Towards a DeFi reshuffle?

Market Insights Feb 25, 2021

Ethereum scalability challenges paving the way to Binance Smart Chain

Ethereum success story

Ethereum, the second largest blockchain by market capitalisation, is a tremendous success story. It was built in 2014 to allow real-world assets, such as stocks and property, to communicate with applications on the blockchain, expanding crypto use cases well beyond money and leading the way to decentralised finance (DeFi). But Ethereum seems to be victim of its own success: it struggles to deliver as the DeFi ecosystem is booming and it’s now losing ground due to scalability issues. Like Bitcoin, the main reason for the Ethereum scalability problem is the proof of work protocol where each node in the network has to process each transaction, then the huge growth of decentralised apps has led to congestions and uncontrolled transaction fees (gas fees) since mid 2020. Gas fees are currently 21 times as expensive as those a year ago. Ethereum is working on ETH2.0, a more scalable network moving to Proof of Stake* (PoS) protocols and Shardings: PoS solves the problem of speed transaction and energy consumption while Shardings refers to splitting the entire Ethereum network into multiple portions called 'shards'. Each shard would contain its own set of account balances and would validate transactions independently from other shards. Altogether ETH2.0 shall definitely fix scalability issues but these changes take time and won’t be fully rolled out until a couple of years.

*More information about PoS on the article Blockchain Technology and Sustainability

Ethereum vs Binance Smart Chain average transaction fees (gas fees)

Sources: Ychart, BscScan   29 Aug 2020 -  22 Feb 2021

Shift to Binance Smart Chain

Throughout the Ethereum’s crisis, many DeFi protocols may shift to Binance Smart Contract (BSC), an independent blockchain created by Binance last September, specifically designed to enhance scalability: BSC’s transactions are validated through a Proof of Stake protocol, a quicker, cheaper and more environmentally friendly protocol, and it's compatible with Ethereum Virtual Machine (EVM). In short, this makes it easy for developers to migrate their application over from Ethereum. In terms of metrics, BSC Total Locked Value (assets locked in liquidity pools)  has grown ten fold over the month, at the current pace, it might overtake Ethereum's in the next few weeks. Volumes have shifted earlier this month (see chart below), BSC now have twice as much transactions as Ethereum.

Sources: BscScan, Etherscan  29 Aug 2020 - 24 Feb 2021

As a result of BSC’s rising popularity, Binance native token (BNB) has skyrocketed and gained 462% over the month (from $43.9 on 01Feb to $227 on 25Feb), flipping Tether (USDT) as the third-largest cryptocurrency by market cap.

Store of value

Unlike Ether, BNB supply is not inflationary: it does not mint new BNBs during transactions, on the contrary, the supply of BNB decreases over time, as Binance regularly conducts coin burns. As a mechanical monetary effect, buy-back-and-burn programmes will boost Binance coin price and shall make it an efficient store of value.

Any clouds on the horizon?

  • Centralisation: Binance Smart Chain is not as decentralised as some might think: its validation process only requires 21 validators compared to the 1,000s of validators that ETH2.0 will have. This small set of validators, vetted by BNB holders, makes it easier for Binance to control the network.
  • Controversial governance: Although Binance Smart Chain is independent from Binance Chain (the centralised exchange), both blockchains share the same native coin (BNB), which might suffer from either chain’s challenges. Binance Chain is sometimes criticised for its governance and its lax regulatory processes.

Many seasoned traders believe BSC is only a short term solution and, if the Ethereum network manages to get the gas fee in control, traders could be back to it.

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Carole Laizet

Senior marketing manager with 15+ years of experience in the Financial Industry (traditional Banking as well as Crypto Assets). Responsible for market research @trakx.io