
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