1. Overview
Bitcoin halved in the first half of 2020, rekindling market enthusiasm slightly; in the second half of the year, an unexpected fire in the decentralized financial market detonated the entire crypto community in one fell swoop. Beginning in June, DeFI projects such as Compound, yearn.finance, Sushiswap, etc. have taken turns, and related tokens have shown a trend of increasing prices by several or even dozens of times.
The market is growing wildly, aggregated DeFi projects are emerging in an endless stream, and fund users are swarming; but most of the participants in the carnival have not realized that these high-yield financial projects with superimposed functions have invisibly integrated multiple risks. With the recent failure of the YAM project and the sudden cash out of the founder of Sushiswap, DeFi tokens have continued to avalanche, the popularity of the field has diminished, and the market has ushered in a new turning point. In this article, Hashpie will analyze decentralized financial projects and observe the huge risks behind the wealth-making effect of the DeFi market.
2. From June to September plummeting, DeFi fever declined rapidly
From 2018 to the beginning of 2020, the total market value of DeFi projects has only increased by about 92%; as of January 1, 2020, the data reached 1.53 billion U.S. dollars, less than 1% of the current market value of Bitcoin. In the first half of this year, the market trend remained unchanged. The total value of DeFi was still hovering at the level of about 1.5 billion US dollars. According to data from DeBank, the total value of the DeFi market has jumped from US$3.3 billion to US$17.1 billion in just three months, a cumulative increase of over 446%. During the same period, the total amount of DeFi locked up has also shown a soaring trend, surging tenfold to a level of around US$10.5 billion.
The market’s surge in June cannot be separated from the credit of the loan agreement Compound. Since the project announced on June 16 that it will use liquid mining output to govern the token COMP, the secondary market that provides transactions in this currency has quickly spread from decentralized exchanges to centralized exchanges, including Poloniex, Coinbase, and Binance More than 70 trading platforms have added support for COMP, and token output has increased by more than 3.29 times in less than a week. In the following month, Compound attracted more than $1 billion in lock-up volume, and the increase in related data was 48% higher than the total lock-up volume of the entire DeFi market at the beginning of 2020.
Similarly, Balancer, which follows in the footsteps of Compound, has also shown a strong growth trend. When the total lock-up volume of DeFi projects doubled in June, it contributed a lock-up amount of US$1.38 million. Although the prices of the two projects have been in a sideways state since July, Compound, which was the first to start loan mining in the DeFi field, set off a boom in revenue mining in this market, followed closely by sweet potatoes, salmon, corn, pearls, Kimchi and other DeFi “foods” that focus on liquidity mining have appeared on public chains such as Ethereum and TRON, and star projects such as YFI, YAM, and SUSHI have detonated the market one after another.
Liquidity mining was launched on July 18, and yearn.finance, a governance token, was launched. The price of the token surpassed Bitcoin one month after its launch, and reached a peak of $39,894 on September 13. The YFI market is unprecedentedly hyped, attracting media rushing to report, and the dispute over additional issuance has set off a wave of forks in the market for DeFi projects.
YAM, which uses the YFI mining distribution model, forked AMPL, and it skyrocketed by 260% within 24 hours of going online. And Sushiswap, which also uses a similar YFI mining mechanism, was forked from Uniswap, which did not issue coins. It absorbed more than 75% of Uniswap’s traffic within four days of launch, and the total value of locked assets exceeded 700 million US dollars; project token 9 As soon as it went online on the exchange on the 1st, it jumped from $6 to $16, an increase of over 166%.
Sushiswap’s strong eye-catching and gold-absorbing ability pushed the market sentiment to a climax. On September 1, the total value of the decentralized financial market reached a peak of 17 billion US dollars, and DeFi tokens including SUSHI, DF, KIMCHI, etc., set new highs in the next few days. However, four days later, as the founder of Sushiswap was cashed out, problems such as the project team running off the road, thunderstorms and other problems emerged one after another. Many popular DeFi tokens began to fall in an avalanche.
Token rise and fall in September for the DeFI project that focuses on liquidity mining (data source: Coinmarketcap; deadline: September 25, 2020)
Although there have been good news about the exchange’s entry of DeFi, new currency excavation, and SUSHI’s $1,400 repurchase of tokens, the market is not as hot as before. From the beginning of the month to the present, with the exception of YFI, YFII and COMP, all DeFi projects that focus on liquidity mining have not escaped the fate of price cuts, and related tokens have fallen by up to 82% in a single day.
