Save for the past few days when practically all crypto markets have been hit by a correction, DeFi projects have been in a rally for the better part of 2020 and outperformed Bitcoin and other cryptocurrencies. Anyone who has held Bitcoin for the past year is down by 4.35%. In the same period, DeFi projects have gained exponentially. Ethereum, the backbone of the DeFi ecosystem, is up by 86% in the past year.
Other DeFi projects are up by much higher percentages. Below are some of the biggest DeFi gainers in the last 12 months:
- Aave – 13,847.3%
- Yearn Finance – 2000%
- Synthetix Network – 1115.36%
- Kyber Network – 582.66%
- Chainlink – 572%
Many others have made a big run over the year. The rally in DeFi projects is a confluence of multiple factors, both technical and market-related. These factors have reinforced each other to create the DeFi environment that we have today.
In crypto, any leap in technical development is followed by an increase in use cases that unlock new areas of value growth. For context, one needs to look back to 2015, when the ERC20 technology was discovered.
This ERC20 contract opened a new way to crowdsource financing for blockchain projects, and the result was the ICO explosion of 2017, and the bull run that saw Bitcoin rally to $20,000. The ICO rally created a self-reinforcing cycle where investors looking for quick gains would throw money at any ICOs that was coming up, adding to the liquidity.
DeFi is in a similar situation right now. Back in 2019, the technical setup for DeFi started to take shape. Ethereum, the base layer DeFi contracts infrastructure was already developed in 2019, with the solidity programming language offering an easy way to create contracts. Then there are the Ethereum DeFi protocols that created the perfect environment of Ethereum Lockups (an essential aspect of DeFi).
As of December 2019, one in forty Ethereum were locked in DeFi projects such as Maker and Synthetix. Then there was the rise of the decentralized oracles platform Chainlink (LINK). Chainlink is a central component of the DeFi ecosystem as it provides data to DeFi projects like Compound.
The confluence of these factors meant that more and more Ethereum started getting locked up, eating into its supply. As more projects came up, the demand for Ethereum and the tokens underpinning DeFi projects has exploded in 2020. This has created a bubble that is reminiscent of the ICO bubble of 2017.
The market forces of demand and supply that are driving DeFi have a basis in the technical factors. The average crypto investor is not well-versed on the technical aspects of blockchain technology, and mostly follow gains.
This is evident in the ICO bubble where billions of dollars were thrown at random projects, most of which were scams with fancy whitepapers. Back in 2018, a report by ICO Ratings stated:
“We expect some strongly hyped projects which raised significant funding to actually fail for a variety of reasons – due to being compromised as scams, to conflicts between founders, failure to deliver the promised technology or a failure of solutions offered to be widely adopted.”
The euphoric nature of the average crypto investor is also captured in the sentiments of Jamie Burkie, CEO of Outlier Ventures, who said:
“We knew what was happening towards the end of last year was unsustainable. The reason it was unsustainable was a lot of it was not tied to underlying value. Being more technically involved in the industry, we were aware that the hype was running ahead of technology.”
Essentially crypto investors follow the money, and DeFi offers a fantastic option both for gains and recovery. Gains, in the sense that the Bull Run of 2017 opened people’s eyes to the limitless potential of blockchain investments. With DeFi projects showing potential for profits, investors have jumped in to try and catch the new wave of growth.
On recovery, lots of investors burned their fingers after the market crash of early 2018. As such, the resurgence of a new wave of Ethereum projects in late 2019 and early 2020 offered hope for a recovery of losses incurred in ICOs. This has seen investors FOMO into DeFi, adding to the momentum that started building in 2019.
The Underlying Fundamental Strength of DeFi
Every financial market, be it stocks, crypto or commodities has two types of investors – smart money and the average price chaser. Smart money invests based on underlying fundamentals. For context, while average investors were throwing money at every ICO project that came along in 2017, smart money could identify good projects that have stood the test of time.
A project like Tezos is an excellent example of a profitable ICO that has recorded a healthy growth rate. Similarly, some smart investors understand the power of DeFi and are increasingly getting into DeFi.
Banking the Unbanked
The DeFi ecosystem is one of the most vital aspects of blockchain technology. That’s because it provides an avenue for banking the unbanked. There are billions of unbanked people in this world and once fully developed, DeFi will unlock financial solutions in an unprecedented way.
According to internet entrepreneur, and CEO of Civic, Vinny Lingham,
“The reality that we face with this situation, the narrative for many years, has been to open accessibility to more people to use financial services. But the existing banking paradigm has a bunch of risks, costs and consequences, as well as censorship globally, which make it really difficult to scale. For example, if we look at interest rates, look at the difference between what you are receiving and what you are paying, and the profits the banks make. If we think about the way we consider banking, it’s really centralized by nature. You go to a bank, you put money there, they lend it out, and you receive interest. Financial services are broadly someone looking after your money, and they are taking a cut.”
The large unbanked population globally provides an opportunity for long-term DeFi growth and will see the market keep drawing in money over the long term.
DeFi also has an opportunity for growth through layer two solutions that are coming up in the space. One such chance is in no-fungible tokens (NFTs). NFTs are cryptographic tokens that can be used to represent real-world assets such as real estate, stocks, and art. The NFTs space is still in its infancy and is mainly relegated to the gaming world. One project that is gaining momentum in this space is Open-Sea. It’s a relatively new, but smart money can see the opportunity that such projects create for DeFi.
As money flows into DeFi for such fundamentals, it will create a self-reinforcing loop that will attract more FOMO in the space
Believe the DeFi Hype
The attraction to DeFi is a combination of technical development, FOMO, and the growth prospects that the market offers. As the market grows into areas as diverse as asset tokenization, DeFi projects are likely to keep drawing in more investors’ long term.