DeFi 1.0 was built for highly volatile assets; traditional finance tools will fail on-chain.

Author: Multicoin Capital

Compiled by Deep潮 TechFlow

DeepChain Summary: This in-depth article by Multicoin Capital highlights the most critical mismatch in today’s crypto market: all core primitives of DeFi 1.0 were designed for highly volatile speculative assets; when low-volatility assets such as U.S. Treasuries, equities, and corporate credit are brought on-chain at scale, AMMs, perpetual swaps, and floating-rate lending will collectively fail. For investors and developers building in the RWA space, this is a roadmap for “what the next generation of infrastructure will look like.”

This is the fourth article in our on-chain markets series. In the first article, we discussed Application-Controlled Execution (ACE) and how it creates new ways for tokens to capture value. The second article explored adverse selection in DeFi and defense models. The third article examined how various sectors of real-world assets (RWA) will be brought on-chain.

It should be noted that in this article, we use “cryptographic assets” to refer to native on-chain assets such as BTC, ETH, SOL, and HYPE, and “RWA” to refer to assets originating outside the crypto space, including stocks, bonds, commodities, currencies, and other traditional financial assets.

The earliest assets on the blockchain were native crypto assets such as BTC, ETH, SOL, and now HYPE. Consequently, early DeFi primitives were primarily built for these assets. These products include AMMs (Uniswap), vAMMs (Perpetual Protocol), CDP stablecoin protocols (Sky, formerly MakerDAO), synthetic assets (Synthetix), open-ended floating-rate lending pools (Compound/Aave), and perpetual contracts (dYdX). We believe these products have operated relatively well due to the underlying markets’ high volatility, substantial speculative trading, oversupply of long-tail tokens, and permissionless access. Looking back at history, the DeFi total value locked chart used to look like this:

Source: https://mikemcdonald.github.io/eth-defi/

But portfolios and user bases are evolving. U.S. Treasuries, equities, corporate credit, commodities, foreign exchange, and other RWAs are being tokenized. These assets typically exhibit lower volatility, narrower spreads, well-defined maturities and cash flows, serve as superior collateral, feature clearer borrower identities, and are traded by large institutional participants. As a result, a new set of primitives is becoming essential: central limit order books (CLOB), request for quote (RFQ), propAMM, fixed-rate lending, vaults, interest rate derivatives, repurchase agreements, dark pools, portfolio margining, options, and futures with dates. We refer to these as DeFi 2.0 primitives.

Many of these primitives have existed in DeFi for years. In many cases, DeFi built these primitives before the appropriate assets were tokenized on-chain.

The context of this article is that most discussions about RWA have focused on tokenizing assets and moving them onto blockchains, including our recent article. However, few have explored how the underlying market structures and primitives will evolve with the arrival of these new (and old) assets.

Building new foundational primitives should create significant downstream opportunities for investors, as value is likely to be captured across the entire stack—from the general-purpose chain itself, to the core primitives being built, to the frontends and order flow engines that manage end-user relationships.

From a traditional finance perspective, early DeFi primitives appear extremely inefficient: AMMs have lower capital efficiency than professional market makers, overcollateralized CDPs are an expensive way to leverage long positions, floating-rate lending makes funding costs unpredictable, and risk is globalized into just a few pools. But what is underdiscussed is that these primitives were designed for crypto assets.

For newly issued crypto assets, the primary challenge is gaining any liquidity, not optimizing execution price. The core advantage of AMMs is that anyone can quickly create a market and achieve some degree of price discovery.

In permissionless systems, anonymous borrowers have no balance sheets or credit histories, so these protocols rely on over-collateralization rather than systematic credit reviews that could have secured them better terms. In practice, this doesn’t matter, as it’s well known that most users of lending protocols borrow not to finance activities, but to leverage purchases of highly volatile crypto assets or to obtain liquidity without selling their crypto holdings. For these users, variable interest rates are perfectly acceptable, since when the underlying asset can fluctuate by 100% in a month, a few hundred basis points in additional cost is negligible.

Perpetual contracts follow the same logic. Cryptographic assets do not expire, carry no legal rights, and generate no cash flows, so traders typically seek continuous leveraged exposure to price movements. Eliminating expiration dates and enabling synthetic derivatives simplifies the product and better aligns it with the underlying asset. Similarly, for those seeking 2x long exposure to highly volatile crypto assets over short timeframes, funding rates are not a significant barrier.

