There’s no doubt that there has been a lot of innovation and opportunity in the DeFi ecosystem. In the three months since the launch of COMP, the growth in the space has been phenomenal. We’ve seen an endless stream of farms, forks, crashes and heists. There has been a yield-farming frenzy, with often funny sounding meme-coins and returns of 1,000%, even 100,000%. The total value locked on Ethereum DeFi has exploded again. Today’s data from DeFi Pulse puts it at $8 billion. While some of this growth is coming from asset appreciation, we are also seeing organic growth with new investors swarming to Defi, increasing the amount of collateral and liquidity supplied. However, the real story lies beyond the numbers. In a few months, DeFi became the world’s biggest and most active open financial laboratory. DeFi is the idea that cryptocurrency technology can be used to offer transparency and recreate traditional financial instruments such as loans and insurance. Some think that DeFi, in its current state, is destined to fail. Like the ICO boom of 2017, DeFi plays to our desire to get rich fast without any responsibilities.
While we have another three months before this year is out, 2020 has already been unexpected and surprising. Unexpected because no one, with the exception of Bill Gates, imagined that a virus like Covid19 would bring the global economy to its knees. Surprising, because since the beginning of year, Bitcoin’s market share has dropped by 9% to 57%. The reason for this drop is the rise of existing and new cryptocurrencies.
Ethereum along with DeFi applications, built on the Ethereum blockchain, has attracted a lot of attention. To put some figures on the table, the average block size doubled this year from 20MB to about 40MB, and fees have increased by 10x. In August alone the average daily transaction fee totaled $3.68 million, a 240% increase from just the month before. Increased demand has also impacted Ethereum’s (ETH) price. Earlier this month, it passed over $480, for the first time since the bull run of 2017-2018.
The adoption of DeFi has come in two waves.
The first is the explosion of stablecoins, that occurred when the COVID crisis hit the economy. Tether is the undisputed king of stablecoins. Since March 2020, it has witnessed the largest growth, jumping 3x and going from $4.8 billion before the Covid19 pandemic to $15.2 billion now.
The second wave for DeFi, even more powerful than stablecoins, is yield farming. Yield farming are activities ranging from borrowing and lending cryptocurrencies, using dedicated DeFi applications. Yield farmers are propping up the markets, by buying assets for the sole purpose of locking them up to earn interest. This buying action is driven by the idea that they’ll be able to buy other assets with the interest earned and repeat this cycle.
The crypto community is abuzz with hot new yield farming tokens like YFI. The governance token for yearn.finance, shot up 165% in value past $39,000, almost three times higher than Bitcoin’s current price and twice as much as Bitcoin’s all-time high of $20,000.
Yearn aggregates the different yields of DeFi protocols. Users earn yields by lending their coins on various protocols or storing them in vaults. Governance tokens like YFI can also be earned by users who provide liquidity. Holders of these governance tokens can also vote on proposals for the network.
Thursday marked a pleasant surprise, when Uniswap released its UNI governance token, airdropping it to traders, liquidity providers and SOCKS holders. In total, 150 million UNI, or 15% of the token’s supply, is now available to be claimed by anyone who has used the platform.
Governance tokens are becoming a popular speculative asset because of their limited supply, and investors want to get in on the action before it’s too late.
Though DeFi apps give users the opportunity to earn money without having to trade, trading is still a part of it. You can trade with margin, you can do just market orders or market swaps… there are futures… there’s all sorts of things. You even have options and derivatives, but what’s more interesting with DeFi is it gives people the ability in many cases to let their assets do the work, as well as provide liquidity that often earns them interest.
The yield farming frenzy started when Compound began the live distribution of COMP, with Compound reaching more than $600 million total value locked. Investors who missed out on the initial gains of Compound, are looking for similar projects to invest in and make a profit.
But massive returns often come with high risk of loss. As many investors are quick to jump on the yield farming bandwagon, some still remember the ICO craze of 2017–2018 and compare it with what’s happening in the DeFi market today. Many DeFi projects are still speculative, carrying both risks and rewards, just like ICO projects did in the past. However, unlike the 2017 ICO craze where retail investors were speculating, the high yields of DeFi are incentivizing greater participation and efforts geared toward robust market development. Therefore, it’s unfair to compare the ICOs with the DeFi market.
DeFi promises to give the world access to an unlimited number of financial products and services. New projects have been launched, among them platforms, like Polkadot and Cosmos, that allow different blockchains to speak to each other.
But just like any new technology, things need to mature in order to overcome possible barriers and create a safe environment for investors. These barriers may include legal and regulatory frameworks. Lack of regulations and KYC/AML procedures, creates high risks for money laundering via liquidity pools and sooner or later DeFi will get on the radar of regulators, just like ICOs did.
On the bright side, just as ICOs survived and morphed into IEOs, DeFi protocols that create genuine value, like Yearn Finance, will continue to thrive.
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