In the “folded” DeFi world, how to find new value anchors?

Source: TechFlow

Author: Bonnie

In mid-2020, DeFi entered the eye of the storm.

This is a game that deconstructs traditional rules, where people and codes interact directly, and middlemen such as centralized exchanges and investment institutions are left out.

This is a technological utopia that does not require KYC and is completely anonymous. Developers create the rules and those who are willing to take the bait will do so.

This is also a gold mine with rapid rise and fall. The annualized yield of mining and staking exceeds 10,000 yuan, and the governance tokens can double or halve in a single day.

DeFi was considered a white horse to save the market. After running blindly for more than two months, the market plummeted, Sushiswap split... bringing an autumn rain to the hot speculative world.

When the frenzy fades, we suddenly discover that this is also a folded world - big investors and scientists take away the profits, retail investors often become the ones to take over, and the gap between the rich and the poor is widening.

This is the DeFi world today, where people hype governance tokens but ignore the value of governance. The value lacks reference and loses its anchor.

The weightless world of DeFi

Just as shown in "Folding Beijing", which won the 2016 Hugo Award for Literature, the DeFi world is also folded in different dimensions.

In an article titled "Memoirs of a DeFi Big Player", a big investor reviewed his story of making $5 million on Sushiswap.

This big investor had a capital of 3 million US dollars. Through liquidity mining and staking, he earned 5 million US dollars in just 5 days.

This is a microcosm of how big investors make money in the DeFi world. They enter the project at the beginning, pay handling fees, exchange for free governance tokens, and sell them in the secondary market, that is, "dig-withdraw-sell".

During these two months, the transaction fees on Ethereum have remained high, reaching $70 at one point. "Don't participate in mining if you don't have $50,000 in capital," a DeFi miner warned.

“The transaction fee was charged three or four times, and the round trip cost nearly $500,” an investor complained on September 3, adding that mining on Ethereum is simply not a game that retail investors can play.

Big investors/whales, scientists, and retail investors are the three classic roles in the DeFi world. Big investors and scientists occupy the DeFi high ground, while retail investors, under the influence of the get-rich-quick effect, mostly choose to take over in the secondary market.

This is an infinite nested game. Once these tokens have the support of the secondary market, they can be used as asset collateral or provide liquidity to obtain more project tokens, and the cycle continues.

Under the DeFi craze, funds flowed in quickly, and the locked-in amount of DeFi projects increased 10 times in just three months. But we also saw that the rapid flow of funds brought about a rapid differentiation between the rich and the poor.

It seems that decentralized finance is not decentralized, but rather a game that widens the gap between the rich and the poor.

Aave co-founder Stani Kulechov said that the current DeFi distribution model is unfair and mainly serves whales. This is equivalent to the rich eating a free lunch while ordinary people pay the bill.

Standing at the top of the DeFi pyramid are whales, scientists, and Ethereum miners. Those who buy governance tokens in the secondary market are playing the game of passing the parcel.

The leverage is passed down layer by layer. The more popular DeFi becomes, the more unbalanced its distribution becomes. The DeFi world is gradually losing weight, and collapse is imminent.

Who will pay for it in the end? "When the music stops, the people who are still on the stage pay for it."

Mainstream assets and stablecoins are locked in liquidity pools, market liquidity is drying up, and risks are transferred from top to bottom. Does this remind you of a familiar scene? That’s right, the DeFi world is repeating the 2008 subprime mortgage crisis.

The subprime mortgage crisis in 2008 was caused by many factors, including mortgage companies' excessive lending driven by profit, people's aggressive leverage, Wall Street investment banks' frantic packaging of deals, and rating agencies turning a blind eye... In essence, it was a systemic disorder of structural bubble + investment bubble.

Weiss Ratings recently tweeted: We are almost seeing use cases for DeFi that no one thought was possible before. This is fascinating, but please don't forget that many innovative ways of using decentralized finance are also multiplying systemic risks.

The secondary crisis of DeFi may be different. The bubble of DeFi is mainly in the secondary market, and the liquidity of coins is much higher than that of houses. What's more, DeFi only accounts for 4% of the entire crypto market.

In the sharp drop on September 4, Bitcoin briefly fell below $10,000, and Ethereum fell 23.7% at one point. We saw a flash crash in the DeFi sector, with SUSHI falling as much as 80%.

Overnight, the DeFi market fell into an icy cave. After Sushiswap, imitations emerged one after another, from digging shit to digging graves. The cycle of liquidity mining is getting shorter and shorter, the collapse is getting faster and faster, and the old anchor has gradually failed.

FOMO Dominates DeFi

The liquidity mining that started in June this year has ushered in a wave of DeFi craze.

Looking back now, it injected new distribution mechanisms and governance models into the crypto world, which brought a brief boom to the market.

dYdX divides the early DeFi token economic models into fee-based, governance-based, and re-collateralized types. Today, the main function of most DeFi tokens is governance.

What is the benefit or value anchor of the governance token?

In the eyes of some practitioners, governance tokens are equivalent to free coupons and have little value.

"Based on rewards and transaction fees, the reasonable valuation of YFI should be $3," said Andre Cronje, founder of Yearn Finance. Now, the price of YFI has exceeded that of Bitcoin.

Putting aside the question of whether governance tokens have value, the more important question is, can these governance tokens actually accomplish governance?

In terms of token supply, DeFi may not be much different from the ownership structure of JP Morgan and Bank of America - the Curve core team controls 71% of the protocol's governance voting rights, and more than 13% of Compound's voting rights are controlled by the top 10 addresses.

