Why does the next stage of DeFi rise depend on "infrastructure"?

Source: Dewhales Research Translation: Shan Ouba, Golden Finance

Introduction

Despite billions of dollars in liquidity flowing between protocols every day, the lack of measurement for value creation is threatening the sustainability of DeFi. In 2020, DeFi users would deposit tokens into a single protocol to earn yields, and that was it. Today, the same users may traverse five different blockchains in minutes, interacting with dozens of protocols and executing complex strategies, while the protocols struggle to track what is actually happening.

Why is this a problem? Because the protocol cannot currently distinguish which users are creating real value and which users are gaming the system for quick rewards. When a user's activities span multiple chains and protocols, the existing infrastructure cannot connect these dots. Ultimately, the protocol rewards mercenary users who extract value and leave, while completely overlooking the most valuable contributors. It is this complexity of DeFi that is undermining systems designed to sustain its development.

Why is the issue only becoming prominent now?

Two major market changes have brought attribution issues into the spotlight. The first is scale. The total value locked (TVL) in DeFi has grown from $1 billion to over $100 billion, meaning the wasted funds due to attribution failure are several orders of magnitude greater than in the early days of DeFi. Losses that were acceptable in 2020 have now become a substantive risk to the sustainability of protocols.

Next is competition. With the surge in the number of DeFi protocols and rising user acquisition costs, the ability to identify and retain valuable users has become a competitive advantage. Protocols that can distinguish between true contributors and mercenary users will be able to outperform competitors that still rely on rough metrics like TVL or trading volume. The infrastructure supporting this competitive advantage is finally beginning to mature, making attribution capability a key moment in distinguishing winners from losers.

The Invisible "Track" of DeFi

The infrastructure for tracking user activity and distributing rewards has become the most critical bottleneck in DeFi. When protocols cannot accurately attribute user actions across chains and activities, they make poor decisions in incentive distribution. Bots and value extractors can easily manipulate fragmented reward systems, exaggerating metrics while contributing nothing to the long-term health of the protocol. Due to the inability to clearly understand who is actually creating value, protocols waste millions of dollars in growth funds, which evaporate instantly when the rewards stop.

Failure of Incentive Mechanism

The risks have been validated. Protocols like Alchemix and Compound have experienced this firsthand. Alchemix's aggressive token rewards attracted mercenary capital, leading to a dramatic surge in liquidity during the incentive period, but it turned out to be short-lived. As shown in the figure below, when the rate of token release slowed down, the TVL plummeted sharply, losing most of its early gains.

Image: Alchemix (ALCX) Historical Chart

The COMP distribution of Compound also reveals a similar dynamic. Most of the distributed COMP tokens are immediately sold by opportunistic miners rather than being held. Governance participation is limited to a small group of recipients, and rewards mainly flow to short-term speculators rather than contributors to governance and protocol health. This dilutes the quality of governance and increases the volatility of the ecosystem.

Chart: Compound (COMP) 5-Year Chart

These failures reveal a deeper issue: the protocols cannot distinguish between value creators and value extractors because they lack visibility into user behavior. Alchemix and Compound cannot identify that the users they reward the most are actually mercenaries who cycle the same funds between different protocols to maximize returns and exit immediately when rewards decrease.

Today's challenges are much more complex. An advanced user might provide liquidity on Uniswap v3, hedge on Arbitrum, participate in liquidity mining through a bridge to Optimism, and leverage lending protocols, but the current infrastructure treats these actions as unrelated isolated activities rather than a coherent value creation strategy.

This attribution crisis has given rise to a new class of infrastructure specifically designed to address these blind spots.

Infrastructure Pattern

• Merkl: An attribution and reward distribution system that is capable of tracking the behavior of liquidity providers beyond simple deposit events. It can measure rewards based on factors such as liquidity depth and utilization rate. For example, on Uniswap v3, liquidity is provided near active price ranges. Merkl is responsible for handling the indexing and data normalization required for these cross-chain computations, allowing DeFi protocols to directly code more detailed reward rules on-chain.
• Layer3: A coordination layer for on-chain actions. It initially focused on user guidance and now provides attribution for cross-protocol multi-step workflows (e.g., staking → providing liquidity → bridging → lending). By recording proof of completed actions at the wallet level, it captures user intent and engagement more accurately than just raw transaction volume.
• Galxe: An infrastructure for identity-linked rewards. It issues and verifies credentials from on-chain actions, off-chain data, or specific protocol requirements. Rewards can be weighted based on persistent identity or reputation, making the system more resistant to Sybil attacks than wallet activity-based attribution methods.

These platforms aim to address attribution challenges but serve different use cases. Merkl excels at tracking liquidity depth and capital efficiency for DEX and lending protocols. Layer3 focuses on multi-step user journeys across protocols. Galxe rewards long-term community participation through persistent identity rather than wallet-level activity. Despite the targeted nature of these approaches, the fundamental gap in cross-chain attribution still remains.

