What Does Ethereum’s DeFi Hype Indicate?

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The latest DeFi craze is starting to imitate the ICO bubble of 2017 and early 2018. Less than $500 million was spent in decentralised finance software a year ago. According to DeFi Pulse data, the overall value locked reached a high of more than $9.5 billion in early September.

total value locked in DeFi

However, as you can see, this has not been a steady rise. As Compound released its COMP governance token in June of this year, the DeFi bubble quickly exploded.

Since then, fuelled by the hysteria, yield farming has become the buzzword du jour. yEarn Finance is one app that has gotten a lot of attention since it was supplying yield farmers with returns of over 1,000 percent at one point. Its YFI governance token is now listed in the top 30 cryptocurrencies, with a valuation of more than $30,000 at one stage.

So, what does this craze mean for the price of ETH, and are the numbers really what they seem?

Question the Price of ETH

When you dig a little further, you’ll find that there’s cause to doubt some of the numbers being bandied around. The overall value locked in DeFi, for example, is a direct function of the price of ETH. The gross USD value locked in DeFi seems to have risen six times since the beginning of June. However, the value of ETH has more than doubled since then.

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This hasn’t gone unnoticed. In a blog post in late August, dApp data aggregator DappRadar announced it was launching a new metric to track DeFi growth. Called “Adjusted Total Value Locked,” it takes the ETH price from 90 days ago as a more objective measure of DeFi expansion.

While the 90-day measurement is arguably somewhat arbitrary, it paints a less volatile growth picture than considering current ETH prices alone.

Is Restricted Supply Driving ETH Prices?

Is the success of DeFi enough to justify ETH’s bull market? The promise of such large returns is almost certainly pushing demand to some degree. Furthermore, tying ETH to DeFi causes a supply crunch.

However, based on the data, it is unclear whether this supply crunch is a major driver of ETH prices. According to DeFi Pulse, DeFi has just under 7 million ETH locked up. This equates to around 6% of the overall circulating supply.

 

Furthermore, over the week leading up to September 4, the number of ETH locked in DeFi rose sharply.

In the same week, the ETH price followed its well-trodden path of tracing the downward movement of BTC prices.

Therefore, it seems unlikely that a pure DeFi drive supply squeeze is directly responsible for ETH’s previous price increases.

This makes sense when you know how impossible it is to determine the precise amount of ETH trapped in DeFi. Yield farming, by definition, entails sequential trades through various applications. For example, a consumer could lock their ETH into Maker to mint DAI, then put the DAI down as leverage in Compound, and then put the cUSD they receive back into a Curve Finance liquidity pool. Essentially, the same ETH is reused through different applications.

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In terms of this, it is likely that even the total amount of ETH trapped in DeFi is in trouble, since none of the data aggregators can account for it.

 

What’s the Potential Impact on Proof of Stake?

In the future, it will be interesting to see how these crazy DeFi yields will affect Ethereum’s upcoming transition to Proof of Stake consensus. Currently, the expected returns from being an ETH 2.0 stakeholder range between 4 and 10%. Why will anyone put up 32 ETH to become a validator while they can win up to 1,000% by playing in DeFi?

Aside from the fact that becoming a validator is likely to be a far less risky proposition for investing 32 ETH, the spiraling gas fees on Ethereum are another factor at play here. The DeFi hype is pushing up transaction fees to new all-time highs.

Given that Ethereum’s scalability issues are unlikely to be resolved before a later stage of the ETH 2.0 launch, perhaps a year or more out, transaction costs are unlikely to fall any time soon, unless traffic decreases.

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As a result, the payments themselves could raise the returns for validating nodes above the original estimate of 10%, making the proposition more appealing to would-be stakers.

How long the regulators will allow the DeFi bubble to keep inflating?

Ultimately, one major concern is how long regulators can encourage the DeFi bubble to continue to inflate. If DeFi fits the same trend as the ICO craze, a few bad SEC rulings will serve as a giant pin that will crack the bubble for good. There has also been some talk that this could occur.

However, for the time being, DeFi fans are making the most of the situation. With the 2.0 update looming and the price of ETH reaching new yearly highs, one thing is certain: it’s an exciting time to be an Ethereum follower.

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