Is the turning point for DeFi here, and is now the perfect time to position yourself?

Author: Alvis, MarsBit

Are the OG tokens in the DeFi (Decentralized Finance) space dead?

This has been the focus of discussion following the notable black swan event in the crypto market on August 5. The global market was shrouded in panic over recession, leading to a spectacular crash, with the cryptocurrency market suffering severe deleveraging shocks. However, during this stress test, the DeFi sector, as a pillar of liquidity, did not experience significant dislocation or credit risk, and instead demonstrated a stronger ability to withstand pressure than ever before.

Does this mean that the turning point for DeFi has arrived? Let’s re-examine this phenomenon.

Token Performance

Data source: CoinGecko

Despite Bitcoin reaching an all-time high in March, we find that the performance of most DeFi tokens has lagged far behind BTC, and even ETH. The DeFi Pulse Index (DPI) has been declining relative to ETH for three consecutive years. During this cycle, ETH itself has also underperformed compared to BTC. DPI includes DeFi-related tokens such as UNI, MKR, LDO, AAVE, SNX, and PENDLE.

Total Value Locked (TVL)

Data source: DeFiLlama

As of August 21, 2024, the total value locked (TVL) in multi-chain DeFi has fallen to $8.46 billion. This figure represents a 54.7% decrease from the historical peak of $18.68 billion reached in December 2021, and is only 61% higher than the levels following the market turmoil triggered by the Luna incident. This significant downward trend can be partly attributed to the general reduction in asset consolidation, such as wrapped assets for Ethereum and Bitcoin, while the contraction of capital outflows has also contributed to this decline.

Lending Volume

Data source: Token Terminal

Lending volume—measuring the value of outstanding debt in lending protocols—currently stands at $106 billion. This is a 49.7% decrease from the peak of $211 billion in December 2021. The decline in demand for loan leverage has directly contributed to the weakness in the DeFi ecosystem.

As one of the oldest tracks in the crypto space, the DeFi sector has not performed well in this bull market.

Based on the above three points, we would unhesitatingly conclude that DeFi has fallen far short of expectations in this bull market.

The reasons for the continuous decline of DeFi tokens are similar to those of most altcoins, which can be summarized in three points:

First, the growth on the demand side appears weak. There is a lack of novel and attractive business models in the market, and the product-market fit (PMF) seems out of reach in many areas.

Second, the growth on the supply side has been too rapid. With the continuous improvement of industry infrastructure and the lowering of entry barriers, a large number of new projects have emerged, leading to a token issuance that exceeds the market's capacity.

Finally, the continuous wave of unlocks. Tokens from projects with low liquidity and high fully diluted market cap (FDV) are continuously being unlocked, creating significant selling pressure in the market.

The decline in the valuation center of altcoins is, in fact, a result of market self-regulation, a natural process of bubble bursting, and a manifestation of capital self-redemption through market selection.

Most venture capital-backed tokens are not without value; they have simply been overvalued, and the market ultimately brings them back to reasonable levels.

After the storm, there is a glimmer of hope.

DEX Volume

Data source: DeFiLlama

In recent months, DEX trading volume has surged, reaching 80% of the peak of $308.6 billion on November 21, 2021. The trading volume in June 2022 is currently expected to reach $190 billion. Since trading activity is highly correlated with price appreciation, this upward trend may continue until the end of the year, fueled by liquidity from ETF funds.

Stablecoin Supply

Data source: CoinGecko

The current market capitalization of stablecoins is $169 billion, gaining widespread attention and application globally, gradually expanding from a narrow scenario of cryptocurrency trading to an important choice for global payments.

Institutional Financing

Venture capital funding in the DeFi space is experiencing a significant revival. According to the latest data from Rootdata, in the first half of 2024, the total investment in the DeFi sector has climbed to $900 million. Although this figure has not yet reached the glorious peak of 2021, it has clearly emerged from the lows of 2023, showing signs of market recovery.