DeFi 1.0 is not merely an early version of traditional finance. It was built for a specific set of native crypto assets and users. When the assets change, the primitives change as well.

A set of characteristics distinguishes RWA from the crypto assets that our industry has grown upon. These DeFi 2.0 features—or flaws, depending on whom you ask—include:

Lower volatility and tighter spreads

Term and predictable cash flows

Better collateral and identifiable borrowers

Larger institutional market participants

A more diversified portfolio and risk exposure

AMMs excel at bootstrapping liquidity for long-tail crypto assets. If you launch a new token on Pump.fun or fund through MetaDAO, the first challenge is getting the market up and running. But for U.S. Treasuries, Apple stock, or EUR/USD, this is not an issue at all—these markets already have professional market makers, deep liquidity, low volatility, and extremely tight spreads. For these assets, execution quality is what truly matters.

When someone buys a memecoin, under otherwise identical conditions, they won’t care about a few basis points. Traders can pay 2% slippage and either double their money with a 30% profit or lose 30% an hour later, barely noticing the execution cost. But for U.S. Treasuries or forex trading, 10 basis points could represent the entire economic value of the trade.

In these cases, CLOB, RFQ systems, and propAMMs are more suitable. Professional market makers can price their inventory based on external prices, volatility, order flow, and their own risk limits, rather than simply laying liquidity along an AMM curve. These primitives have existed in DeFi for years, but their importance is especially pronounced for assets where small execution differences can have significant impacts.

It is also much easier to onboard market makers for these assets, for several reasons. First, there is already a large market maker industry actively trading them, along with numerous traditional venues available for hedging and offsetting risk. Second, more attractive and liquid assets naturally generate greater retail demand, giving market makers more incentive to provide liquidity for these underlying assets. Third, the gap risk is significantly lower than with memecoins and high-beta crypto assets, making it less likely that market makers will be caught off guard even in environments with slightly higher public chain delays.

Low-volatility assets also make certain derivatives more useful. Protocols like Ribbon, Katana, and Friktion built automated covered call and put-selling products years ago. Some of these products gained limited attention, but the underlying assets often didn’t align well. Selling covered calls works well for stocks that may rise 10% over a year, providing additional yield to holders. However, applying this strategy to SOL is less sensible, as SOL could fluctuate 50% in a single month, causing holders to give up significant upside potential for relatively modest yield. We understand the market prices this in, but historically, liquidity in the crypto options market has been far lower than in the stock market.

Crypto options have arguably always been somewhat unnecessary due to the nature of the assets themselves. If you're seeking a high-slope, dopamine-driven trading experience in the crypto market, you can simply go 3x long on HYPE perpetuals—this Delta One derivative already offers sufficient risk-reward and entertainment value. You don’t need options, because options inherently require precise timing judgments and carry the risk of losing your entire principal.

As equities, indices, commodities, currencies, and other low-volatility RWAs come on-chain, options may finally experience meaningful growth. Liquid options markets open the door to primitives such as covered calls, collar strategies, downside protection, volatility trading, and structured yields. We believe that some DeFi infrastructure built years ago—such as option vaults—wasn’t wrong; it simply arrived too early relative to the assets it was meant to serve.

Finally, volatility has a significant impact on the credit market. When collateral itself can fluctuate by 10% in a single day, lenders require much larger buffers—which is why early crypto lending markets typically set LTV ratios around 66% alongside extremely stringent liquidation penalties. This also explains why floating-rate borrowing has been sufficient for DeFi centered on crypto assets. If Alice borrows USDC against SOL to leverage her position, she may not mind if her annual borrowing cost jumps overnight from 7% to 10%, since her collateral’s value could fluctuate by more than that in a single day.

Duration and predictable cash flows

Most crypto assets are perpetual. BTC, ETH, SOL, or HYPE have no concept of an expiration date, which shapes lending and derivatives markets in DeFi. Aave and Compound primarily offer floating-rate loans with no fixed term, making them suitable for traders who may not know how long they’ll hold their positions, and where borrowing costs are secondary to the volatility of the underlying asset.

