It was the hottest trade of last summer – decentralized finance or DeFi was winning over traders and minting millions for investors.
The value proposition was seductive – the ability to access financial services without a trusted intermediary, smart contract code plus the security of immutability of the blockchain would enable users to borrow, lend, trade and insure, all without barriers to entry or exit.
But DeFi has not been immune to the recent rout in the cryptocurrency market in general.
Part of that of course has to do with market forces.
During periods when cryptocurrencies rally, DeFi benefits because it facilitates another added layer of speculation, for instance, it’s possible to borrow, trade and return the loan all within a single block, allowing traders to essentially bet without any skin in the game.
But now that prices of cryptocurrencies have slipped across the board, the number of new DeFi users looking to speculate has also dropped dramatically, hitting its lowest level in months.
Over the past week, just a few thousand new users were logged, down from nearly 40,000 in mid-May.
And that could prove to be a damper for some of the triple-digit yields that DeFi protocols were touting.
The bulk of DeFi apps let users lend out their cryptocurrencies and receive interest, often in the form of the project’s tokens,
But if the number of borrowers declines, the interest rate on loans declines, and the pressure to sell the existing tokens received as yield, for instance SushiSwap or Compound tokens, increases, leading to a perfect storm.
DeFi yields are a function of new buyers supporting token prices, because the actual yield cryptocurrency lenders receive is determined by the exchange rate between the yield tokens paid out, and some other cryptocurrency, like Ether or a dollar stablecoin.
While DeFi may not be going away, it needs to develop some new use cases outside of speculation and in the immediate term, token holders are likely to suffer.
Already the amount of funds locked into DeFi applications has fallen by around 40%, although a large portion of that decline can also be attributed to the recent correction in cryptocurrency prices.