Decentralized finance: lots of promise, and exciting concepts, but still too complicated for people to use. Investors still like the different product lines – from dApps, to interest rate bearing protocols. Those different DeFi segments keep investors curiously watching this roughly three-year-old market. Nevertheless, investors would have been better off starting the year by buying and holding bitcoin. The 2022 crypto winter has been especially frigid in DeFi land.
From an investor and user perspective, “DeFi is still largely absent from most people’s habits,” says Tony Tran, founder & CEO of Peer Inc, a Bellevue, WA-based Web3 developer building an exchange for blockchain-based capital raising. “There needs to be significant innovation for DeFi to become the preferred choice, both on user experience and in technology. The absence of a limit order/stop loss feature on decentralized exchanges; the vulnerability to hacks, exploits, the need for over-collateralization and systemic risks from the cascade of automated liquidations could prevent DeFi from capitalizing on its opportunity.”
Except for a couple of companies, DFI.Money (YFII), a fork of DeFi aggregator platform Yearn.Finance, and GMX, a decentralized spot and perpetual exchange, nearly every DeFi coin I’ve looked at is underperforming bitcoin.
YFII and GMX are up over 20% in the last month. GMX is the better of the two, up 83% over 12 months. They are an anomaly.
DeFi liquidity market makers Aave
Grayscale’s DeFi investment fund is down over 71% in the previous 12 months. That fund is open to accredited investors only
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Ultimately, decentralized finance is peer-to-peer lending and transacting. It is an entirely new financial market, which looks a bit like a Star Wars cantina, where you can swap credits and borrow in currencies you couldn’t buy paper towels with, but can somehow earn 2% interest or more on. That’s better than returns on U.S. savings accounts.
This year’s downturn was already in play long before the world learned of FTX founder Sam Bankman Fried.
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“DeFi is in no way responsible or complicit in the FTX collapse, but it is a potential antidote to the problem,” says Beth Haddock, a New York-based advisor to Balancer
Most investors are holding onto their bitcoin and alt-coins, of which DeFi is a huge part. But are they buying? It seems not. Using bitcoin trading volume as an indicator, some $21 billion in bitcoin was traded on Dec. 5, one of the lowest volumes of the year. On Dec. 6, 2021, trade volume was over $30 billion.
“Eventually, regular retail users will start testing the water again,” says Shahmeer Chaudhry, CEO of Fluidity Money in Adelaide, Australia, a DeFi “Spend-2-Earn” protocol. “But before they do, DeFi protocols will have to solve one of the most difficult problems in crypto if they wish to capture this audience and even retain some of their user base. Have you ever tried explaining DeFi to any non-crypto-native? Set up a wallet, explain secret keys, explain how to use their address, explain how to avoid getting their wallets drained. It's an arduous process,” Chaundhry says. “All of these problems can be solved by having a simple domain as an address that works cross-chain, and works frictionless with dApps. When this becomes possible, I’m sure that DeFi will not only become the preferred choice, but it’d make centralized platforms obsolete.”
Meanwhile…
DeFi: Another Bad Day.
The FTX debacle is a headwind for all crypto. DeFi plays are alpha returns for crypto investors, and so when the market turns, they suffer like an emerging market in a developed market recession. Recent bad headlines include the Solana-based decentralized exchange Serum failing victim to the FTX bankruptcy. FTX was an investor.
Another DeFi crypto trading firm, Auros Global, missed its principal repayment on a 2,400 Wrapped Ether DeFi loan and Ankr
The story behind all things DeFi was “we are safer than centralized exchanges.”
In 2022, hackers stole over $3 billion worth of cryptos from DeFi applications, including $611 million from Poly Bridge, $190 million in Nomad, and in 2021, hackers got $130 million from Cream Finance.
There’s a lot of money to target.
The total value locked across DeFi is around $50 billion, which is up 2.5 times over the last two years and nearly 70 times over the last three years, notes Alexander Kravets, CEO of Symbridge, a digital asset trading ecosystem based in Greenwich, Connecticut.
“The FTX collapse amplifies the need for transparency and visibility into where your assets are held, and if they even exist – such as proof of reserves. The only way to truly accomplish this is on-chain, where people can see all their assets twenty-four-seven, all year long,” he says about the trust factor.
Cryptocurrency investors know these are new worlds being built by software engineers hunched over computers, typing away in a language most of us do not understand. They are based all over the world, with coders in Russia, China, and often led by individuals looking to make fast money to buy their next Patek Philippe, or throw a banger in Miami on the sidelines of some bitcoin conference.
Learning Chinese might be easier for the average DeFi coin holder. The belief that DeFi start-ups will build more user-friendly products in the next five years keeps high risk investors interested, even as market values collapse.
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“We have a long way to go before DeFi, and even decentralized exchanges, see mass adoption,” says Andrei Grachev, managing partner at DWF Labs, a digital assets market maker and Web3 investor based in Zug, Switzerland. They were part of the Industry Recovery Fund, launched by Asian cryptocurrency exchange Binance last month.
“Less than six months ago, the Terra/Luna failure was seen as evidence DeFi was not sustainable. The recent FTX fiasco shifted the focus on centralized crypto exchanges as the new villain. I think the sudden shift in focus on DeFi is a self-defense mechanism (against the FTX crisis) in favor of decentralization,” he says. For Grachev, decentralization might entice more investors to store crypto on hard wallets and shift some of their crypto activity to decentralized networks. That might lead to capital flowing back into some decentralized finance projects, if they can stomach more losses.
Yearn Finance (YFI) was priced at around $78,000 on May 11, 2021, an all-time high. It hit an all-time low of $4,397 on June 18, 2022. Newcomers who took the Yearn Finance cold water plunge in June are up over 40% since. But those still holding tokens from last year have a long way to go before the ice melts on YFI.
*The writer of this article owns bitcoin.
