Lending apps are ‘hardest hit’ by DeFi TVL churn

Liquidation risk ‘nesting’ often brings a chain of blowouts.

Lending apps are 'hardest hit' by DeFi TVL churn

The dramatic volatility in the crypto asset market has once again confirmed what insiders call “one day in the cryptocurrency world, one year on earth”. Due to the continuous decline in the broader market, the total market capitalization of the crypto asset market has been moving down from the high of USD 3 trillion on May 11, and as of May 25, the figure shrunk to USD 1.7 trillion, a decline of 43.33% in half a month.

The DeFi market was also hit hard in this round of selloff, with the total lock-up value (TVL) of all mainstream public chains falling from an intra-month high of $130.337 billion to $80.034 billion, a half-month drop of 38.59%. Among them, the decentralized exchange and decentralized lending segments lost the most TVL, especially the lending application, whose TVL shrank from an intra-month high of $42.48 billion to $26.95 billion, down 36.56%, with a decrease of $15.53 billion, the most money lost by any track.

Industry analysts say the main reason for the significant loss of TVL is the shrinking asset prices. In addition to this, the large liquidations that occurred in the lending agreements are quite remarkable.

On the day of the market crash on May 19, the liquidation of all on-chain lending agreements reached a record high of $614 million. The founder of Wavefield, Sun Yuchen, had 606,000 ETH, which was also nearly liquidated due to the market crash.

The current round of market crash has once again exposed the systemic risk of the crypto-asset market caused by lending and leverage. Jeffery Wang, head of the Americas at Amber Group, believes it is necessary to remove some of the bubbles from over-leveraged positions if the market is to continue to move higher.

DeFi TVL plunges, lending and trading segments lose the most
DeFi’s total locked-in value (TVL), which has been growing for a year, was finally caught up in the market’s plunge. According to DeBank data, TVL across mainstream public chains fell from $130.337 billion on May 11 to $80.034 billion on May 25, a 38.59% decline in half a month.

DeFi’s total lockup value dropped 38.59% in half a month

According to OKEx Research Institute, the TVL loss of decentralized exchange and decentralized lending is the most serious in two sectors. The TVL of the lending section shrank from a high of $42.48 billion to $26.95 billion, a drop of 36.56% and a decrease of $15.53 billion, the most of any track in terms of lost funds.

The dramatic fluctuations in market sentiment once again provided a stress test for DeFi during its development phase. From the data drawdown ratio, DeFi development was greatly affected by the crypto asset market, and the fall in most asset prices caused a sharp decrease in TVL, and the overall market resilience is still fragile.

Some data worth noting in the midst of the selloff market.

DeBank shows that during the May 19 selloff, the cumulative daily trading volume of market DEX reached $21.738 billion, setting a new record high. Some analysts believe that the surge in DEX trading volume is not only due to frequent trading by investors under the violent market fluctuations; in this environment of DeFi, many quantitative robots also take advantage of the spread between DEX and centralized exchanges for frequent arbitrage; in addition, when there are assets in the lending agreement that are liquidated, they will also get DEX for selling immediately, further boosting the trading volume.

The number of times the on-chain prophecy machine was called also increased significantly that day, with over 35,000 calls in a single day, indicating that the prophecy machine feeds busy prices when the market fluctuates drastically.

In addition to these two figures, the lending segment received the most attention among all DeFi tracks due to the clearing mechanism. In particular, on the night of the May 19 crash, Wavefield founder Sun Yuchen’s 600,000-plus ETH came close to being liquidated, nearly setting the highest liquidation volume ever. Ether developer Philippe Castonguay said that with about 2 minutes left, lending platform Liquity Protocol would have liquidated Sun Yuchen’s 606,000 Ether, but then Sun repaid $300 million, making the liquidation not happen in the end.

Sun Yuchen also clearly felt the aftermath, “There was indeed a moment when it was like a bullet brushing past my scalp, making me sweat cold, I didn’t expect the pin to come so fiercely.

Other liquidated DeFi players were not so lucky, as DeBank data showed that on May 19, the chain’s liquidated funds reached $614 million, setting a new record high. Keep in mind that only a year ago, the TVL of the entire DeFi ecosystem was only $813 million.

Users on-chain lending more need to grasp the risk control
In the past, investors heard about liquidation more in the futures contract market, it is more commonly known as “burst”. So how is liquidation triggered in an on-chain lending agreement? And how does liquidation convey risk?

Currently, almost all on-chain lending agreements use an over-collateralized lending method. For example, if a user holds BTC or ETH, he can pledge it to a lending platform such as Compound, lend out assets such as USDT, and then use the borrowed assets for arbitrage such as mining and trading.

In this scenario, the BTC and ETH deposited by the user are the collateral. Suppose a user deposits 1 BTC into the lending agreement when BTC is $58,000 and lends $35,000 in stable coins, at this time, his collateral is sufficient. However, if BTC falls close to $35,000, liquidation is triggered. Then, the user’s 1 BTC will be quickly taken to the trading market and sold off to pay off the debt, or else bad debts will occur or bad debts will be incurred.

According to this mechanism, taking the case of Sun Yuchen, if his 606,000 ETH are liquidated, this huge amount of assets will be quickly sold in the trading market. Even if the sale happens on a decentralized exchange, this price shock will be quickly passed to the centralized exchange due to the presence of market arbitrageurs. Fishpool F2Pool founder Godfish predicts that ETH could smash to $1,000 if Sun Yuchen’s assets are liquidated that day.

Lending agreements mostly use the over-collateralization mechanism, which is still essentially leverage. Although this leverage is less than 1, users will face liquidation once the value of collateral plunges or the value of lending assets soars. Especially on the ethereum public chain, due to network congestion, many users find it difficult to make repayment or increase collateral quickly when they face liquidation, and the liquidation risk rises sharply under the violent market fluctuations.

After “liquidity mining” took the cryptocurrency world by storm from last year, the high APY (annualized rate of return) of various new mining assets stimulated investors’ desires. Assets lent from ordinary lending apps seemed to be unable to satisfy users seeking high returns, and some leveraged mining platforms came into being, allowing users to lend assets higher than 3 times or even 6 times the principal to various liquidity pools, which inadvertently increased the risk of being liquidated.

The deadly thing is that when a user’s collateral is liquidated, their collateral assets will be immediately dumped into the market, which in turn causes the price market to continue its downward spiral; in theory, the price drop will in turn cause other users to be liquidated, forming a “chain bust” like effect, leading to a deep retraction of the entire market and a dreadful “death spiral”.

Jiang Zhuoer, the founder of Lepit Mining Pool, pointed out that the nature of DeFi is unregulated, completely free finance, with various ecological layers of nesting and countless crazy high leverage, so the “3-12” of leverage trampling is bound to happen again and again. The scary scene also makes the industry need to reflect on the huge risks embedded in DeFi.

In fact, not only the lending agreement in DeFi, but also the futures contracts in centralized exchanges can be forced to close, creating a similar effect. For example, when users’ long orders are forced to close, they will immediately sell in the market, and in extreme quotes, quantitative funds or robots that are unable to quickly eat these sell orders will also cause a trampling down leading to a series of blowouts.

The current round of market crash has once again exposed the huge risks of lending and leverage. Jeffery Wang, head of the Americas at Amber Group, believes that it may be necessary to remove some of the bubbles from over-leveraged positions if the market is to continue to move higher.

The fine print is that the first pinch of de-bubbling tends to hit highly leveraged participants first, until the pain gradually spreads throughout the market.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/lending-apps-are-hardest-hit-by-defi-tvl-churn/
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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