Much like the dotcom bubble of the early 2000s and the ICO boom of 2017, decentralized finance (DeFi) is quickly turning into yet another fad possibly primed for failure. But, how will bitcoin react if the sector does fall to complete ruin?
The DeFi sector, an Ethereum-dominated ecosystem for lending and borrowing, has grown to incredible heights in recent months according to the sector’s best metric of measurement: Total Value Locked (TVL). Denoting the aggregate amount of user funds used within loans, collateral, or trading pool liquidity, DeFi’s TVL grew from around $600 million at the start of the year to over $9.6 billion, at its peak in early September, per data from DeFi pulse.
What’s Driving DeFI?
The DeFi hysteria was established less on financial libertarianism and much more on two jargonistic mechanisms: yield farming and liquidity mining.
Yield farming can be defined as the act of leveraging DeFi lending/borrowing protocols to generate the greatest interest possible—with some participants managing annual yields of more than 1000% primarily thanks to liquidity mining.
Liquidity mining goes hand in hand with yield farming and is essentially an incentivization program launched by DeFi protocols in an attempt to lure liquidity. In rewarding liquidity providers, by essentially printing money via their platform utility tokens, these protocols have thrust prices tokens far beyond their fundamental worth.
An illustration of this type of degenerate finance comes from a yield aggregating platform yEarn Finance and its governance token YFI. The token surged from a price of $35, after its inception in July, to over $38,000 at its peak in August. The gains kept coming despite its founder admitting that YFI had no intrinsic value whatsoever:
“We have released YFI, a completely valueless 0 supply token. We re-iterate, it has 0 financial value.”
Clones, Scams, and Congestion
Attempting to profit from the DeFi rush and the yield farming phenom, other similarly unaudited clone tokens reared their heads. Among them: Yam, Hotdog, Sushi, Pasta, and Kimchi.
While sounding like the menu of a dodgy fusion food restaurant, these novelty DeFi tokens have blurred the line between farce and finance, capturing millions of dollars in value propelled by little more than socioeconomic experiments.
And most have already failed, dramatically.
Yam’s market cap swelled to $60 million soon after launch, but less than two days later, the rug was pulled when its founders discovered a bug. As a result, Yam’s entire market cap came crashing down to zero.
Given this, it’s hardly surprising that people analogize the DeFI boom alongside the ICO and dotcom bubbles. Both observed hefty price tags for companies and projects that couldn’t live up to the hype. The ICO boom also yielded its fair share of scams–not unlike DeFi.
HotdogSwap, a clone of popular lending platform Uniswap—and its mostly illiquid meme token HotDog— pumped and dumped hours after it launched—heading from a price point of $4,000 to $1 in just five minutes.
The same goes for SUSHI, whose founder dumped $13 million worth of tokens on the community, subsequently tanking the token’s price.
However, it isn’t just valueless, unaudited tokens, scams, and hacks threatening to topple DeFi’s house of cards, the Ethereum network is buckling under the pressure of usage—causing transaction prices to soar.
Last week, Ethereum’s average network fees reached $8.60 per transaction—up over 470% from $1.5 per TX, month over month. And that’s just an average. Some users have reported individual fees stretching into their hundreds.
DeFi’s Doom is Bitcoin’s Boon
With legitimacy waning and sky-high Ethereum fees slowly pushing retail investors away from DeFi, a sector-wide collapse could be on the cards. Consequently, some believe that bitcoin could see some uplift via capital inflow as investors jump out of DeFi and into comparatively risk-free bitcoin positions.
As touched upon in last week’s piece, with the global economic situation worsening and an inflationary environment slowly emerging, bitcoin’s narrative as a hedge against macro risk is only strengthening, which could reflect well on bitcoin’s value proposition. Should this be the case, it would be hard for investors to ignore, potentially leading to FOMO and thus divestment from DeFi.
The ICO boom analogy seems to apply here. While Bitcoin tumbled in tandem with the altcoin market, the pioneer unquestionably emerged the victor from the collapse. This can be seen from the bitcoin dominance index (BDI)— a measure of bitcoin’s market cap against the aggregate market cap of the altcoin market.
Bitcoin dominance remained well above 77% from 2009 until the altcoin bubble in June 2017, where it fell as low as 37%.
Since then, while the altcoin market has remained mired in the losses of the collapse, with some coins completely dead and others barely alive, bitcoin has bounced back, managing to regain dominance and around 45% of its losses from a bottom of $3,000 in early 2018 to its 2020 yearly high of $12,000.