Bubble burst: DeFi deleveraging begins

The Ethereum DeFi market is undergoing a dramatic deleveraging, with more than $124 billion in funds evaporated in just six weeks, and the Ethereum investor base is now heavily losing money on spot positions. The global financial situation in 2022 is unusually sluggish, not only for digital assets, but almost all asset classes. Monetary policy has tightened around the world, the dollar has strengthened, and risk asset valuations have fallen, triggering a series of margin calls, debt liquidations and deleveraging.

Bubble burst: DeFi deleveraging begins

In the field of digital assets, Ethereum is still the largest smart contract platform, carrying a large number of financial products, innovations and automation, with varying degrees of decentralization (commonly referred to as DeFi). The adoption of these products by both retail and institutional investors during the 2020-21 bull cycle has caused an excessive build-up of leverage within the DeFi space. With the arrival of the bear market, the price of Ethereum’s native token ETH has fallen to a low of $1,030, 75.2% from its all-time high of $4,808. As a result of this perfect storm, the entire Ethereum ecosystem is currently experiencing a historic deleveraging event. In this post, we will explore some of the early warning signs, the scale of the deleveraging event, and its impact on the profitability of ETH investors.

Bubble burst: DeFi deleveraging begins

weaker demand

There are some early signals that a decline in Ethereum usage and network demand is underway after the November ATH. Daily transaction volume (pink) and average gas price paid (blue) are both in the macro decline of the past 6 months. This shows that the overall activity, demand and utilization of the Ethereum chain is weakening.

Average gas prices have recovered slightly in recent weeks, however this is more likely due to congestion due to slowing block intervals (purple) due to the difficulty bomb of the upcoming merger.

Bubble burst: DeFi deleveraging begins

The chart below shows the dominance of gas usage for stablecoins (blue) and DeFi applications (green). Stablecoin transfers, and DeFi protocols now account for 5.2% and 10.2% of current Ethereum gas usage, respectively. This utilization dominance has steadily declined since the market high in May 2021, when stablecoins and DeFi accounted for 11.4% and 33.4% of gas usage, respectively.

This is partly due to the crowding out of the NFT boom in the second half of 2021, but also indicates a decline in demand conditions.

Bubble burst: DeFi deleveraging begins

Across the NFT space as a whole, the relative share of gas used for NFT transactions peaked in the second half of 2021, but has since declined from a high of 46.0% in early June 2022 to 19.6% today. Throughout 2021-22, there has been a boom in NFT transactions, maintaining over 20% of all gas usage during this period.

The recent spikes and dips in NFTgas usage may indicate a macro shift in which investors are increasingly reacting negatively to market volatility.

Bubble burst: DeFi deleveraging begins

A similar observation can be made in terms of NFT transaction volume. The chart below shows the ETH-denominated volume of OpenSea (blue) and LooksRare (orange), which will remain between 50,000 ETH and 100,000 ETH per day for most of 2022. However, after May of this year, the transaction volume dropped sharply and currently only remains above 22,000 ETH/day (~$24.2 million/day @ 1100 ETH).

Bubble burst: DeFi deleveraging begins

In many aspects of the Ethereum ecosystem, demand conditions have been weakening, general application usage has been declining, while network congestion has eased after the November 2021 ATH, and in recent weeks, the cooling of the NFT market has become It is clear.

measure the degree of loosening

One of the more popular metrics in the DeFi ecosystem is the concept of Total Value Locked (TVL), which attempts to track the dollar or ETH-denominated value of tokens deposited into various DeFi protocols. These protocols include money markets, lending protocols, decentralized exchange liquidity pools, and more. A popular use of DeFi protocols is to obtain leverage, often by borrowing cryptocurrency collateral through dollar-based stablecoins. In many cases, this leverage is traded and/or re-deposited into DeFi protocols, forming a form of on-chain rehypothecation. With capital increasingly taking a safe-haven positioning, TVL in DeFi protocols has seen a dramatic unwind, caused by two main mechanisms.

Leverage as well as recursive borrowing and lending positions accumulated by the market during bull markets are closed, and the value of crypto collateral falls as tokens locked in DeFi protocols are repriced, often as a result of the sellers arising from point 1 above.

Ethereum’s TVL has fallen by $124 billion (60%) over the past six weeks, pushing total TVL down to $81 billion. In May and June, this unwinding occurred in two batches, first during the collapse of the LUNA project – $94 billion, and then in mid-June – $30 billion.

Bubble burst: DeFi deleveraging begins

On a 7-day basis, these two most recent TVL write-offs were some of the most significant in the past 18 months, with the latest sell-off prompting TVL to contract by -27% in a week. Looking at this metric, there were only two larger deleveraging events; the first was -46.0% associated with the recent LUNA crash, and -37.5% during the sell-off from the then ATH in May 2021.

Bubble burst: DeFi deleveraging begins

stablecoin

Since the beginning of May, stablecoin redemptions totaled $9.92 billion, with capital flowing out of the market. USDT had the largest redemption volume at -$13 billion, followed by DAI at -$2 billion, as investors closed leveraged (or were liquidated) through the MakerDAO vault. Interestingly, USDC’s supply has increased by $5 billion since May 1, suggesting that the market’s preference may shift from USDT to USDC as the most popular stablecoin.

