Setting the Stage

Arbitrum has emerged as a prominent hub for decentralized finance (DeFi).
Since its inception, it has consistently scored as one of the leading Layer 2 (L2) scaling solutions for Total Value Locked (TVL) and the number of protocols in the ecosystem.

Arbitrum’s unique value proposition lies not only in its robust technological infrastructure but also in its community-centric ethos. Initially spearheaded by prominent names in the perpetual trading space, Arbitrum has established itself as a dynamic ecosystem to develop DeFi applications, focusing on composability and cooperation over competition.

This report explores the state of DeFi on Arbitrum One, emphasizing the chain's defining features that have driven its growth and innovation.

Furthermore, it provides a comprehensive overview of the current ecosystem, offering a sectoral and comparative analysis of Arbitrum’s protocols within different niches. 

Moving DeFi Away from the Base Layer

The advent of L2 solutions offered a much-needed alternative for hosting DeFi applications beyond Ethereum’s base layer. 

Before this development, decentralized applications (dapps) faced constraints due to Ethereum’s limited gas capacity and transaction throughput (about 15-30 transactions per second). This created a bottleneck for the explosive growth of major dapps such as Aave, Uniswap, Curve, and Compound, which could not scale effectively, restricting access for small users and impacting their overall user experience.

L2 solutions democratized DeFi, transforming it from a domain accessible primarily to “whales” and high-net-worth individuals into a more inclusive ecosystem. Transaction costs have been reduced significantly, allowing broader participation.

This shift led to a surge in activity and transaction volumes. While alternative Layer 1 (L1) blockchains such as BNB Chain, Avalanche, and Solana already offered an alternative, L2 solutions like Arbitrum allowed users to leverage Ethereum’s security and network effect at a fraction of the cost.

L2 solutions, including Arbitrum, have enhanced DeFi accessibility by:

• Reducing the gas fees

• Increasing transaction throughput

This, in turn, has facilitated previously unattainable use cases such as:

• On-chain derivatives, using on-chain order books

• Looping strategies

• Peer-to-peer (P2P) Payments

• Institutional use cases

Arbitrum’s DeFi Landscape

Arbitrum gained initial traction thanks to two main drivers:

• New DeFi use cases: Perpetual and Option Protocols

• Airdrop farming frenzy and the “Arbitrum Odyssey”

During the summer of 2022, many users bridged to Arbitrum to participate in the Odyssey. 

The early adopters exploring the Arbitrum ecosystem in 2021 will remember the anxiety of bridging to an L2 for the first time.

Although most were incentivized by the prospect of an ARB token airdrop, which materialized in March 2023, most users remained active in the ecosystem post-airdrop.

This retention capacity can be attributed to the innovative DeFi applications that initially attracted users to Arbitrum, notably protocols such as GMX, Dopex, and Premia, which launched with the chain in September 2021.

• GMX: This perpetual exchange enabled on-chain derivatives trading, a domain previously dominated by centralized exchanges (CEXs). GMX pioneered a dual-token model incorporating escrow and multiplier mechanisms to align token-holder incentives and introduced GLP, an index of assets serving as the counterparty to traders.

• Dopex and Premia: These protocols introduced options trading on-chain, democratizing instruments traditionally reserved for traditional finance (TradFi).

Arbitrum’s low transaction costs facilitated these protocols’ success, enabling affordable trading for users. Furthermore, the ecosystem thrived on collaboration, with projects like GMX and Dopex supporting each other to create synergistic DeFi primitives. 

In particular, GMX acted as a fundamental infrastructural block, allowing other protocols to leverage its assets and contracts to launch new products and create the dynamic and collaborative DeFi ecosystem Arbitrum is known for.

These products include Umami Finance (yield product on GLP), JonesDAO (yield strategies on GLP and Dopex), and Vovo Finance (structured products on GLP).

On the other hand, Dopex also supported ecosystem projects in other ways, such as offering GMX put and call options.

Since Arbitrum's inception, composable DeFi legos have been critical, allowing other protocols to integrate with one another in innovative ways to create new primitives. As more applications are developed and integrated, a new layer is created, allowing the next generation of entrepreneurs to build on top and increasing the value of every other app in the stack.

This collaborative ethos laid the foundation for a composable and interconnected ecosystem.

