The Bull and Bear Rotation: Is the DeFi Narrative Over?

We know it’s the end of a cycle when people start questioning everything they believed during a bull market.

This round of the crypto cycle started when Compound launched COMP and brought the concept of Yeild Farming (liquidity mining) to the masses, and finally officially ended with Terra being killed by Anchor’s promised 20% yield and over-inflated LUNA.

The crash triggered a series of introspective questions about the effectiveness of other DeFi projects:

ejup8BaKkEAMYo79z0IcTiVW78IZfgx05wAKzHx5.png“I don’t think there is a clear difference between Terra and more standard DeFi protocols. Until DeFi meets a real economic need (i.e. getting something to finance), isn’t that a different style of putting your money ahead of everyone else?”

Even questioning Bitcoin:

VLVnlEmbt77qu0Oz3KuDs9GWdkSlGToZ2Hra2hjh.png“On a long enough time frame, Bitcoin’s mechanism design is as flawed as Terra’s.”

Often, when the trend collapses, the bubble also evaporates. Take Terra, which was once the biggest success story of DeFi and L1, as an example. Its failure means that liquidity mining has lost its luster, reassessed expectations, and adjusted prices.

While many coins are now at all-time lows, the market is now converging to new prices that are based less on hype and more on a realistic view of what we have accomplished in the last cycle. Crypto Winter is a good time to look back at the past and how far we have actually come.

zHxBUc3AIZNGf4PM8sv8ezb9H4cTZkhExlcS9gwp.pngSource: DeFi Llama (excluding double counting, staking, pool 2 and borrowing)

To put the last price cycle in context, we benchmarked the current prices of some of the most prominent DeFi and L1 projects with their all-time highs and prices on November 1, 2020. The latter date was chosen because it was at the beginning of the cycle, when DeFi and L1 were starting to look good, but the bubble was still small – Uniswap launched its token two months ago, but prices hadn’t recovered at this point; DeFi’s TVL is on the verge of breaking the $10 billion mark, but has yet to see exponential growth; projects like Avalanche, Solana, and Terra have yet to launch their own liquidity mining plans and are rarely discussed.

These price points can reveal some insights into: 1) the maximum return an investment project can generate since the beginning of the cycle; 2) the project’s ability to preserve value at the end of the cycle; and 3) the drawdown the token has experienced from ATH to the end of the cycle.

Both DeFi and L1 have proven to underperform Ethereum and Bitcoin in terms of pullbacks. This is not surprising, as ETH and BTC have the strongest market consensus, and this consensus is less affected by market ebbs and flows. For the same reason, Ethereum and Bitcoin have worse maximum returns compared to most DeFi and L1 tokens.

nKjin3Y4iWBSH9JkWaSz6nn1mdQNbNZ59rGxkSSR.pngData as of June 28, Coingecko

Meanwhile, L1 is the clear winner this cycle when it comes to maximum returns. The top two projects, Solana and Polygon, made a name for themselves this cycle through generous ecosystem funding and liquidity mining incentives. Each of their projects posted 5-figure maximum returns, far outpacing other L1s like Avalanche and Near.

Overall, L1 outperformed DeFi as a whole. DeFi blue chips are lagging overall (though still posting impressive 4-figure gains). COMP and SNX performed worse, but this may be because their price cycles do not match the price cycles in question (SNX was launched in 2018, COMP ran until November 1, 2020).

This pattern tells us one thing – DeFi hasn’t generated much alpha on top of L1 beta in past cycles .

Jason Kam (@mapleleafcap) has a great mental framework for thinking about this argument. In the 2020 DeFi summer, he asked a rather pointed question – if ETH is similar to the energy commodity that builds the petrochemical value chain (DeFi), then “is it better to invest in oil or petrochemical/industrial chain stocks?

tqzvdpg573f8mCyYHcnAkt0hvphLPI6cLUuZoMq7.pngLooking back at what we’ve accomplished in past cycles, I think the answer to this question is clear – the risk-reward ratio of the underlying token is better than any application based on it, at least for now. Over the past two years, blue-chip DeFi tokens have experienced a similar pullback to L1 when the market fell, but showed less upside potential than L1 when the industry took off.

