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DeFi Hit Bottom Or Further Down To Go?

Written by:
Aeon Flux
Published on:
13 October 2020
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Edward Valencia

While major cap assets like bitcoin and ether stay relatively neutral, the DeFi space has felt a tremendous blow. As written before, the riches being made in DeFi was unsustainable and the bubble had to pop sometime. Now, with the DeFi space experiencing significant corrections, is it safe to get back in, or does it need to go further down?

Yield Farming

Yield farming has been the main reason for DeFi’s euphoria. What started as a cleaver intensive mechanism turned into a money printing machine. Yield farming was created to give liquidity providers (LPs)something to compensate them for their contribution to a protocol. It was picked up by major lending protocol Compound which helped spark an entire movement. Many LPs made a decent return lending their assets to Compound but greed took over and investors were looking for a greater return.

Now, we’re seeing a great deal of DeFi tokens collapsing in price. Compound’s token ($COMP) broke through its August price floor of $127 to $108. Yearn Finance ($YFI) is down 66% from its all-time-highs while SushiSwap entered into a death spiral of losing 90% of its value in September. These corrections don’t result from a healthy market with objective price valuation.

Fundamentals

Let’s take a look at fundamentals and see if there’s a chance of recovery for the space. DeFi Pulse, a metric and analytical site, composed an index made up of major DeFi token protocols and projects to keep track of the DeFi market as a whole. As shown below, the DeFi market has corrected by more than 20% in just one week.

Source: DeFi Pulse

The hope is that liquidity remains in the DeFi space and investors aren’t pulling all their capital from it. The DeFi total value locked (TVL) is still high at $10 billion, but this metric must be taken with a grain of salt. Due to the way it’s measured, TVL may not be an accurate representation of the actual amount locked in DeFi. This is because of an issue called double-counting.

Writer Andrey Shevchenko from Cointelegraph gives an excellent example of double-counting by saying:

A major source of double-counting is DAI — the collateral used to create it gets assigned as Maker TVL, and then DAI itself is counted when it makes its way into Uniswap or Compound. With DAI, one could argue that the collateral and the stablecoin itself serve different purposes, so it makes sense to consider both instances. But WBTC is just a token that does nothing on its own — it’s like counting the entire Ether supply as TVL in DeFi.

Yield farming brought a second consequence to the network other than greed and that is high gas prices. Whether it was a good thing or a bad thing, high transaction fees created a ceiling and bottleneck to the DeFi ecosystem. The congestion in the Ethereum network made users bid on higher gas prices in order for their transactions to be one of the first to be validated. This left many retail investors on the side-lines due to high transaction fees eating into their profit margin.

The average gas fee has been unreasonably high for months. Source: Etherscan

DeFi’s Savior

What can stop DeFi’s bleeding? Have a scaling solution to make DeFi mainstream and cost efficient. There are currently two major solutions that are being worked on, Ethereum layer-two and bridges to other blockchains. Ethereum layer-two allows developers to port Ethereum contracts one-to-one but have user experience kinks. Bridging other blockchains require rewriting existing contracts to a new language and then patching all the holes between the two networks so that everything flows. All-in-all there is no clear winner or solution and it won’t be until year 2021 until we start seeing them in action.

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