Partnered With:

Inside the DeFi Crash: Hyperinflation, Profit-Taking, and Growing Pains

Read this article in 15 Minutes

It provides a powerful explanation for the recent sluggish DeFi market and currency prices.

Original title: "Hyperinflation, profit-taking, and growing pains – Inside the collapse of decentralized finance || Deribit Insights"

Original source: Deribit's trading class

Summer 2020 has been a breakout season for decentralized finance (DeFi). The value locked in DeFi protocols grew from $2B in July to $11B in October, with several DeFi tokens gaining 5-10x in value throughout July and August. Since September, however, there has been a clear divergence in decentralized finance token prices and protocol metrics, with tokens retracing by more than 50%, even as locked value continues to grow. This divergence may be due to investors turning to a safe-haven environment as they decide to lock in profits and become wary of high supply inflation for tokens that are still in their nascent stages.

Source: IntoTheBlock's DeFi Insights2

Overall, ethereum's decentralized finance governance token dropped by about a third from $7.5 billion to $5.07 billion in the last month alone. Meanwhile, stablecoins and tokenized versions of Bitcoin have managed to continue growing in terms of market capitalization.

Source: IntoTheBlock's DeFi Insights2

This comparison suggests a shift in the market towards a risk-off environment as traders move from governance tokens to less volatile, yield-generating assets. Furthermore, it appears that the catalyst for DeFi’s initial surge may also be the reason behind its collapse. While yield farming (aka yield farming) is not a new phenomenon, Compound’s mid-June COMP mining is largely considered the tipping point that triggered the explosive growth of decentralized finance.

Since then, hundreds of protocols and forks have launched their own Yield farming schemes became the primary method for simultaneously attracting liquidity and distributing governance tokens. Initially, the protocol managed to grow both token prices and liquidity supply, but things quickly changed as the market began to crash in September. Since then, governance tokens, especially those that have resulted in high inflation rates through yield farming, have retreated sharply.

Non-exhaustive list of decentralized finance tokens with current yield farming plans , as of October 19, 2020. Source and methodology: IntoTheBlock3

As can be seen from the above table, since 9 Since March 1, decentralized finance tokens with a 1-year inflation rate of more than 100% have plummeted by at least 75%. Likewise, tokens with a lower circulating percentage of total supply saw a larger decline than tokens with a higher circulating percentage of total supply. Although the sample size is small, the correlation between the 1-year inflation rate and price changes since September 1 is -0.73, suggesting a strong negative relationship between the two. Overall, this suggests that while yield mining can stimulate demand on the supply side, it can also lead to a setback for tokens, similar to hyperinflation-induced devaluation. DeFi protocols seem to have realized this, with projects such as Compound4 and Pickle5 reducing their supply emissions.

Leaving aside high inflation rates, for tokens that have been around in crypto long enough, it's not at all surprising that tokens with a 10-20x price increase followed by a 60-80+% correction. This is due to natural market forces and profit taking. By comparing the number of addresses that are profitable at a certain price level, we can estimate that DeFi token holders are closing their positions. Using IntoTheBlock's Historical In/Out of the Money, it is clear that fewer holders were profitable at the same price level prior to the crash.

Source: IntoTheBlock's YFI financial indicators6

The above picture shows, At $15,170, the number of YFI holders who are making money or taking profits on their positions has dropped from 5,970 to only 1,630. This suggests that addresses that are profiting notional may decide to realize their gains when the price moves higher. Other governance tokens such as SNX, LEND, and UMA show the same pattern. Ultimately, this highlights how investors opted to take profits and liquidate positions following a parabolic rally in decentralized finance tokens.

It is normal for an emerging market like decentralized finance to experience this kind of price volatility, especially in the cryptocurrency space. In this context, decentralized finance tokens on Ethereum remain insignificant: they currently represent only 1.39% of the $365 billion total cryptocurrency market cap. DeFi tokens have an even smaller market share in terms of number of holders.

Source: IntoTheBlock's DeFi Insights2

At present, holding Aave (LEND) ETH addresses have the highest proportion, although it has undergone a token migration process. None of the decentralized finance tokens managed to reach 0.5% of Ethereum addresses. This shows that decentralized finance tokens are still far from gaining a large number of holders within Ethereum, suggesting that it is a field that is still in its early stages.

Decentralized finance continues to move forward despite the collapse in token prices. With protocols like Synthetix testing layer 27 solutions for greater scalability, precedents for mass adoption are being built. At the same time, the progress of Ethereum 2.08 shows that a more robust infrastructure for decentralized financial services is on the verge of being ready.

While decentralized finance may currently be insignificant compared to the broader cryptocurrency market (let alone traditional markets), this suggests it has potential to grow. Admittedly, with token price spikes in July and August, investors’ expectations exceeded their own. Since then, decentralized finance tokens have retraced as investors grew wary of high inflation and decided to lock in profits in a broader risk-off environment. Ultimately, these price swings are characteristic of a nascent field with enormous potential. Prices and hype may subside as the market settles down, but the building blocks of a decentralized financial system will continue to be in place.

Appendix link

< p align="justify" line="slQX">1. Original link:

https://insights.deribit.com/%e8%a1%8c%e4%b8%9a/%e6%81%b6%e6%80%a7%e9%80% 9a%e8%83%80%e3%80%81%e8%8e%b7%e5%88%a9%e4%ba%86%e7%bb%93%e5%92%8c%e6%88%90% e9%95%bf%e9%98%b5%e7%97%9b-%e5%8e%bb%e4%b8%ad%e5%bf%83%e5%8c%96%e9%87%91%e8 %9e%8d%e5%b4%a9/?lang=zh-hans

2. IntoTheBlock's DeFi Insights:

https://app.intotheblock.com/insights/defi/charts

3. IntoTheBlock:

https://docs.google.com/spreadsheets/d/1YwLUsOHT4 dwbcF4NBpYjD3I4xOKNgGbcOUXyGLBFMRg/ edit#gid=0

4. Compound :

https://compound.finance/governance/proposals/21

5. Pickle:

https://snapshot.page/#/pickle/proposal/QmYZqjjvgkC3u4nNXf5ywufVWGtNj1VAEkg8PJ7Z2P6nzx

6. IntoTheBlock's YFI financial indicators: