0/ A small move in $BTC has already created ruptures in a number of speculative DeFi assets with some falling over 20% in a day. A further rotation of capital into $BTC and $ETH will likely expose some of the DeFi projects that are overhyped.
1/ The $COMP token distribution that started in June was a seminary event. It unlocked the potential of token incentives to bootstrap liquidity on a platform. It created a “eureka moment” for DeFi.
2/ Not surprisingly it sparked a frenzy in yield farming and a spike in DeFi platform adoption (as measured by TVL), causing a re-rating of DeFi assets.
3/ With the interest to farm yield so high, DeFi projects had to offer increasingly higher yields to attract capital and liquidity. This makes sense up to a point. In order to juice returns investors also recursively added leverage and risk to the system.
4/ Inspired by the success of Kyber, Aave, Balancer and Curve investors also started going out the risk curve to chase after smaller cap projects hoping they might find one that replicates their success.
5/ This led to rise of REN, Thorchain, Ampleforth etc culminating in the creation of yEarn, whose overnight success illustrates the animal spirits that powerful incentives can generate.
6/ While exhilarating, some of us have watched the developments with increasing unease as the incentives create a perverse motivation to keep chasing after ever higher yields in what might eventually become a zero sum game. The echoes of 2017 were also becoming louder.
7/ When everything is going up, people don’t think about risks. When asset prices go down, everyone will try to get out at the same time, creating a downward spiral. That’s why we advised against trying to chase after unproven lower cap DeFi assets.
8/ The ruptures we have seen so far are probably not the end of it. There are a number of other speculative activity that needs to unwind and we might see further correction in some asset prices before we get a bottom. This is not a death knell for DeFi, just a rude awakening
9/ The top projects that have a real value proposition will do fine during this period. The weaker ones may not come out of the wreckage in such good shape. Hopefully that will be a short and not so painful lesson for investors.
10/ A short term correction is a good thing in that it will reveal how much of the TVL locked is short term vs sustainable allowing us to evaluate what is the real sustainable activity. This will hopefully convince some of the DeFi doubters that DeFi is not purely ponzinomics.
11/ During this selloff, some good assets will be unreasonably marked down. This will create opportunities for investors who missed the initial DeFi run to pick up some of these good assets on the cheap.
12/ While it is encouraging to see the strong interest in DeFi to date, the community at large needs to reassess how to grow the space sustainably. Increasingly higher liquidity incentives is not sustainable.
13/ The DeFi space still has a lot of innovation and growth ahead of it, but to achieve its long term potential, we need to back the good ideas/platforms and throw out the bad ones. Another silver lining: has fees might finally see some respite!
14/ DeFi will make a comeback again once the price of BTC stabilizes and this short term DeFi cleansing is complete. That could take months or it could be over in weeks given the pace of crypto. Stay safe out there.