From the perspective of the secondary market, the scale of the DeFi market has shrunk sharply, and the transaction volume is gradually declining; but returning to the primary market, the admission funds for DeFi projects seem to have no obvious signs of exit. According to data from DeBank, the total lock-up volume of DeFi has experienced a sharp drop in the first few days of the month, and then quickly turned to rise; although the growth rate has slowed, the current total assets have returned to the level of tens of billions of dollars. After Uniswap, the largest decentralized exchange in the field, announced the issuance of coins, the total lock-up volume continued to rise and broke through the US$2 billion mark on September 19, setting a record high.
3. DeFi explodes this summer, in the final analysis it is money temptation
Before Compound had launched liquid mining, the locked-up volume of the project was only US$90 million. Before Balancer started liquid mining, there were fewer than 1,000 users. Today, the number of users of these two projects has soared dozens of times, and the amount of locked positions has increased to hundreds of millions of dollars. According to the statistics of DEFIPLUS, the lock-up amount of projects that have started liquid mining currently accounts for more than half of the total lock-up amount of the DeFi protocol.
The siphon effect formed by the DeFi project’s opening of liquidity mining is related to its incentive mechanism for the distribution of governance tokens. In theory, users can passively obtain governance tokens in the process of participating in project transactions, mortgages, quotations, etc., to vote for future changes and development of the protocol. However, judging from the crazy skyrocketing of the tokens of various DeFi projects, compared with holding the currency to participate in community governance, users value the instant income that can be earned by selling in the secondary market.
In liquid mining projects, the price of tokens usually increases with the increase in the number of platform participants and capital injection; in turn, the increase in token prices will continue to stimulate more capital to enter the market. In order to chase the rewards of project tokens, a large number of investors actively provide liquidity to the DeFi protocol, thereby further pushing up the price of tokens and forming a positive cycle.
Taking yearn.finance as an example, on August 13, 2020, yearn’s locked position on Curve was USD 140 million; two weeks later, as of August 31, 2020, the relevant data increased to USD 870 million. The expansion of the project’s lock-up volume led to the increase in the price of its governance tokens. During this period, YFI soared from $5,354 to $35,060.
For liquidity providers of DeFi projects, selling project tokens through the secondary market is the fastest way to make profits. Not only can they make high profits while token prices are rising, but they can also pass the risk of holding tokens to Investors who buy governance tokens. As long as someone in the secondary market is willing to take over and the price of tokens remains high, the DeFi market will continue to expand under the influence of a positive feedback loop, and even give birth to a false prosperity.
Fourth, DeFi overturned at speeding speed, Lego structure welcomed the domino collapse
Liquidity mining has brought a large number of new entrants to the DeFi market. However, under the background that the scalability problems of public chains such as Ethereum have not been solved, and the entry barriers of projects are still high, the decentralized financial project itself There are very few users who have real needs for functions such as lending and transactions; among the participants who have poured into the DeFi system, the proportion of speculative users is much higher than the proportion of those who have real demand.
For example, Compound, according to the original design of its liquidity mining, both borrowing and lending can get COMP rewards, leading to the emergence of a large number of pure arbitrageurs in the early stage of the platform. They earn a lot of project tokens through continuous lending and repayment operations. . For this reason, for a period of time, nearly 80% of the output of COMP was taken away by several big BAT players.
With the FOMO sentiment in the market, the liquidity of DeFi projects continues to increase, but the maintenance of the primary market needs the support of token prices. What needs to be vigilant is that the secondary market has long been reduced to a silly game of drumming and spreading flowers in the cycle of positive feedback. In theory, if you do not participate in community governance and do not plan to participate in the project for a long time, these exponentially-growing tokens have no practical effect or real value in the hands of the entrants. Investors are willing to buy at high prices in the secondary market because they presuppose that more blind speculators will pay higher prices to take orders from them. Once the price of tokens drops and speculators in the secondary market exit, this kind of silly game collapses instantly, and the profit farmer’s “dig-up-sell” wealth creation model will gradually fail.
However, in the DeFi field where the total market value is less than one-tenth of the total value of the Bitcoin market, any emergencies may cause an avalanche of token prices. What’s more, this field has just started, and there are many unknown risks in various projects, whether it is system security or team personnel. For example, YAM with a lock-up volume of over US$400 million on the day that liquidity mining was started, the team blew up a serious loophole in the smart contract within 48 hours of being online, and directly declared a failure; Sushiswap, whose annualized mining revenue was as high as 9500%, just Within five days of the launch, news of the founders selling cash out appeared, and the project tokens plummeted by 80% overnight.
