Is investing in DeFi still viable?

Since the start of the year, we have seen much attention given to decentralized finance. This emerging niche in the cryptocurrency market has revived many investors’ interest. Crypto market has been showing excitement to everything DeFi related and that has been imprinted on the price charts of some of the existing projects that have been considered pioneers like the MakerDAO. Those investors who were late to the party, also wanted new opportunities which brought to life even a bigger number of interesting projects and protocols. 

Did the bubble pop? 

As the demand rose so did the supply, and this cycle spiraled into what some called the next major bubble after the ICO one in 2017. First we have seen an increase in prices of the existing projects like Kyber Network which experienced growth of over 10x, coming from its lowest levels at around $0.15 on January 1st to slightly above $2 on the 13th of August. Since then the price decreased to $0.87 levels where it’s currently sitting as investors saw opportunities in new concepts of investing like yield farming. Competing projects like Uniswap have also taken the lead in the crypto investment space. Uniswap is currently the biggest DeFi project measured by Total Value Locked. Additionally, Ethereum wallet Metamask mostly used to participate in these protocols reached a key milestone of 1 million users.   

Market exuberance started as the majority of the investors that could participate already did while others – who have been sitting on the sidelines – are still there. This is mostly due to Ethereum network getting congested as well as the high fees associated with participating.  As a result, the viability of participation decreased for the retail investors. It appears that only “whales” that have high sums of ETH are left to provide liquidity for profit as they can afford the high gas prices. 

This has led to the recent flattening out in interest which is seen in the total value locked in these liquidity pools, and many posing the question: “Is the DeFi bubble popping?”

Total Value Locked according to the DeFi Pulse has fallen back from its high of $11.351B made on the 30th of September to $10.35B on the 8th of October. This isn’t as significant compared to the correction that occurred in the first days of September but looking at the increase from the start of the year we can see that momentum has definitely been slowing down. 

This can also be seen by looking at the DeFi Composite index of Binance against USDT which has fallen by 61% from its launch, measured to its lowest point on the 8th of October. 

As of October 15th the index consists of 19 coins out of which all are established and fairly large projects, and is excluding for example a popular Uniswap fork – SUSHI. You can see the full list and their weights below. 

This means that the whole DeFi space would have slid even further downwards if all the smaller cap projects were to be included in the index. 

The most notable DeFi projects of 2020 (So far)

In the following paragraphs we are going to provide an overview of what were the biggest market movers so far and how they have performed. There are multiple ways you can earn in DeFi so a comparison on those points will also bring us closer to concluding which projects have performed better than others.

A key distinction can be made between liquidity mining/ yield farming, and purchasing governance tokens. Decentralized finance is providing or aims to provide all the equivalent services of traditional financial institutions but in a non-custodial way. This is where liquidity providers come into play by supplying token for these operations like borrowing or exchanging to take place. They get a return expressed in the form of the annual percentage yield which can either vary or be static depending on the terms and conditions of the used platform. In order to maximize their return those that have large sums can choose to manage their holdings but providing liquidity to the pools that offer higher yields – thus also called yield farming. 

Depending on the pool, project or platform liquidity providers receive different compensation amounts and in different forms. One of the biggest and most notable projects in the DeFi space is Uniswap, a decentralized exchange with currently over $2.74B worth of cryptocurrency locked in its pools and smart-contracts and has a 24.43% DeFi market dominance. In return for providing liquidity on the exchange the liquidity provider receives an equivalent percentage of the 0.3% swap fee that is deducted from the user who exchanges crypto on the platform. 

Unlike Uniswap which requires a 50-50 deposit in both cryptocurrencies in the pool (for example DAI/ETH), Balancer liquidity protocol was built with another mechanism that enables 80-20 or even 90-10 token ratio. In addition users can receive BAL, network governance token when they offer to lock their crypto. This is due to attempting to eliminate or at least minimize the effect and impact of the impermanent loss, which can occur if the price of the provided token depreciates in value while being locked, or appreciates so that liquidity providers experience an opportunity cost. 

Curve Finance is another liquidity protocol but unlike the previous two has attempted to eliminate the possibility of impermanent loss by only allowing trading of stablecoins to stablecoins in a decentralized way. 

The project that established yield farming as a term and popularized the concept so much that the whole niche was born is Compound. Since the introduction of its governance token COMP that was introduced in order to further incentivize liquidity providers in June, the price and the platform has experienced rapid growth. It serves as a money market where people can lend and borrow cryptocurrency. While lenders receive interest for staking the funds, those who borrow must deposit an over-collateralized. While it hasn’t Compound didn’t invent the concept of yield farming it introduced a new distribution mechanism of its governance token and that through liquidity mining.