Bubble burst: DeFi deleveraging begins

The total capitalization of the top four stablecoins (USDT, USDC, BUSD, and DAI) also now exceeds Ethereum’s market cap by $3 billion. During 2020-22, the combined market capitalization of the four major stablecoins has repeatedly reached 50% of Ethereum’s market capitalization, but there was a dramatic breakout in May and June of this year.

This is the first such event that brings into view three observations about the structure of the digital asset market:

  • The dramatic rise of USD stablecoins as a unit of account and quoted asset.
  • There has been a strong demand for dollar-denominated liquidity in recent years. We note that stablecoins now account for three of the top six digital assets by market cap.
  • During 2022, the valuation of the Ethereum ecosystem will depreciate significantly.

Note that not all stablecoins are hosted on Ethereum, and a small percentage is borrowed capital from DeFi protocols. Still, the event highlights why the current deleveraging is taking place as the gap between the value of cryptocurrency collateral and the unit of account for margin debt (USD stablecoins) widens.

Bubble burst: DeFi deleveraging begins

Latest Ethereum Research

Our latest research article explores Ethereum from the perspective of the market share occupied by various use cases in terms of on-chain transactions and gas consumption. One of the most powerful tools in on-chain analytics is the ability to calculate realized prices for various sectors of the market. This can estimate the cost basis for these groups by valuing each coin when it was last moved between wallets.

With the ETH spot price now trading at $1212 (June 17), the overall market is now well below the $1730 realized price. This means that the average unrealized loss held by the market is -30.0%. If we look specifically at ETH 2.0 depositors, we can directly measure the value of ETH tokens when they are deposited, since they cannot be uncollateralized. On this basis, the realized price cost basis for ETH 2.0 savers is much higher at $2,400, resulting in an average unrealized loss of -49.5%.

Notably, some of these deposits will be tied to liquid collateralized derivatives like Lido’s stETH, which does allow individual investors to sell assets without affecting the realized price of the original deposit.

Bubble burst: DeFi deleveraging begins

Percentage of Supply (blue) and Addresses in Profit (pink) are two high-level on-chain metrics that measure the current financial versus past cycles of the Ethereum market. Network profitability is now at its lowest level since June 2020, when the market was recovering from the COVID crash. Both supply and address profitability suggest that about half of Ethereum holders are underwater on their holdings. Note that the bear market lows of 2018, 2019 and 2020 reached 23% of supply and profitability of only 2.8% of addresses. If the cycle reaches similar levels, that may paint a somewhat dire path ahead.

Bubble burst: DeFi deleveraging begins

We can also investigate the total unrealized profit and loss of long-term Ethereum holders, the Long-Term Holder Unrealized Net Profit/Loss (LTH-NUPL) metric shows that this group is currently more than breakeven in profitability Points, now holding unrealized losses equal to 23% of market cap. This means that even the strongest and longest-lasting ETH investors are now under water on average. The last time this happened was in September 2018, when the price fell from $230 to $84, a 64% drop in a more severe sell-off.

Bubble burst: DeFi deleveraging begins

lock in losses

With such large unrealized losses held by Ethereum holders, we can turn to spending behavior and observe how much profit or loss is locked in by actual spending. The sell-off fueled by LUNA in early May remains an all-time high for Ethereum investors to realize losses, with $2.85 billion in capital outflows in one day. The current deleveraging followed, reaching a $2.16 billion loss on June 14.

Bubble burst: DeFi deleveraging begins

Finally, we can take a look at the relative Ethereum On-Chain Transaction Profitability Indicator (SOPR) to see the regime in which the overall market is achieving profit or loss. This also confirms that the Ethereum market is likely to confirm a transition to a bear market in January 2022, when losses start to dominate spending behavior. Similar behavior can be seen in May 2018, before a deep bear market that took nearly 2 years to recover, culminating in a sell-off in March 2020.

Current trade profitability suggests that an average ETH trade locks in a loss of -13.5% on average. While significant and in line with past Ethereum bear markets, this is still low relative to the -20% to -22% losses achieved at the lows of the 2018 bear cycle.

Bubble burst: DeFi deleveraging begins

in conclusion

In the 2020-21 digital asset bull market, there has been a plethora of innovations and new product launches across the DeFi space, with Ethereum continuing to lead as the dominant underlying platform. However, with innovation and adoption, there has been an accumulation of leverage, margin debt, and excessive speculation. As market valuations collapse in 2022, the value of cryptocurrency collateral has fallen sharply, creating an unsustainable divergence relative to borrowed USD stablecoin capital. The result was a historic massive deleveraging in the DeFi space, with total value locked down by -$124 billion (60%) in just six weeks. Ethereum holders are now firmly under water, with huge unrealized losses for holders and historically large losses locked in in recent weeks. This portends a high level of financial pain among the investor base, and while scary, it still falls short of the extreme lows in profitability and price declines seen in the 2018 bear cycle.

Overall, the ongoing deleveraging event in the market is clearly painful, akin to a mini-financial crisis. However, with this pain, more leverage crises were also avoided, and a healthier rebuilding of the market began afterwards.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/bubble-burst-defi-deleveraging-begins/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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