The DeFi bubble keeps on growing but what will happen when it bursts?
Bitcoin may have outperformed most other assets in 2019 but 2020 looks set to be an even stronger year for cryptocurrency generally. The Bloomberg Galaxy Crypto Index (BGCI) is up 64% this year, beating the Nasdaq 100 and silver (both up 36%), gold (up 22%), and dozens of other commodities and indices futures.
In September, Intercontinental Exchange (ICE) announced record trading volume in Bitcoin futures. Millions of consumers have been attracted to gamified platforms that offer ways to invest in and day trade crypto along with other assets.
According to research from Fidelity, a growing number of institutional investors believe that digital assets should be included in their portfolios.
The sector is continuing to grow rapidly and this is largely thanks to an explosion in Decentralized Finance (DeFi) projects. The problem is that there are concerns that the sector is growing too rapidly without building the foundations for sustainable success.
Why Is DeFi So Popular?
DeFi has become something of a buzzword in the crypto community but at its core, DeFi projects attempt to mimic various financial instruments, such as banks or exchanges, that are currently controlled by centralized entities.
The logic is that a decentralized solution will be more secure, private, and fair than any existing centralized solution.
There are hundreds of DeFi projects but the two most important at the moment are decentralized exchanges and decentralized lending platforms.
Decentralized exchanges are important because projects like UniSwap have become very popular. They combine the ease of use of a centralized exchange with the privacy and security of a decentralized P2P exchange.
In September, UniSwap processed more than $15.3 billion in transactions. This surpasses Coinbase.
Lending platforms have proven wildly popular. They provide a way for crypto investors to make their assets work for them without being forced to liquidate.
An investor can lock Ethereum or Bitcoin to a lending platform to provide liquidity for borrowers. In exchange, they are offered interest rates that significantly outperform the market average.
This helped fuel a boom that saw $12.77 locked into the DeFi ecosystem to date. This has created an enormous opportunity but some see it as a looming catastrophe.
This boom has been fuelled by rate farming. Investors are currently chasing the highest interest rate and moving their assets around to catch it.
The problem with this is that it is encouraging platforms to offer artificially inflated interest rates to attract the lenders they need to maintain liquidity. This practice is largely unsustainable and could lead to several platforms folding.
The Air Could Be Coming Out Of The Bubble
It’s not all bad news, however. The volume on decentralized exchanges in October dropped by about 26% compared to September. DeFi protocols managed to keep just over $11 billion locked into the ecosystem.
This might concern some investors but it is a sign that the market might be cooling off, providing it time to reach its natural level before striking out and growing again.
Indeed there has been a slight increase in the total locked value over the beginning of October. It does look like the DeFi sector will continue growing, albeit at a somewhat reduced rate.
In the long term, this will hopefully give investors time to breathe and identify which projects they want to lock their money into.
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