Arbitrum’s Edge

Arbitrum distinguishes itself among L2 solutions through:

• Tech-first Approach: Arbitrum has one of the most performant tech-stacks across all L2s. Recognized as a Stage 1 rollup by L2Beat, Arbitrum boasts a cutting-edge tech stack with a 250ms block time and one of the fastest finality rates. This approach has ensured that teams building on Arbitrum can benefit from the best tech among L2s. Innovations like Stylus and Timeboost are positioned to extend this advantage further. 

• (Real) Decentralization: Unlike other L2 solutions with semi-decentralized structures, the Arbitrum DAO effectively implements Arbitrum’s development and decision-making. For this reason, building on Arbitrum requires a different flow and organization than other L2s. This gives projects more skin in the game to become part of the DAO and actively contribute to community-driven decision-making.

• DeFi composability: Arbitrum organically created a budding ecosystem of intertwined protocols, sharing assets and revenue and relying on one another for yield. The ecosystem encourages synergy among protocols, enabling them to integrate and create novel DeFi primitives. This was kickstarted as GMX, Premia, and Dopex products could be leveraged to create other DeFi primitives. Rather than compete across verticals, the extensive composability of the ecosystem led to a win-win approach where all projects collaborate to increase the ecosystem's collective value and market reach.

Once we have introduced the differentiating elements of Arbitrum, it is time to analyze how this evolved and expanded, introducing the current ecosystem.

Sectorial Analysis of DeFi in Arbitrum

This section provides an overview of Arbitrum’s DeFi ecosystem based on on-chain data, with insights into adoption, TVL, transaction volume, and other metrics.

The second section will dive deeper into the main verticals of Arbitrum’s DeFi:

• Perpetual Derivatives Exchanges: the foundation of Arbitrum’s success

• DEXs

• Yield and Lending Protocols

• Stablecoins

• RWA

• Data analysis, leaderboard

• New developments & future roadmap

According to data provided by Defillama, Arbitrum ranks:

• 4th by TVL (behind BSC, Solana, Tron, and Ethereum), with about $20b in bridged TVL (including canonical and external bridges, tokens minted on Arbitrum such as USDC) and $6b of native TVL within DeFi.

• 2nd by the number of protocols.

• 6th in active addresses, exceeding 314,000.

• 3rd in stablecoins, with $6.7 billion.

• 5th in 24-hour transaction volume, surpassing $700 million.

Here’s how Arbitrum’s bridged TVL compares to its closest competitors:

These are incredibly healthy metrics, a statement of Arbitrum’s active ecosystem and the importance of DeFi, exemplified by the number of stables and on-chain volume.

Where is the activity taking place?

Arbitrum hosts a blend of native and non-native protocols. While prominent platforms like Aave, Curve, Uniswap, and Compound have expanded to Arbitrum, native protocols such as Camelot, GMX, Stryke (previously Dopex), GammaSwap, and MUX have flourished. 

For many non-native protocols, Arbitrum is the most active network after Ethereum. This is true for Curve, Balancer, AAVE, and Compound.

Key Protocols and Ecosystem Dynamics

The Arbitrum ecosystem features a diverse array of active protocols. 

The most significant contributors for the main DeFi sub-sectors include: 

• Aave: Dominating the lending category, Aave accounts for $2.2b in TVL and generates monthly fees exceeding $4.8m.

• GMX: Leading in derivatives, GMX maintains $780m in TVL and generates over $8m in monthly fees.

• Uniswap: The most utilized decentralized exchange (DEX) on Arbitrum, Uniswap boasts $369m in TVL and $14m in monthly fees.

This diversity balances derivatives, lending, DEXs, and yield-focused protocols, emphasizing the ecosystem’s adaptability.

Out of the top 10 protocols: 

• 3 are Derivatives exchanges

• 3 are Lending Platforms

• 2 are DEXs

• 2 are Yield Protocols

Let’s now go deeper into different niches to assess how they have been performing. 

1. Perpetual Protocols

Perpetual trading represents the foundation of Arbitrum’s initial success (GMX, Gains, Vertex) and continues to be a defining element of Arbitrum’s DeFi ecosystem, generating an average of $800m in daily volume.  Nowadays, many others have migrated to complement the offer of these OG protocols. 

Traders on Arbitrum have ample choice between protocols, taking advantage of Arbitrum’s tech stack to differentiate in terms of architecture and design choice, including:

• Liquidity Pool Models: Offered by GMX and MUX, where users trade against multi-asset pools.

• Hybrid Models: Vertex combines off-chain order matching with on-chain execution.

• Synthetic Trading: Gains Network facilitates efficient leverage trading through price oracles and over-collateralization.

