Is DeFi a Ticking Time Bomb Just Waiting to Explode?

DeFi is a hot space with a lot of activity going on, so much, so the total value locked in its projects has reached a new high of $3.09 billion, as per DeBank’s data. Maker and Compound are currently leading with more than $600 million in locked value.

The market, however, is not really positive about it and sees it as a ticking time bomb. As we reported, while Litecoin creator Charlie Lee isn’t “too excited or optimistic” about DeFi space, Ethereum co-founder Vitalik Buterin doesn't think the interest rate offered on these projects are sustainable.

Binance CEO Changepeng Zhao also said that this “very new area” has “a lot of potential risks.” He cautioned users that “if you do go into those areas do go there with caution.”

The reasons are many, how about this one. DeFi projects are are more risky than Ponzi schemes. In addition to expected exit-scam by project founders they can be unexpectedly hacked by external players. https://t.co/L6lj6v4DVJ

— ʲᵒᵉ🕶️7 (@J0E007) July 19, 2020

While some say it’s a Ponzi, others argue, “the legacy financial system is also a giant Ponzi” and a “much bigger” one than DeFi.

“Defi is equipped to become a less corrupt one (…) speculation might be a necessary step to bootstrap the critical mass,” said analyst Qiao Wang.

Interestingly, yEarn recently released what it calls a “zero-value, worthless” governance token. There are currently two proposals the community has to vote for, for which they launched a governance forum.

Poll 0 is to vote on whether the supply of YFI should be capped at 30k or mint new ones. Poll 2 is to keep the burning mechanism to claim trading fees or change it to stake the token to collect trading fees staking.

YFI holders voting to cap the supply at 30,000 forever. pic.twitter.com/2Fj72hrpKp

— eric.eth (@econoar) July 20, 2020

“Want YFI to go from having 0 value to a little bit of value? Then make it happen,” reads the official blog.

And it did… to $2,000 in a day.

After seeing what’s happening in YFI I’m starting to change my mind on this. In 2016 when you bought ICOs you had to rely on Poloniex to list them. You had to take substantial liquidity risk. Nowadays a new token can get insta-listed on a DEX. This can get out of control quickly. https://t.co/m8OdISHwf7

— Qiao Wang (@QWQiao) July 19, 2020

Smoke & Mirrors

What DeFi is, no one knows, but what can’t be ignored is billions of dollars, $1 billion in Compound alone, are put in DeFi projects, which has massively grown in the past few months. The market cap of the likes of SNX, COMP, Lend, and MKR is also up significantly.

Not only the world is putting its money in DeFi products, on Sunday, Curve.Fi, a decentralized exchange (DEX), saw nearly $100 million in volume, which is greater than Deribit and Bitfinex put together while Uniswap traded $36 million that day. 1inch has also been nearing $1 billion in total historical volume.

Numbers are still going up

-Pool Y on Curve did 52 Million USD Today.
-BTC:USD on Coinbase did 28 Million USD today.

-Buying 10 million USDT with USDC on Curve has 0 Slippage.
-Meanwhile on Binance spot, the entire orderbook sell side liquidity is thinner than 1 million. https://t.co/2YR9051ExO pic.twitter.com/NBj6mcN7jN

— CL (@CL207) July 19, 2020

“The numbers look pretty good–they all pretty strongly support explosive growth,” but these Defi exchanges have revenue of $0, argued Sam Bankman-Fried, CEO of crypto derivatives platform FTX.

He explained how Bitfinex processed billions of dollars of fiat/stablecoins trades this year but didn't show it in their volume because the exchange doesn't consider it real. They also have relatively high fees, which means their volume is real.

While Bitfinex only traded $35 million on Sunday, “it probably made around $50k on that,” while Defi exchanges traded $100 million and had a revenue of $0.

All of the DeFi trading volume and locked volume is just stablecoins.

“Most of DeFi right now is people locking, trading, and lending stablecoins against each other (…) because at this point, any project with their salt has liquidity incentives,” said Sam.

People are currently buying, selling, borrowing, lending, and locking their stablecoins for pay, which comes from governance tokens that are airdropped on platform users.

As such, the tokens have such huge valuations, “but you can't spend valuation.”

The whole positive feedback cycle is: “Liquidity incentives –> TLV up –> valuation up –> larger incentives –> TLV up more –> …”

So, it may be creating billions of volume, locked assets, and valuation, but it is not creating revenue or value for users other than the price paid by governance token buyers.

“It's the entire sub-industry. Out of nothing, it made something,” said Sam.

But it doesn't mean what has been “almost entirely hot air and marketing bubbles” would end in rubble rather, DeFi is now facing a choice to be either that or “mark the beginning of the true decentralization of finance” but for that good products need to be built.