Defi, another name for Ponzi?
The overall cryptocurrency market cap. has again experienced an increase in value since last week. Ethereum is up 7.44% week on week vastly outperforming, exchanging hands at $426.25 on Sunday. Meanwhile, BTC had a pretty flat week, trading in the range of 11,500 to 12,000, waiting for the catalyst to break higher. Similarly, XRP traded in a range between 0.285–0.31, and ended up gaining almost 5% on Saturday, last traded at 0.30. As market continues to focus on DeFi, gas price skyrocketed to as high as 263 GWEI on Thursday. Ethereum futures open interest reached an all-time high of 1.75b on 14th of August. [Figure 1]
In alt coins space, ChainLink (LINK) posted another whopping 36.7% gain last week. The recent explosive move fueled mainly by DeFi frenzy has pushed LINK to be the 5th largest cryptocurrency by market capitalization. The DeFi market has expanded rapidly in recent months, causing most DeFi-related projects to rally. Despite this, there is a significant valuation gap between major and smaller networks. As an example, Chainlink is currently valued at $4.475 billion. In contrast, Band Protocol, the second largest oracle project in the market, has a valuation of only $257 million. If the price of LINK rose above $30, it would place the network’s market capitalization over $10 billion. Whether Chainlink has sufficiently strong fundamentals, user activity, and other metrics to support a $10 billion market cap by year end remains uncertain.
What is Happening?
U.S. equities registered another weekly gain, and almost five months after the bear-market low in March, the S&P 500 closed within striking distance of its record high. Mainland Chinese stock markets ended the week broadly unchanged as investors remained on the sidelines ahead of U.S.-China trade talks on August 15. Many analysts see the talks — which are intended to review the progress of the phase one trade deal over the past six months — as a potential risk to markets, though President Trump is believed to want the deal upheld ahead of the November presidential election. However, the scheduled trade talk was later announced to be postponed due to scheduling conflicts and the need to allow time for more Chinese purchases of U.S. exports.
MicroStrategy, a publicly-traded business intelligence company has spent $250 million buying 21,454 Bitcoins to use as its primary reserve asset. It would be interesting to see whether other mainstream institutions start to diversify their balance sheet into digital assets.
Elsewhere, CEO of BitMex, Arthur Hayes tweeted about joining the DeFi community in playing around with yield farming. A recent development in DeFi highlighted that outsized returns do not come without taking extra risks. Compound kicked off a “liquidity mining” euphoria in DeFi. Liquidity mining incentivizes participation in DeFi protocols by rewarding those who interact in the protocol with the native token of the project. Yam Finance followed suit with their own liquidity mining program and quickly accrued a value of $750 million in locked liquidity within 2 days. However, a critical bug was found in the protocol which flooded the protocol with Yam tokens and caused governance issues. The excessive number of Yam tokens meant that the quorum for voting on governance changes could never be met and Yam tokens and the value locked in the protocol quickly plummeted. This all happened within 48 hours of the project launching. Despite the recent surge of popularity, Defi space still have room to grow. Portfolio tracker Blockfolio reported that 32% of their users are neither involved nor aware about Defi.
If you are not already active in the DeFi space but are considering, there are some important practical implications in this week’s piece. Nobody is disputing that there is currently a lot of opportunities for earning large returns in DeFi. This ecosystem has been extremely volatile and the hype surrounding this emerging area has resulted in significant upside potential for investors. However, blindly taking risks will leave investors more vulnerable to events such as the YAM incident.
If investors are exposing themselves to a project that they have limited understanding of, it is advisable to have strict risk parameters in place. Keeping the entire exposure to one given project at 1% of the total value of a portfolio limits the downside risk while also giving significant upside exposure. If the project fails, the investor loses 1% of their portfolio whereas they will observe a significant increase if 100x plus returns are materialized. It is also possible to gain exposure to DeFi without investing in any protocols. Products such as the FTX perpetual futures contract allow investors to bet on the success of a basket of DeFi tokens without having to own the underlying assets.
Good Luck !