The ecosystem’s flexibility caters to a wide range of user preferences, from large-scale trades to cost-effective alternatives for smaller participants. 

For instance, the GMX model can accommodate larger trades. At the same time, the fees might not be ideal for small users who prefer alternative venues for their activities. 

This offer is complemented by innovative platforms like Pear Protocol, which further enhance the perpetual trading landscape by leveraging a range of base protocols (incl. intents) to facilitate pair trading across a wide range of assets.

Perpetual volume on Arbitrum has been up only. Even though the launch of Hyperliquid has acted as a significant liquidity vacuum throughout all perpetual platforms, Arbitrum has been largely unaffected, as observed in the Defillama chart of trading volumes above.

2. Options Protocols

Since its inception, Arbitrum has distinguished itself by fostering native options protocols, an underrepresented niche within DeFi.

Dopex (now Stryke) led this charge, laying the foundation for what has become a proactive niche within Arbitrum. Combined, they cover a wide range of instruments that Arbitrum options traders can take advantage of.

Ranking second only to Ethereum in options trading volume, Arbitrum hosts notable protocols such as:

• dVol: attracting over $21m in TVL by creating a solution called Option Liquidity Pools, abstracting the complexities of options and allowing users to deposit liquidity and participate in yield-generating strategies.

• Hegic: allowing trading of American-style options (exercisable at any time before expiration). They accrued over $11m in TVL by allowing users to provide liquidity in Options Liquidity Pools, funding the options sold to traders. The protocol is fully decentralized, and users can choose their strike prices and expiration dates.

• Premia: one of the pioneers of Arbitrum options. The protocol uses an AMM model to allow peer-to-peer pricing and options settlement, with complete customizability of all parameters. Users deposit their liquidity in strategy vaults and trade options.

• Gammaswap: allowing the perpetual trading of options by borrowing liquidity from AMMs. Users on Gammaswap can trade the volatility of assets, turning impermanent losses into impermanent gains for LPs through strategies such as straddles and long or short positions. Lately, it has been under the spotlight with significant growth, now ranking 3rd by TVL within this category. 

Nonetheless, Options remain a niche product appealing to more sophisticated traders, and as such, their contributions to Arbitrum’s current TVL and volumes across DeFi are limited.

To simplify them, most protocols in this niche focus on abstracting the complexity of these instruments and making them similar to the widely used perpetuals by introducing gamification elements and user-friendly interfaces.

3. Decentralized Exchanges (DEXs)

DEXs are critical to Arbitrum’s DeFi infrastructure, enabling efficient token swaps with minimal fees. 

Uniswap leads this category, with weekly volumes exceeding $5 billion, significantly outpacing Camelot, with over 5x its volume ($1.05b).

Other DEXs are much smaller, with PancakeSwap ranking 3rd in volume, with $679m weekly, and Balancer coming 3rd in TVL, with over $60m locked in the protocol.

The DEX landscape is highly competitive, and it’s not easy for new protocols to carve a niche.  Only two of the top 10 protocols are Arbitrum native: Camelot and Ramses. 

Native protocols like Camelot and Ramses contribute to the ecosystem’s growth by introducing tailored tokenomics and liquidity models. For example:

• Camelot is a native Arbitrum protocol focused on supporting Arbitrum Orbits and launching native tokens. It employs vote escrow mechanisms to align stakeholder incentives long-term, allowing users to lock GRAIL into xGRAIL, giving them rights over protocol fees. 

• Ramses leverages the Solidly AMM design, fine-tuning the model to lead to more sustainable emissions and establishing itself as a liquidity layer for Arbitrum, where protocols can leverage its pools to attract voters and bribes. 

Given the competitive landscape and the barriers to entry in this sector, DEXs are one of the niches that are the hardest to innovate.

One of the most significant catalysts in this sector is the launch of Uniswap V4 hooks, which will provide unprecedented flexibility to customize the Uniswap AMM model to the specific needs of protocols. 

This model has been followed in other notable advancements, including the launch of Balancer V3, Camelot’s partnership with Algebra, and Pancakeswap V4.  Both Balancer and Pancakeswap feature hooks in their subsequent deployments, showcasing the focus on modularity and customizability.

4. Yield and Lending Protocols

An ecosystem is only as good as the yield opportunities within. 

Yield opportunities play a pivotal role in retaining users within an ecosystem, or they might wonder cross-chain to find better opportunities.

Arbitrum’s yield and lending protocols collectively account for approximately $300 million in TVL, a decline from their mid-2024 peak of $1.2 billion.