In addition, whales use recursive liquidity provisions to maximize the returns of governance tokens, which ultimately leads to the concentration of these tokens in the hands of a small number of players.

Judging from the market performance, most participants are just chasing the value of the secondary market. Big whales choose to "dig-withdraw-sell", while retail investors operate in the secondary market but do not participate in governance.

“The essence of the popularity of liquidity mining comes from the resonance effect formed by arbitrage in the primary market and the superstition of locked-in data in the secondary market,” said Yang Haipo, founder of ViaBTC.

The FOMO sentiment in the secondary market has dominated the direction of DeFi, which is almost contrary to the original intention of DeFi, but is in line with market laws.

DeFi’s structure and reorganization

The DeFi explosion stems from the inherent resistance of the traditional crypto world.

Both Bitcoin and blockchain have brought the possibility of creating wealth to ordinary people in the early days, which is why cryptocurrencies attract investors. Compared with the already mature stock market and other investment markets, the crypto world has created possibilities for ordinary people and is therefore popular.

In the next three or four years, the crypto world formed a mature chain of VC, exchanges, Token Fund, and mining.

The explosion of DeFi is not only due to the premise that the DeFi industry has gradually matured after two years of development, but also due to everyone's higher pursuit of fairness after the "312" crash.

Fairness means re-establishing the rules of the game without the support of bigwigs, harvesting of crops, and collusion of the strong. The "good latitude friends" that caused a lot of controversy some time ago is a negative example.

No matter whether they are new or old, they no longer believe in the traditional cryptocurrency system. Compared with the early days of Bitcoin when everyone was equal, after 10 years of development, the crypto world is also facing the challenge of class solidification, and people have higher requirements for fairness.

DeFi just meets the imagination of the cryptocurrency community. The main contradiction that DeFi solves is the contradiction between investors' growing need for fairness and justice and outdated rules.

The sudden emergence of Uniswap has mixed up all the investors' imaginations of the decentralized world. It does not require a centralized exchange, listing fees, or quantitative market makers, and it governs by doing nothing.

Uniswap’s total transaction volume exceeded US$10 billion, but problems had already emerged at this time. As mentioned in the first part of this article, the subprime mortgage crisis reappeared in the DeFi world.

Last week, Sushiswap came out of nowhere. Compared with Uniswap's VC faction (Uniswap was invested by a16z), Sushiswap is known as the community faction, which rebelled against the former, is more friendly to retail investors, and is a more ultimate version of DeFi.

However, due to reasons such as the anonymous founder, Sushiswap failed and management rights were transferred to the founder of the FTX exchange, which was invested by Binance.

From VC to community, and then back to VC, DeFi still cannot do without the endorsement of centralized institutions. DeFi's decentralized governance development has a long way to go - it cannot get rid of the influence of human interests for the time being, nor does it attract people who can truly participate in governance.

The hype of governance tokens while ignoring governance issues is the key to the DeFi world. FOMO and human rule are both unsustainable and have squeezed out the last bit of value from liquidity mining. If DeFi is to continue to develop, it needs to find a new value anchor.

Finding a new anchor for DeFi

DeFi brings about the rapid flow of funds, and more projects are emerging and being seen by us. One day in DeFi is equivalent to one year in the traditional cryptocurrency world, and one day in the cryptocurrency world is equivalent to one year in the human world. In just half a year, DeFi seems to have gone through decades of development in the traditional world.

Think about it, can DeFi really change the world?

First of all, can DeFi really achieve inclusive finance? Libra, which also wants to achieve inclusive finance, has been suppressed by many governments, and the existence of DeFi governance tokens makes it impossible to evade regulation - the rule in the traditional world is that whoever governs is responsible.

What’s more, the only purpose of most DeFi projects is regulatory arbitrage, not inclusive finance. Perhaps compared to most short-lived new DeFi projects, we should choose projects that require long-term cultivation and continuous product iteration, such as MakerDAO.

Beyond that, what is the value of DeFi?

The value anchor of DeFi is not the governance token itself, but on-chain governance, to jointly discover greater value.

Most of the profits from this wave of DeFi craze have been captured by big investors, scientists, and graphics card miners. They follow the profit migration and have no intention of participating in the long-term construction of a DeFi project.

"Price surges will attract users who don't care about sustained returns, don't provide liquidity, and don't participate in governance," said Andre Cronje, founder of Yearn Finance.

This is an equal but unfair game, and what needs to be done next is to find a fairer governance design that does not just attract speculation.

For example, Wan Hui, founding partner of Primitive Ventures, said that the participation threshold of a project currently being played is to have voted in the on-chain governance of YFI, which directly aggregates the traffic to people who really care about the future of YFI, and all of them are high-quality traffic. There is also another project that requires that before a certain block height, it has interacted with several staking contracts, which effectively prevents speculators from taking advantage of the situation.

After this round of DeFi fever, the market began to calm down. Fortunately, people began to pay attention to the blockchain ecosystem again, discover the next value target, and look for opportunities to participate, rather than just playing speculative games such as leveraged contracts.

As Three Arrows Capital co-founder Su Zhu said, it is difficult for DeFi projects to strike a balance between obtaining funding, attracting talent, decentralization, and providing products that users really want.

Both the DeFi project and the DeFi world will find balance again in this repeated imbalance.

As economist Joseph Schumpeter once pointed out, at its core, capitalism lies in creative destruction — the repeated, often painful reorganization of economic structures as traditional ways of doing things are replaced by innovative alternatives .

*TechFLow reminds all investors to guard against the risk of chasing high prices. The views expressed in this article do not constitute any investment advice.