We wrote about the opportunity in fixed-rate markets within DeFi as early as 2021. To be honest, we were too early, primarily due to the nature of the assets themselves.

A company borrowing $100 million for three years to fund an acquisition or capital expenditure plan needs to know whether its annual interest expense will be $5 million or $10 million. Similarly, an asset manager who buys bonds yielding 6% while financing at 4% is betting on a 2% spread; if financing costs suddenly rise to 6%, the economic viability of the trade disappears. Therefore, certainty is crucial for these groups.

In addition, perpetual lending suffers from structural inefficiencies. Lenders require the ability to withdraw at any time, while borrowers prefer the longest possible loan duration. As a result, the risk management frameworks of these protocols typically require additional liquidity buffers to accommodate lender withdrawals. By the way, this is why perpetual lending pools in DeFi have such aggressive utilization curves—they aim to prevent the entire pool from being fully borrowed. A portion of lenders' funds remains idle, creating a gap between the interest rate paid by borrowers and the rate received by lenders, not to mention fees charged by protocols like Aave and Kamino.

A fixed-rate, fixed-term market is one way to address this issue. Borrowers and lenders commit to specific maturity dates rather than allowing lenders to withdraw funds at any time. This means more of the lender’s capital remains actually deployed, while borrowers know their exact financing costs. The trade-off is that liquidity is dispersed across different maturities. Three-month loans and one-year loans are separate markets, but this is how you begin to achieve genuine price discovery over time and ultimately form a yield curve.

Morpho Midnight is one example. It creates fixed-term markets where interest rates are determined by bid and ask quotes for specific maturity dates, allowing lenders to trade positions before maturity. If liquid markets for three-month, six-month, one-year, and multi-year terms eventually emerge, you could begin answering how much capital costs at different points in time. On this foundation, pricing loans, bonds, forwards, swaps, and virtually any product dependent on duration would become significantly easier.

Pendle and Exponent are two other examples whose TAM evolves as their asset base expands. These products split yield-bearing assets into principal and yield components, allowing users to trade fixed and floating yields. Historically, the range of on-chain yields has been relatively narrow: staking rewards, lending rates, perpetual contract funding rates, and ultimately, protocol tokens. In fact, one of the most notable uses of yield tokens has become leveraged exposure to DeFi protocol token incentive programs.

With the emergence of RWA, the scope of yields has expanded to include government bond rates, credit spreads, dividends, floating-rate loans, and other contractual cash flows. Yield stripping has evolved from a means of amplifying protocol incentives into a general-purpose tool for separating and trading principal from income—which is why we’re so excited about this primitive.

The same logic applies to interest rate derivatives. Pendle’s Boros allows users to trade fixed versus floating perpetual funding rates on specific maturity dates. Today, the underlying interest rate remains crypto-native. But once the hedged asset becomes Treasury yields, corporate borrowing costs, or other real-world benchmarks, this structure becomes significantly more interesting.

The same applies to futures and forwards. A company hedging a foreign exchange payment due in six months does not want a perpetual instrument. Neither does a producer locking in a commodity delivery price, nor a bond investor hedging duration. These exposures have specific dates, and so should the hedging instruments.

Finally, we believe that as the range of assets and strategies in DeFi expands, vaults should become more versatile. Early DeFi vaults primarily automated crypto-native strategies such as yield farming, leveraged looping, market making, and selling options on volatile tokens. With RWA, vaults can bundle Treasury ladders, covered call options on stocks, diversified credit portfolios, basis trades, or various combinations of fixed- and floating-rate exposures. The underlying primitives are not new, but the range of strategies they can accommodate will be significantly broader.

Better collateral and identifiable borrowers

When crypto lending began, the assumption was that protocols knew almost nothing about borrowers. Ethereum or Solana wallets have no income statements, credit scores, or legal repayment obligations that smart contracts can easily enforce. Overcollateralization solves this by making identity essentially irrelevant: if a user wants to borrow $100 in USDC using ETH, Maker requires $150 in ETH as collateral, and liquidators will liquidate the position once it becomes unsafe.

This may suffice for anonymous borrowers using volatile collateral, but it is far less efficient for many RWA assets. Treasuries are not ETH—they have lower volatility, deep external liquidity, and allow lenders to more confidently mark their value. Requiring $150 in Treasuries to borrow $100, simply because crypto lending evolved this way, wastes the advantages of high-quality collateral. A 66% LTV is clearly unreasonable for Treasuries and other high-quality collateral.

