Liquidity Miners Extract Value As Crypto Holders Gamble With DeFi
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The crypto cauldron assigned to decentralized finance is bubbling merrily. And judging by the hordes of liquidity miners flocking to defi protocols, they like the scent of what’s cooking. What started as an organic movement to bring open finance to the masses has turned into a frenzied search for yield as speculators seek profits from lending crypto assets. “In Compound Finance's current incentive structure, there [has been] a schelling point for everyone to stake and borrow huge amounts of the same coin,” acknowledges Ari Paul.
Protocols such as Compound and Balancer have seen explosive growth, not only in users, but in the price of their native tokens. The utility token era is over. Right now, governance tokens are the hottest assets in town, and everyone wants a slice of the action – even if they’re not so fussed about participating in on-chain voting.
Centralized exchanges such as Coinbase and Binance have rushed to list assets designed for decentralized finance, creating a curious juxtaposition. CEXs are now acting like DEXs, while DEXs, fueled by liquidity miners topping their protocols to overflowing with tokens, are gaining liquidity once synonymous with centralized exchanges. It’s just one of the many contradictions of decentralized finance, a $1.6 billion industry that’s just getting started.
Thrills And Spills Down At The Defi Farm
Yield farming, in which asset-holders compete to lock their tokens into the decentralized protocol promising the highest APR, is all the rage right now. So is speculation on the tokens themselves, many of which are now governance tokens that provide voting rights and in some cases a share of the pool fees for supplying liquidity. Some see the speculation as a vital means of bootstrapping fledgling networks, while others see little difference between locking WBTC into a lending protocol and gambling your crypto in a bitcoin casino. You lock your funds into a smart contract and you take your chance.
While some observers are adamant that a defi bubble is brewing, insiders aren’t so sure. Defi investor Andrew Kang believes defi is still at a very early stage, pointing out that the sector still only has 6,000 daily active users and is worth just 1% of the market cap of BTC, ETH, and USDT. At the moment, there is more money waiting on the sidelines than there are protocols to invest in, which accounts for why some of the leading defi tokens have seen such strong demand. Compound’s COMP surged to over $400 on news of its Coinbase listing, having traded for less than $20 only days earlier. It has since slumped to under $190. A pretty profit for early adopters, but a painful lesson for those who bought the top.
DEX volumes have quadrupled this year, with over $1.5 billion in volume in June alone. Exchanges such as Uniswap and IDEX have been at the heart of the action, while aggregators such as 1inch exchange have also prospered. So far, defi is following bitcoin’s trajectory, with the primary use case being speculative trading initially. The banking the unbanked stuff will come later, once the protocols have matured and the kinks been ironed out. Or at least that’s the plan.
High Fees Keep The Defi Dream On Hold
One of the biggest impediments to greater defi adoption is a broader blockchain issue: scalability. The Ethereum network is overloaded with transactions, and the number of ERC20 transfers recently hit a record high. This has caused blocks to become full and gas prices to rise. For so long as the price of trustlessly trading defi assets is anywhere from $5-30 depending on the complexity of the smart contract, defi will do nothing for the little guy.
There are signs that the blockchain scaling impasse is starting to ease as new protocols come online and layer twos pick up the strain. Blockchain bridges such as Syscoin’s enable ERC20s to be trustlessly transacted on a second chain connected to Ethereum, while Matic has been onboarding dApps and blockchain gaming projects to its Plasma-based network. ZK-rollups, touted by Vitalik Buterin as the likeliest Ethereum scaling solution for the near future, are also starting to see action. All of this should combine to make defi transactions cheaper and faster. This will provide a proper testing ground for decentralized finance at last.
Will defi bring open finance to the masses, or will the only winners be the early adopters and liquidity miners who secured high yields while the going was good?