Aave is another money market platform and Compound’s competitor and has overtaken it in the amount TVL as it currently sits at around $1.02B while Compound has around $893.6M. It provides stable rates unlike its competitor whose rates are variable while in both cases they are adjusted algorithmically. It uses LEND governance token but recently it introduced a new AAVE token whose migration is still in place in a 100 LEND : 1 AAVE in hopes that the platform with its new governance framework will bring far better interest and incentive structure for its participation. 

As the DeFi hype continued, new projects were born, forks of the old once, while liquidity pools kept growing and growing in numbers. The project that aims to solve this problem of choosing the pool they want to participate in and maximize their profits on autopilot is Yearn.Finance. The project has gained much popularity in the yield farming community as it enables users to optimize their token lending for best returns on automatic. It does so by converting deposited token into yTokens and periodically rebalancing them into different pools and services. It too has experienced a high demand and rapid growth especially of its governance token YFI which has risen in value from just below $800 on the 21st of July to around $40.670 at its all-time high on the 14th of September. This is mostly due to its token design with a small total supply of only 30.000 YFI tokens, which enabled its exposure in press and high ranking on CoinMarketCap. 

Profitability comparison

Even though some of the projects in DeFi are several years old the real boom in demand occurred in the third quarter (Q3) this year. According to the research report from Bankless, we have seen an increase in growth of 26x from the last quarter alone. 

As you can see from the chart above the biggest quarterly revenue contributor is Uniswap with 67M in revenue. Compared to the previous quarter when it made around $298K this is an increase of 22,400%. Second largest contributor is Balancer which generated $16M in revenue for liquidity providers, while on the third place we have Compound with around $10M in revenue in the Q3. 

Looking at this chart it is evident why Uniswap holds its dominant place in the DeFi space and is the number one in total value locked. Due to the high activity, liquidity providers even though may not get the best APY, can earn through frequency alone. As the supply gets bigger the following questions arise: how will the pie get split between the liquidity providers? And also: Can it leave whales to collect the majority of the revenue? 

Looking at the price performance of the DeFi’s governance tokens in the Q3 we can see a mixed picture with some of the tokens showing significant decrease since the last quarter, while others a significant rise. LEND token on Aave platform was one of those tokens that performed significantly better then others with an increase of almost 300% from last quarter. 

Loopring is the second highest gainer with an increase of 191.29% from Q2 and third is Synthetix with 155.36%. Worst performing governance token is CRV with a downfall of 91.99%. Fundamental reasons are behind these price fluctuations as all of the projects have attempted to gain advantage in the new DeFi climate. Aave with its announcements of the new governance token swap or Loopring which is attempting to capitalize on Ethereum’s network congestion. Curve’s stablecoin platform hasn’t been of much attention (even though the protocol works fine) while its token circulating supply is only around 83M of the total 3.3B CRV. 

Conclusion 

Decentralized finance space is still very young and while we have seen market exuberance, it appears that will only be a temporary standstill. Protocols are working properly with constant announcements and upgrades ahead and are collecting high amounts of revenue, while governance tokens of the underlying protocols have also experienced growth in price. 

While there is an issue of suffering the opportunity cost or what’s now called an impermanent loss, this has always been the case with investing. Because of the new technological developments and decentralized way of handling money which enables us to directly interact with the protocols it has just started to be more apparent. 

Direct investment in the platform’s governance token can be highly lucrative if the platform succeeds and has high activity, especially if it’s governance token is exclusively mined with providing liquidity. On the other hand, it can be detrimental if the token economics aren’t sound and the platform has limited usage. That’s however the inherent risk with investing in all of the cryptocurrencies as most of them represent the network in some way or the other. 

Either way the viability of investing in DeFi depends on the successful navigation between these digital assets, tracking these investing opportunities and how they are performing. This is why Crypkit is a solution to assist you in this endeavour as it enables DeFi tracking in all of its complexity, so you can have a data-driven and benchmarked approach to investing. 

Our unique Crypto DeFi Asset Tracker with features like Auto-sync data from wallets, smart contracts and exchanges, PnL and AUM stats, Trading history and journal, Portfolio dashboards and performance statistics and Analytics such as Rebalance tool and Portfolio simulator you can increase the viability of your DeFi investments as you can easily keep track of their performance. 

Leave a Reply