Original title: Redefining DeFi: DeFi tokens have fallen sharply, technological progress may support the next rebound
DeFi is notable this week due to the lack of notable events. No one has set a new record for the fastest cracking of a new contract, no one has implemented a well-known exit scam, and no one is playing tricks.
You can feel the difference now. In the past, every weekend we would discover some new exotic food, or someone would cleverly pretend to be a Ponzi scheme to launch a vampire attack on another protocol.
It’s not that nothing happened this week, it’s just that the vision feels different this time.
What has really attracted attention is the sharp drop in the price of a large number of DeFi tokens, and the various DeFi indexes launched recently reflect this well.
The DeFi Pulse index fell by more than 20% in a week
Compound’s COMP fell below the lowest price of $127 in August, touching $100. Now, Year Finance’s YFI has fallen 66% from its all-time high. SushiSwap’s token has entered a death spiral: after peaking in September and falling by nearly 90%, it has fallen another 50% since the last news. The Uniswap token fell below the psychological barrier of $3.
Do fundamentals support current levels?
One hope is that the locked total DeFi value (TVL) remains high, reaching $10 billion, which some analysts say is a sign of solid fundamentals.
I disagree with this. I have written in detail that with the advent of liquid mining, TVL really cannot represent anything. The high lock-up value of Uniswap, Compound, SushiSwap, Curve, etc. is due to the continuous issuance of new tokens to incentivize them. Protocols like Maker or Aave also get a second windfall from the demand for DAI or the increase in token prices.
SushiSwap and UNI tokens were launched before these tokens skyrocketed
The problem of double counting has also become very obvious. For example, WBTC is worth $1 billion in the DeFi Pulse ranking. More than 83% of the supply comes from other projects, especially Uniswap, Maker and Curve.
A major source of double counting is DAI-the collateral used to create it is designated as Maker TVL, and then DAI is counted when it enters Uniswap or Compound. With regard to DAI, one might say that collateral and stablecoins themselves have different purposes, so it makes sense to consider these two situations. But WBTC is just a token, it doesn’t do anything by itself, just like the Ethereum supply is calculated as TVL in DeFi.
In any case, I don’t think the community has realized what happened. We have seen congestion in the Ethereum network and DeFi has reached its peak in terms of users and activities. It was a great journey, full of suspicious things and complete success (for example, I was amazed by the liquidity and trading volume of the decentralized exchange Uniswap).
In the past few months, the average gas fee has been ridiculously high. Source: Etherscan
But now, similar to cryptocurrencies in 2018, it all depends on scale and development to bring the next wave of projects and success. I have heard this explanation: People who promoted this rise believed that DeFi is driving the mainstream market, and the market size will reach hundreds of billions of dollars.
Instead, all we get are blockchain congestion and valuation indicators, and these indicators reflect circular dependence and bad accounting. Unfortunately, when the market has risen too much, they can also become very unhappy when they realize that the fundamentals behind the rally are insufficient.
So the point is, I don’t think the market really ended the sell-off. I don’t have the method to predict the future. I may be wrong, but I have been engaged in cryptocurrency activities for long enough. I know that until everyone starts talking about technology and future challenges and criticizes the overly optimistic bull market, we haven’t Bottomed out. (So basically everyone is the same as me.)
At the same time, I think it is worth thinking about that technological progress may support the next rebound.
DeFi interoperability gains momentum
There are two main ways that DeFi can be expanded in the short term: Ethereum’s second layer solution and bridging to other blockchains.
Competition in all aspects is fierce. In the second-tier solution, the main competitors are Optimistic Rollups and Zk-Rollups. The former allows developers to port Ethereum smart contracts almost one-to-one, but there are many user experience issues. The latter seems easier to use, but the contract needs to be rewritten into a new language. Both types are still in the testing phase and we expect to launch in 2021.
While waiting, there are many other blockchains eager to provide its throughput to replace Ethereum. Polkadot clearly positions itself as being able to accept the liquidity of Ethereum, but there are also Binance Smart Chain, NEAR, Serum / Solana, NEO, Cosmos, etc.
The latest competitor is RSK, which announced the integration of Dai this week. It becomes quite easy to transfer liquidity in a relatively stable form there, and then use it in the RSK DeFi ecosystem.
But the problem now is that all bridges are not functioning properly or are centralized.
In addition, the liquidity bridging method may require the establishment of a considerable DeFi ecosystem on another chain to function. Finding other use cases is crucial, and if another blockchain can meet the demand before Ethereum, it may win the game.
Currently, it is difficult to predict who will win. Ethereum still has no reason to worry about its leading position.
Miners use their abilities to get value from DeFi
An important but possibly overlooked news this week is the discovery that miners use their abilities to extract value from the DeFi ecosystem.
This confirms the theoretical concept of miner extractable value (MEV) emphasized by some researchers in 2019. This problem stems from the fact that the order of transactions within a block is very important for DeFi, and miners can freely choose the transactions and order to include.
In this particular example, it seems that some small mining pools have packaged transactions with zero fees to take advantage of arbitrage opportunities. The fee is set to 2 Wei, so obviously this transaction will never be reached under normal circumstances.
This discovery may mark the beginning of the DeFi open season for miners. But this is not all bad. Miners have become excellent arbitrage traders and debt auction maintainers, so they can actually improve market efficiency. Of course, doing so will crowd out ordinary users.
The biggest threat is the potential high-value MEV competition between miners, which may lead to chain forks and reorganizations. I think this is unlikely to happen, but in terms of overall fairness, MEV is definitely a serious problem.
The main solution currently under study is to “institutionalize” it by holding MEV auctions. It may take more work to find a way to neutralize it, but there is enough time because the problem will not go away. Miner is a general term, and anyone who controls blocks and transactions has the same ability. This includes mortgagers and certain types of second-tier operators.