What’s more, many current DeFi projects are freely combined by different decentralized financial protocols, which increases the profitability of users while also correspondingly amplifying risks. Take YFI as an example, its income is affected by AAVE, AAVE’s income is affected by COMP, COMP’s income is affected by MKR, and MKR’s income is affected by ETH. For this kind of Lego-style decentralized financial project, as long as there is a thunderstorm in one of the links, the risk is likely to spread to the entire building block, causing a domino collapse in the market.
With the avalanche of coin prices, investors in the secondary market will usher in a positive crit, and related assets will directly shrink; and the liquidity provider (LP) in the primary market will still have to bear the risk of impermanent loss in addition to the reduction in cash gains . Unlike Compound, which simply uses subsidized mining to issue coins, a large part of liquid mining projects today also integrate DEX mining mechanisms. To put it simply, LP deposits two tokens in proportion to provide liquidity to the platform’s fund pool and earn transaction fees; when the unilateral price of the transaction pair fluctuates sharply, the deposit principal of LP shrinks, resulting in impermanence loss.
At present, the currencies supported by the liquidity pool are not limited to mainstream currencies such as ETH and USDT. In order to increase the rate of return, most projects have added non-mainstream trading pairs or even DeFi token liquidity pools. This means that when the DeFi market is down, LPs that provide liquidity for related currencies will lose a large amount of principal.
5. Liquidity is gradually drying up, and the market will end in a spiral of death
Without the support of price, without the Bossy investors in the secondary market, a large number of liquidity providers will leave the market. From the data of DeBank, the current decentralized financial market is not as popular as before. Although the amount of locked positions has recovered from the previous decline, after the market avalanche in early September, the growth rate of DeFi pledges has slowed down significantly, or even stagnated. Take Uniswap, the largest DeFi market, as an example. After the project announced the issuance of coins on September 17, the lock-up volume gradually recovered and rose to the current level of 1.97 billion US dollars; however, the lock-up volume changed from rising to falling on September 5 Compared with the turning point, it only increased by eight percentage points.
The stagnation of locked positions means that market liquidity is declining, and the price of DeFi tokens falling sideways means that the capital hot money entering the market is decreasing. If there is no new driving force to stimulate the market for a long time, the secondary market speculators attracted by the positive feedback loop will gradually leave the market; without the existence of buying speculators, these are almost zero-cost DeFi generations. The currency will continue to fall or even hit the market directly.
The weakening of the secondary market, the collapse of LP’s high-yield model of “recharge-withdraw-sell”, a large number of speculative users withdrew, the gradual decline of project liquidity, further accelerated the decline of token prices, and the market gradually fell into a spiral of death. When the meager income of liquid mining cannot support the high handling fees that need to be paid during the operation, all the speculators will be dispersed, leaving only a small number of DeFi enthusiasts who really desire to use it.
Although the current DeFi secondary market has not yet collapsed, and the price of the top project tokens led by YFI has picked up slightly; the field “lemon market” has already formed, and the risk of market collapse is gradually increasing. Because many decentralized financial projects are code open source, the cost of plagiarism is extremely low, driven by the effect of sudden wealth, the market has spawned a bunch of “lemon” projects; for example, the Sushiswap imitation project KIMCHI.finance, which is currently close to zero. And YUNO.finance, the emerald EDM whose founder ran away early. These low-quality projects that have emerged invisibly robbed the liquidity of high-quality projects. With their successive thunderstorms, the process of the DeFi market entering a death spiral will also be greatly accelerated.
Six, summary
Hashite believes that the rapid rise in the decentralized financial market from June to August is due to the wealth-making effect brought by liquid mining. The DeFi project with superimposed function combination links the entire decentralized financial field and attracts users to flock to it; but the rapidly expanding market is fragile, and the prosperity supported by price alone can easily collapse. Recently, with the frequent thunderstorms of projects, the secondary market has gradually returned to rationality, and the enthusiasm caused by liquid mining has gradually faded, which will eventually lead to the exhaustion of the liquidity of DeFi projects.
Of course, the decline of liquidity mining does not mean the end of DeFi development. From another perspective, the bursting of the bubble is actually a healthy cleanup for the entire decentralized financial industry. But for speculators who are still immersed in the money-making effect of DeFi, if they don’t recognize the risks early, they are likely to become the most costly participants in this carnival.
