Lending Protocols vs. PoS Security
DeFi is an umbrella term that encompasses all decentralized finance. 2020-21 boom centered around the breakthrough mechanisms of liquidity pools and providing liquidity to many lending and swapping protocols in exchange for a share of transaction fees (liquidity mining).
Liquidity pools do not create new coins but offer liquidity for transactions. Their rewards are related to market supply and demand for certain crypto assets and can be highly unpredictable. At the heights of the market, APYs (Annual Percentage Yields) of some liquidity pools reached hundreds and sometimes thousands of percent.
According to Chitra (2020), DeFi lending protocols cannibalize PoS networks’ security because their APY is higher than PoS staking rewards. In a rational market, PoS chains should struggle to find willing validators.
Luckily, markets aren’t 100% rational or reward-oriented. Many validators run nodes altruistically to support blockchain networks. Some users also prefer more secure and passive rewards to the unpredictable and volatile DeFi smart contracts.