Heuristically, this is easy to understand. So far, much of the hype around DeFi is because it can bring “users” and “liquidity” to L1. However, when users do come to L1, most of the time they are attracted by liquidity mining incentives, which they quickly discover are the only things they can do on the blockchain. Then, when yields fall, they move to other L1s with higher yields.

In this relationship, L1 does not add value to DeFi. DeFi exists to make L1 look good – it’s the means to end TVL and user growth and then lead to L1 “adopting”. However, many DeFi projects themselves did not benefit from building different blockchains, and some were even hindered by chains that were incompatible with EVM and poor development documentation.

Therefore, these DeFi projects lack the intrinsic motivation to maintain their market capitalization. Not only are their growth highly dependent on L1 expansion, but their strengths are also limited by the ecosystems to which they belong.

The most telling numbers revealing this vicious growth pattern come from comparing the token prices of these projects now with the prices at the start of the cycle. For a refresher, these numbers show how much value DeFi and L1 projects can retain after most bubbles have been washed away by the LUNA crash.

34Hgpg6PuJInUNGLgYKHzOfmqCiefwWkqpE55tSU.pngData as of June 28, Coingecko

The results show that DeFi did not outperform Ethereum or L1 in terms of retention of value , despite nearly all tokens gaining more than double-digit growth during this period (with the exception of COMP, 1INCH, and SNX) . Take UNI as an example, it has returned 128.22% from November 1, 2020 to today, while Ethereum has returned 208.26% (UNI also recently received additional price increases due to the acquisition of Genie and the new NFT roadmap ). In other words, if you had some ETH at the start of the cycle and held on to it, it would outperform DeFi at this point (“holding on” is important, as ETH has a lower maximum return than UNI). The same goes for many other DeFi tokens.

This observation is a sobering look at what these projects leave behind at the end of the cycle. The old model of using liquidity incentives and airdrops to lure users to DeFi no longer works. DeFi brings users to L1 regardless of what those users actually do. The end result is that DeFi, which is essentially part of the service industry, can only serve itself — users engage in DeFi to participate, not to use it for other activities. This selfishness sometimes degenerates into a Ponzi scheme.

Of course, price isn’t the only factor that matters. There have also been some real innovations in DeFi over the past cycle, the progress of which cannot be quantified by token prices. For example, the groundbreaking centralized liquidity feature of Uniswap V3 has opened up a huge design space for the emergence of new applications; the increased demand for block space has inspired a series of block space financialization protocols such as Flashbots and Alkimiya.

Finally, there are also DeFi protocols that launched their tokens late in the cycle and didn’t have the opportunity to reach their full potential. For example, projects like Lido, Ribbon, and dYdX all have multiple product or industry updates coming soon that will further fuel their growth.

After the Ethereum merger is complete, Lido’s TVL will get a huge boost. Ribbon offers a number of structured products that are great for on-chain composable environments, but are currently undeveloped. There is still a huge untapped market for dYdX and some other derivative protocols to capture, especially when comparing their trading volumes to their off-chain peers.

The truth is that while L1 was able to overtake DeFi in the last cycle, none of them can go further if we can’t figure out where new users are coming from.

DeFi will be exciting again when new categories emerge that can bring real users onto the blockchain with real financial needs that DeFi can serve. And the rise of NFTs and Web3 in the second half of the cycle has demonstrated a different need for overleveraged tokens. These categories will attract new users and reconnect them to DeFi, which will be the story of the next cycle.

Until then, there are still many questions to be answered and significant research by the team working on DeFi. A bear market will give them much-needed time to focus on their product rather than rushing token-based listings.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/the-bull-and-bear-rotation-is-the-defi-narrative-over/
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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