Current Gaps and Bottlenecks

Despite these advancements, fundamental infrastructure issues remain unresolved. Each blockchain uses different data formats and event structures, making it nearly impossible to correlate a user's cross-chain activities without customized integration for each protocol combination.

Cross-chain Data Fragmentation Each blockchain is an independent data island, with different data models, event structures, and transaction finality rules. Indexing Ethereum events and parsing Solana's runtime, or reading state from Rollups like Arbitrum or Optimism, is completely different. In fact, this means that protocols wanting to understand user behavior across multiple environments must:

1. Build custom indexers for each chain and protocol integration, which is costly and cumbersome to maintain, or
2. Relying on incomplete coverage and heuristic methods, which leads to significant blind spots when analyzing complex strategies.

Currently, there is no standardized framework for inter-chain visibility that spans different blockchain architectures, and this fundamental gap means that "holistic attribution" remains out of reach.

Superficial Attribution Signals Most current reward systems rely on crude signals, such as raw trading volume, wallet age, or transaction amount thresholds. These metrics are easily manipulated, as funds can be recycled, wallets can be mass-registered, and transaction spam can masquerade as genuine activity.

Experienced players have exploited these blind spots by simulating high engagement behaviors to gain rewards, while the actual economic utility contribution is negligible. As pointed out above, there is still a lack of a deeper framework to consider context. For example, is liquidity provided during market volatility to stabilize the market, or only during times when arbitrage is easy? Do users bridge funds and use them for long-term strategies? Today's tools cannot parse these nuances.

These technological limitations lead to specific operational issues. If a protocol attempts to internally solve attribution issues by running multi-chain indexers, archiving on-chain data, and maintaining cross-protocol associations, the resource consumption will be immense. Real-time analysis requires synchronization across chains with varying transaction finality speeds. For most protocols, this is not only technically challenging but also economically unfeasible, unless there are dedicated infrastructure partners. Therefore, attribution is often delayed, incomplete, or completely inaccurate.

Next Generation Evolution: Smarter Incentives and Better Filters

The next generation of DeFi infrastructure must address three key challenges:

1. Adjust reward parameters dynamically in response to changes in user behavior.
2. Provide institution-level audit trails that can track complex strategies across protocols and time frames.
3. Even when users perform multi-layer operations involving dozens of contracts, attribution remains clear.

The current reward system is essentially static. A liquidity mining program sets a fixed annual percentage yield (APY) regardless of market conditions or ecosystem health. Future infrastructure needs to respond in real-time to changing behaviors. When advanced users discover new arbitrage cycles or institutional players deploy systematic strategies, the reward parameters should automatically adjust to maintain a balance between growth and sustainability.

Now, retail users may tolerate rough attribution, but institutions need precise accounting of which actions generated returns. As hedge funds and financial managers allocate a larger proportion of their portfolios to DeFi, they demand the same attribution standards as traditional finance. This means comprehensive audit trails are needed, capable of tracking every component of complex strategies, real-time risk monitoring across protocols, and detailed reporting to meet compliance requirements.

Ultimately, the infrastructure must maintain clarity of attribution, even when users execute multi-layer operations involving dozens of smart contracts, in order to preserve the causal chain through complex sequences (such as lending, exchanging through aggregators, providing liquidity, and hedging positions).

As strategies become increasingly complex, maintaining a clear causal tracking is crucial for ensuring the accuracy of value attribution. This creates a recursive loop: advanced users demand better infrastructure, which enables more complex strategies, in turn attracting more sophisticated participants. The result is that DeFi evolves towards operational maturity at a level comparable to traditional finance, while retaining its open and programmable advantages.

Conclusion: Infrastructure is the true frontier of growth

Although new protocols and applications dominate the headlines, the true determinants of long-term success for DeFi lie in the invisible infrastructure responsible for connecting, tracking, and rewarding user behavior within the ecosystem. The current attribution crisis is not just a technical issue; it directly threatens the sustainability of DeFi, as protocols waste millions of dollars on ineffective incentives while their most valuable users remain unrecognized.

Protocols that can accurately attribute value creation, adjust incentives based on changing user patterns, and filter signals from noise will establish a compounded, sustainable competitive advantage over time. Until protocols can seamlessly correlate user behaviors across different blockchain architectures, they will continue to make incentive decisions based on incomplete data.

As advanced DeFi users continue to evolve, the infrastructure must evolve accordingly, not as an afterthought, but as the foundation for the next stage of decentralized finance. The winners of the next chapter of DeFi may not necessarily be the protocols with the most dazzling applications, but rather those with the smartest infrastructure to understand and reward the complex behaviors that create lasting value.