From the above three points, we can also see that the current state of DeFi is not as dire as it seems. Is the reality really as most discussions suggest? Are DeFi value tokens and Layer 2 still in the overvalued region?

Let’s take a look at what some leading DeFi projects are doing.

Lending: Aave

Aave is one of the oldest DeFi projects. After completing its financing in 2017, it transitioned from a peer-to-peer lending model (when it was still called Lend) to a pool-based lending model, surpassing the leading project Compound in the last bull market cycle. Currently, it ranks first in both market share and market capitalization in the lending sector, with active loans amounting to $7.5 billion. Aave's revenue has exceeded its peak during the bull market, demonstrating strong profitability.

Data source: CoinGecko

As of the time of writing, the price of the AAVE token is over $132, with a 50% increase in the past week, reaching the peak levels of March.

DEX: Uniswap

Data source: Token Terminal

Since the launch of version V2 in May 2020, Uniswap has experienced a rollercoaster journey in the decentralized trading space. It once peaked in August 2020, capturing nearly 78.4% of the market, but fell to a low of 36.8% during the intense competition among DEXs in November 2021. However, like a phoenix rising from the ashes, it not only regained its footing but also announced its resilience and tenacity with a market share of 61.7%.

Many DeFi tokens face the issue of lacking practical utility, serving merely as governance tokens. However, this situation is beginning to change: Uniswap's fee switch may become a turning point for other DeFi protocols to emulate, and UNI surged following this news.

Additionally, regulatory clarity may accelerate the trend of revenue sharing. In April 2024, Uniswap received a Wells Notice from the SEC, indicating that regulators may take enforcement action against it. While this notice brings uncertainty, it is accompanied by positive progress on the FIT21 bill, painting a clearer and more predictable regulatory future for DeFi projects like Uniswap.

Restaking: EigenLayer

Restaking refers to the reuse of ETH that has already been staked on the Ethereum mainnet to support the security of other projects. Through this method, users can not only earn returns from their original staking but also increase potential rewards by supporting more projects.

EigenLayer, established in 2021, is a pioneer of the restaking concept. It is a middleware platform located between the Ethereum mainnet and other applications. The platform allows stakers to restake their ETH and ETH-staked derivative tokens (LST) onto EigenLayer by deploying mainnet smart contracts.

Data source: Token Terminal

Since its launch in June 2023, EigenLayer has experienced rapid growth, with a total staking value exceeding $12 billion, making it one of the largest blockchain protocols in the market, even surpassing many major DeFi platforms such as Aave, Rocket Pool, and Uniswap.

Thus, it is clear that DeFi is not dead; rather, it is an excellent time for positioning.

The DeFi sector has already nurtured mature business architectures and profit models, with leading projects like AAVE, Uniswap, and EigenLayer establishing strong moats.

From the supply perspective, leading DeFi projects, leveraging the advantages of early launch, have mostly crossed the peak of token issuance. As institutional tokens are fully released, the selling pressure in the market will significantly ease in the future.

Although DeFi's market attention and price performance in this bull market have not been outstanding, appearing relatively flat compared to emerging concepts like Meme, AI, and Depin, its core business metrics—trading volume, lending scale, and profit levels—continue to rise. For instance, AAVE's quarterly net income has not only surpassed the previous cycle's peak but has also reached an all-time high. This indicates that the recent price rebound of the AAVE token is not unfounded.

Considering the positive attitude of traditional financial institutions like BlackRock towards crypto assets in recent years—whether in promoting the listing of crypto ETFs or issuing sovereign debt assets on Ethereum—DeFi is likely to become a key investment area for them in the coming years. With the entry of these financial giants, mergers and acquisitions may become a convenient way for them to quickly enter the market. Any signs of mergers, even the slightest hint of acquisition intentions, could trigger a reevaluation of the values of leading DeFi projects.

As cryptocurrency investment gradually returns to rationality, the bubbles formed during the irrational boom have been punctured by the tightening of market liquidity. In such an environment, those crypto applications with solid economic value support, high product-market fit, and demonstrated strong resilience are more likely to seize new development opportunities.