This deflation can be attributed to many users unstaking their Restaking tokens from Pendle and claiming their funds post-Ethena farming. 

Pendle leads this category, with $122m in TVL (over 40% of the total TVL of this category). Although initially launched on Ethereum, Pendle has expanded to Arbitrum as its second network.

Its ingenious yield trading mechanisms, combined with ve token locker mechanisms, have established Pendle as the premier protocol for trading tokenized yields on Arbitrum. 

The second protocol by TVL, with over $50m, is Magpie, a cross-chain platform boosting yield and tokenomics. 

Through their offer, they allow Arbitrum users to:

• Leverage ve tokens to boost rewards and align incentives over the long term

• Restake their tokens across the DeFi landscape

• Provide Liquid Staking for more assets, such as native BTC tokens

They run a wide range of SubDAOs cumulatively accumulated over $1.5b in TVL.

Behind Magpie, we find another protocol with very similar statistics: Toros.

Toros is live on Arbitrum, Optimism, and Base, offering automated strategies as “vaults” to maximize user returns. This includes leverage tokens, stablecoin-focused vaults, or Ethereum vaults. Toros's main value proposition is to abstract the complexity of executing and managing these strategies with a set-and-forget model where users only have to deposit liquidity in a vault.

On the other hand, Aura is a protocol on top of Balancer, introducing vote escrow tokenomics, voting, and gauges logic, similar to Solidly-based AMMs. This includes a seamless onboarding to veBAL with a custom token wrapper (auraBAL), which users can stake to receive both BAL and AURA rewards, boost their LP rewards, and use to vote in gauges. 

Last, we focus on another Arbitrum native protocol: Umami.

Initially, Umami launched as a DAO focused on generating Protocol Owned Liquidity (POL), allowing users to buy and stake the native token and take advantage of farming or arbitrage strategies to generate yield.

Umami is now a subDAO of BonsaiDAO, a DAO incubator. The protocol now offers single-sided non-custodial vaults for GMX’s GM tokens, USDC, BTC, and ETH, focusing on automating hedging and liquidity management processes.  

The yield sector is everything but static. Developing new strategies and launching new lending protocols like Fluid (which has over $1.4b in TVL and just launched on Arbitrum) bring leveraged vaults and unmatched capital efficiency for LPs on Arbitrum.

5. Stablecoins

Stablecoins are the backbone of any DeFi ecosystem. 

Arbitrum ranks 3rd among L2s in stablecoins onchain, with over $6.5 billion on-chain. 

However, a significant portion of this is associated with the Hyperliquid bridge, which concentrates USDC liquidity for withdrawal purposes.

To move funds to Hyperliquid, users can only bridge USDC via Arbitrum. When they withdraw their USDC from the network, they are sent to Arbitrum. 

Over 67% of all USDC ($2.3b) on Arbitrum are currently deposited in the Hyperliquid Bridge: 

Binance even blocked withdrawals as too many users were bridging USDC to Arbitrum just to deposit on Hyperliquid: https://x.com/0xShual/status/1868449746282844489.

Here’s how Arbitrum compares to Base and Optimism:

Despite excluding Hyperliquid-related stablecoins, which account for over $2.3b in USDC, Arbitrum remains a leader in stablecoin adoption, with $4.94b in stablecoins, almost 50% more than Base.  

Aside from incumbents (USDT, USDC, DAI), new stablecoin models are increasingly attracting increasing interest, such as Ethena USDe and Usual’s USD0.

This showcases the market appetite for stablecoin solutions that go beyond being a passive instrument and can generate yield. 

Ethena does so by leveraging perpetual futures to delta-hedge their spot holding with derivatives positions. This generates additional funding rate income to the yield from Liquid Staking Tokens (LSTs) deposited. 

Usual mimics this model using short-term bonds. In particular, they invest in overnight repo and US government-backed securities through USYC, the Hashnote “Short Duration Yield Fund”.

These protocols illustrate the ecosystem’s capacity to cater to retail and institutional users seeking robust stablecoin solutions.

Ever since the collapse of Luna, the market has been wary of stablecoins offering risk-free yields. However, the tides are turning with users exploring new ways to use their idle liquidity to generate yield. 

This is exemplified by the rise of Ethena USDe, which is now the third biggest stablecoin behind USDT and USDC.

Arbitrum also offers native stablecoins, such as OpenDollar. However, they have struggled with adoption compared to their biggest competitors. 

For this reason, a key focus for Arbitrum moving forward would be to foster the development (and adoption) of native stablecoins, which can differentiate their offer from that of incumbents.

