DeFi in 2025: Yield Compression and Market Evolution

The Changing Landscape of DeFi Lending

The first quarter of 2025 has showcased DeFi’s continued evolution, despite significant yield compression across major lending platforms. While borrower demand has cooled, innovation at the periphery of the market is accelerating, signaling DeFi’s maturation.

The Great Yield Compression

Yields across decentralized finance (DeFi) lending platforms have dropped significantly:

• The vaults.fyi USD benchmark has fallen below 3.1%, dipping under the U.S. 1-month T-bill yield (~4.3%) for the first time since late 2023. This benchmark once neared 14% in late 2024.
• Spark has enacted four rate cuts in 2025 alone, reducing rates from 12.5% to 4.5% within just a few months.
• Aave’s stablecoin yields for USDC and USDT on the mainnet hover around 3%, a stark contrast to previously attractive levels.

This yield compression reflects a market that has cooled from late-2024’s exuberance, with borrower demand tapering off across key lending protocols.

The TVL Paradox: Growth Amid Declining Yields

Despite lower yields, major stablecoin vaults have seen impressive growth:

• The largest vaults on Aave, Sky, Ethena, and Compound have collectively grown from $4 billion to $15 billion in supply-side deposits within a year.
• Spark’s TVL has more than tripled since the beginning of 2025, even with continued rate reductions.

This trend suggests that institutional investors increasingly view DeFi as legitimate financial infrastructure rather than merely a high-yield speculative playground.

The Rise of Curators: DeFi’s New Asset Managers

A major shift in DeFi lending is the emergence of curators, a new class of asset managers optimizing lending vaults. Protocols like Morpho and Euler now allow curators to actively manage risk parameters, capital allocations, and lending strategies, enhancing yield efficiency.

• Risk management roles previously handled by protocols like Aave and Compound are now managed by curators.
• Firms like Gauntlet, once service providers, now directly manage nearly $750 million in TVL across protocols, earning millions annually from performance fees.
• Curator-led vaults using riskier collateral strategies, such as Pendle LP tokens, have maintained superior returns in this compressed yield environment.

Yields on the largest USDC vaults managed by Morpho and Euler have outperformed market averages, generating 5-8% base yields and 6-12% yields when factoring in token rewards.

Protocol Stratification: A New Market Structure

The current environment has stratified DeFi into distinct layers:

1. Blue-chip Infrastructure (Aave, Compound, Sky)

• Function like traditional money market funds
• Offer modest, secure yields (2.4-6.5%)
• Capture the bulk of TVL growth

2. Optimized Lending Strategies

• Base Layer Optimizers: Morpho, Euler enable modular efficiency
• Strategy Providers: Firms like MEV Capital and Steakhouse leverage infrastructure to generate higher yields (up to 12% on USDC/USDT)

This two-tier model allows advanced strategy providers to rapidly iterate without building core infrastructure, creating a dynamic lending market.

Chain-by-Chain: Where the Yields Are

Despite the rise of Layer 2s (L2s) and alternative Layer 1s (L1s), Ethereum mainnet remains dominant for high-yield opportunities:

• Established chains (Ethereum, Arbitrum, Base, Polygon, Optimism) have seen broad yield declines.
• Base is emerging as a secondary yield hub outside Ethereum mainnet.
• Newer chains (Berachain, Sonic) offer elevated yields due to incentives, but sustainability is uncertain as subsidies phase out.

The DeFi Mullet: FinTech in the Front, DeFi in the Back

Coinbase’s Bitcoin-collateralized loans via Morpho on Base exemplify the “DeFi Mullet” thesis: fintech user interfaces in the front, DeFi infrastructure in the back.

• Users can now borrow up to $100,000 USDC against BTC holdings directly within Coinbase.
• Coinbase integrates cbBTC (wrapped BTC on Base), Morpho (DeFi lending), and Base (L2 network) into one seamless experience.
• This marks a shift where billions may use DeFi without realizing it, similar to how people unknowingly use TCP/IP today.

Looking Ahead: Key Catalysts for DeFi Lending

Several factors could reshape DeFi lending throughout 2025:

1. Democratized Curation: Could AI-powered automation allow retail users to customize their risk-yield strategies?
2. Real-World Asset (RWA) Integration: Expanding RWAs could introduce new yield sources decoupled from crypto cycles.
3. Institutional Capital Influx: Growing institutional comfort with DeFi could reshuffle lending dynamics.
4. Specialized Lending Niches: Targeted lending for specific needs beyond yield optimization could drive new market demand.

Conclusion

The DeFi lending market is undergoing a profound transformation. While yields have compressed, liquidity remains strong, and curation-driven asset management is unlocking new efficiencies. The most successful protocols will be those that balance risk, yield, and accessibility, ensuring DeFi continues to mature into a more structured and sustainable financial ecosystem.