RWA, along with more robust identity and legal frameworks, makes borrowers themselves insurable. When dealing with real companies or funds, you can review balance sheets, cash flows, management teams, contracts, and liabilities. If the borrower is identifiable and the collateral is legally enforceable, lenders no longer need to rely entirely on the value of the collateral. We are also beginning to see protocols link repayment behavior to off-chain credit profiles and impose penalties on borrowers who default on-chain. Maple is already doing something similar today, underwriting institutional borrowers rather than treating them as anonymous wallets.

Early DeFi undercollateralized lending networks fundamentally failed because the only borrowers were those who couldn't access loans in traditional finance. For example, Goldfinch provides funding to small and medium-sized enterprises in emerging markets that lack sufficient creditworthiness or favorable geography to obtain decent credit. This naturally led to significant adverse selection. Once the U.S. regulatory framework truly opens up to allow legitimate businesses to access permissionless credit (while incorporating KYC/AML), we believe this market will expand dramatically, offering global retail investors the opportunity to access well-risk-adjusted loan yields.

Larger institutional market participants

RWA is also changing traders and trade sizes. While blockchain transparency is usually an advantage, it becomes complicated when traders execute large-scale transactions. Buying $20,000 worth of BTC doesn’t require transparency. But when an asset management firm needs to buy $100 million in stocks or bonds, disclosing the entire order could incur extremely high costs.

Traditional financial markets took decades to develop mechanisms that allow institutions to execute large trades without revealing their intentions—this is precisely why block trades, RFQs, hidden orders, crossing networks, and dark pools exist. DeFi is now building similar mechanisms. Renegade uses MPC and ZKPs to privately match orders and settle them on-chain, while Silhouette is constructing a dark pool on Hyperliquid. Our portfolio company Zama takes a more modular approach, building FHE primitives that enable applications on general-purpose chains to add confidentiality directly.

The key distinction lies between hidden settlement and hidden transaction intent. While some institutions may not mind transactions being disclosed afterward, it can be assumed that most, if not all, institutions seek confidentiality during execution to prevent market participants from front-running their positions.

A more diversified investment portfolio and risk exposure

Several years ago, we discussed at the summit the issue of low capital efficiency in DeFi derivatives. In short, protocols currently use isolated margin requirements, leaving room for DeFi-native prime brokers to provide credit against positions and net traders’ overall exposure across protocols, thereby reducing margin requirements.

As asset classes and position sizes grow larger and more diverse, this becomes increasingly important. If a Treasury position hedges an interest rate futures contract, the system should recognize this hedging relationship. Or if Alice goes long an equal amount of SPY and short BTC, she might deserve more favorable margin requirements. We are beginning to see individual protocols adopt portfolio margining, but a full-fledged DeFi prime broker has yet to emerge.

Our portfolio company, Project 0, is building this on Solana, enabling collateral from multiple DeFi venues to enter a unified margin and credit system. Currently, this primarily enhances capital efficiency within the crypto market. However, the value of this primitive will be significantly greater when users can hedge interest rate futures with Treasury exposure, options with stocks, forward futures with commodities, and forward contracts with foreign exchange exposure.

We see this as another example of RWA significantly expanding the total addressable market for existing DeFi primitives. Portfolio margin is useful when traders hold multiple crypto positions, as most crypto assets still share a large amount of the same underlying beta. However, the value of portfolio margin becomes much greater when the portfolio includes truly diverse risk sources such as equities, credit, interest rates, commodities, and foreign exchange, alongside crypto.

As more assets come on-chain, we envision users maintaining a single balance sheet across all asset classes. They won’t need to pre-fund each platform individually; third-party prime brokers will aggregate and net their exposures across all asset classes.

Most importantly, RWA should significantly expand the economic surface area of DeFi.

The most obvious TAM expansion lies in the scale of the underlying asset base. Cryptocurrency assets currently represent only a relatively small portion of global financial assets. Stocks, sovereign and corporate bonds, commodities, currencies, and other RWAs are orders of magnitude larger. Even if only a small fraction of these assets and their associated transactions were brought on-chain, the opportunity space for DeFi protocols would expand dramatically.