In particular, we foresee the development of close connections between stablecoins and RWA and other derivative-based mechanisms we have already seen in others - such as Ethena. 

6. Real World Assets (RWA)

The RWA is one of the sectors that has seen the most significant growth within Arbitrum. The initial DAO proposal (STEP) to diversify Arbitrum’s treasury has eventually morphed into a fully-fledged strategic plan with the participation of many established partners from traditional finance.

Since early 2024, TVL in RWA-related initiatives has surpassed $100m, driven by strategic DAO governance proposals.

Of this sum, about 14.7% is held by the Arbitrum DAO wallet, which approved the “Stable Treasury Endowment Program” (STEP) to diversify the revenue stream of its treasury with an allocation of 35m ARB in RWAs.

This includes a majority (99%) of US treasuries, with Equities and Indexes only starting to pick up.

The DAO’s STEP portfolio currently has a value of $30.5m, with over $178k generated in cumulative interest. The proposal for STEP 2 is already live on the forum. 

The main initiatives in the RWA area are led by Franklin Templeton, Ondo Finance, and Mountain Protocol.

Other RWA initiatives worth mentioning involve:

• Blackrock is launching an Institutional Digital Liquidity fund with Securitize

• Franklin Templeton OnChain Money Market Fund launching natively on Arbitrum

• Paxos launching USDL, giving rights to yield rights for US dollar and other cash-equivalent assets

• Millicent Launching an Orbit chain focused on integrating Tokenized RWAs with several tokenized fiat currencies

More can be found here:

• https://x.com/_ryandesouza/status/1869212868698407316

• https://x.com/EntropyAdvisors/status/1869053546584560026

These efforts highlight Arbitrum’s potential to bridge TradFi with decentralized systems, offering opportunities to both retail and institutional users. 

Food for Thought and Conclusion

After an initial period of rapid growth, Arbitrum’s DeFi ecosystem has entered a phase of maturation characterized by its leadership in composability and innovation. 

Despite challenges such as declining token prices and increased competition, Arbitrum has built a resilient, collaborative ecosystem with minimal reliance on token incentives.

Where does this report leave us?

Arbitrum has an unmatched appeal in attracting non-native protocols compared to other L2. By analyzing on-chain data, we observe how, for many protocols, Arbitrum represents the second most significant and most active chain after Ethereum. 

The rapid rise in RWA TVL and service providers highlights the critical role of DAO governance proposals in stewarding Arbitrum and bootstrapping less active niches. This is exemplified by how STEP contributed to single-handedly launch the RWA category within Arbitrum, which now boasts over $100m in TVL.

The Arbitrum DAO has showcased its commitment and capacity to champion Arbitrum DeFi.

For this reason, we believe it should have renewed focus on three main areas:

• Stimulate the onboarding of non-native protocols within underrepresented niches

• Facilitating the creation of native protocols within underrepresented niches

• Build upon the composability that made Arbitrum differentiate among its peers to kickstart a positive flywheel of DeFi Legos across verticals (e.g., new stablecoin providers could be easily integrated with Arbitrum yield platforms).

However, this preliminary analysis of the DeFi landscape also highlights several areas for improvement, with many assets whose presence should be strengthened.

The main focus should be to bring more yield-bearing assets on-chain and within the Arbitrum ecosystem. This includes Liquid Restaking Tokens (LRTs), more RWA providers, and stablecoins for payments. 

Lately, there’s been a lot of negative sentiment surrounding Arbitrum, stemming from:

• The negative price action of the token

• Losing mindshare compared to other L2s

Nonetheless, if we observe the on-chain data, it paints an entirely different picture where the Arbitrum ecosystem has withstood the intricacies of the bear market and has built an organic and collaborative ecosystem free from token incentives, point programs, and individual grants. 

Rather than chasing fleeting trends, Arbitrum should focus on enhancing its foundational strengths—providing a robust, developer-friendly environment for projects seeking long-term growth. By remaining true to its builder-centric and collaborative ethos, Arbitrum can solidify its position as a leading L2 solution and attract the next wave of DeFi innovation.

Don’t chase, attract.

For users who are interested in learning more about Arbitrum’s DeFi, we recommend to consult the following resources:

• https://portal.arbitrum.io/projects/defi

• https://arbitrum.io/

• https://blog.arbitrum.io/

• https://x.com/arbitrum

• https://www.arbitrumhub.io/

Brought to you by Francesco

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Virtually yours,

The Castle