However, TAM expansion has another dimension we consider equally important: RWAs typically require more financial infrastructure to be built around each dollar of assets.

A memecoin may only require a spot market and a perpetual futures market, and perhaps an additional lending pool if there is any collateral value or short-selling interest. A government bond, by contrast, can be traded on the spot market, financed through repurchase agreements, used as collateral, included in fixed-income portfolios, hedged with futures or interest rate derivatives, and embedded in structured products. A single stock can support spot trading, securities lending, options, forwards, covered calls, portfolio margining, and index products.

So the opportunity isn't just about having more assets on-chain; there should also be significantly more financial activity surrounding every dollar of assets. We believe value can flow throughout the entire stack.

At the base layer are the universal L1 and L2 protocols themselves. More complex financial markets require more transactions: market makers update quotes, traders place and cancel orders, credit positions are financed and refinanced, options are settled, collateral moves between venues, and portfolios are rebalanced. Ultimately, blockchains will continuously update vast amounts of financial state. If—and we believe they should—blockchains become the settlement and execution layer for these activities, L1s and L2s will benefit from larger, more sustained demand for block space beyond mere crypto speculation.

The layer above consists of core financial primitives. Exchanges profit from trading activity, lending protocols capture a portion of the credit spread, interest rate markets profit from duration and yield trades, and options and structured products protocols charge fees for risk transfer. In many cases, the protocols already exist—their underlying TAM is simply growing larger. Pendle no longer needs to remain primarily a market for staking yields and incentives, Boros no longer needs to be primarily a market for perpetual funding rates, and options protocols no longer need to be limited to trading BTC and ETH volatility. They can transcend these constraints and capture more value.

The aggregation layer also holds significant potential value. As more venues and asset classes come on-chain, users won’t want to manage financing, collateral, and execution separately across a dozen different protocols. This creates space for DeFi-native prime brokers that can view a user’s entire portfolio, determine where capital should be allocated, what level of leverage is appropriate, and where trades should be executed. This role has already been highly valuable in traditional finance, and on-chain, as markets become more fragmented and composable, it should become even more critical.

Finally, there is the application and order flow layer. The applications used by customers ultimately determine where most activity flows. They decide where trades are routed, where collateral is held, which credit markets users can borrow from, and which products users see in the first place. We’ve covered this in our article on issuer exchanges. If you control order flow, you can direct it toward trading venues and liquidity providers that offer the best economic returns.

That’s why we believe the opportunity with RWA goes beyond simply putting assets on-chain. As more assets come on-chain, they will drive demand for new financial infrastructure around them, including primitives for trading, credit, derivatives, and risk management.

DeFi has already implemented most of the primitives required for RWA: order books, RFQs, options, structured products, term lending, yield stripping, interest rate derivatives, dark pools, and portfolio margining. We believe the issue is that they were built for the wrong type of asset—crypto assets.

Friktion created covered call vaults, but the underlying assets are still highly volatile crypto assets. Pendle separated principal from yield, but the primary tradable yields are protocol tokens. Boros launched interest rate derivatives, but the underlying rates remain perpetual funding rates. Project 0 unified margin, but most positions are still merely different forms of crypto exposure.

The core primitives that have defined DeFi to date—AMMs, perpetual contracts, open-ended floating-rate lending, vAMMs, and overcollateralized stablecoins—emerged because they align with the characteristics of existing crypto assets. Importantly, these products will not disappear: AMMs will continue to serve long-tail assets, perpetual contracts will remain the primary tool for crypto speculation, and pooled overcollateralized floating-rate lending will still be the best option for anonymous borrowers seeking to leverage their existing crypto assets. However, we need new primitives to support the industry’s next direction, which is likely to be RWA.

The first phase of RWA primarily involves putting assets on-chain and tokenizing them. The next phase is to make them useful once they are on-chain.

In our liquidity and venture capital operations, we are making the biggest bet of our lives: that DeFi 2.0 primitives will unlock a wealth of compelling investment opportunities. We believe these financial building blocks will power the next generation of on-chain assets—assets that people around the world are eager to hold.

In this article, we discuss how DeFi primitives will evolve to support RWA. In the next article on market structure, we will explore why RWA needs DeFi in the first place.