August 25 2022

The Ruins of Crypto

What’s the status report after the quake? Well, it’s not pretty. The Anchor fiasco toppled Defi 2.0, which was a self-serving leveraging scheme. To be clear, nothing is wrong with being a Degen, but it becomes deadly for everyone in DeFi when degen trading becomes the main engine of the system.

This is what happened. In the span of 4 months, DeFi TVL dropped from $140Bn to $63Bn, DeFi DEX volumes decreased from $140Bn in May22 to $40Bn. Curve.Finance, the bellwether of DeFi liquidity war has a TVL of $5.9Bn, which is ~25% of what it used to be pre-crash. Even NFT daily volumes cratered from $280m to $8m.

Developing activity is a lot quieter but not dead. The VC fury of ’21 and early ’22 has left companies well-funded and able to sustain several months of dire liquidity. You’ll hear a lot of people making the argument that the “current crypto winter will wash out get-rich-fast profiteers and leave room for the value-accretive long-term projects”. There is definitely gospel in that. Tokens could still be used as customer acquisition incentives, all the more than their value is about 80% lower than 4 months ago. Huge upside potential. But, fair to say that in the meantime, momentum is lost.

In the camp against momentum are the regulators. The recent crash has given them plenty of ammunition to fight the corner of customer protection. Besides, regulators have been preparing for a long time the clamp down on KYC/AML non-compliant protocols. This might just give them the occasion. And there is the existential question of stablecoins, and whether the US Government should leave a worldwide currency alternative develop in their backyard, even if it’s for now pegged to USD itself.

The recent clampdown on Tornado Cash, a protocol favouring anonymous trading and impunity, gives us plenty of thoughts on that. Also, interesting to see the side effects for USDT and USDC, which stand between a hammer (US sanctions) and a hard place (crypto diehards appetite for freedom).

In the rosy camp vouching for new beginnings are ever and again BTC & ETH maxis. The former are reinforced in their belief that an incorruptible and fully independent protocol will continue to affirm BTC supremacy as the alt asset of choice to hold, transfer, store value across borders. The latter bet all on a successful merge with a proof-of-stake ETH resulting in (i) an ESG-compliant greener process, (ii) lower net issuance, and (iii) higher incentives to lock ETH and limit its circulation. Under the assumption of a stable demand, ETH maxis assume that price will move up. The thing is that DeFi demand is on the wane, and lower liquidity doesn’t automatically results in higher prices.

Finally, the holy Grail remains the adoption of real-life use case for DeFi. Will they, won’t they? Well, initiatives are plenty, from tokenizing real-world assets (RWA), as in the case of, to using RWA as collateral in SPVs with first loss going to underwriters and senior going to crypto lenders as in the case of MakerDAO. Real-world credit is making a foray into crypto via Goldfinch and Maple, and has been driving higher volumes lately, let alone higher returns that compensates for their illiquid nature.

On this quest, the promise is that crypto will bring enlightenment to TradFi with less middle man, lower cost, more transparency, active risk management, and higher yields to boot. In practice, we are almost backward on all those.

It costs 1.5% transaction fee to trade on Coinbase or bid-offer is gigantic, not to mention MEV, which is another word for front-running. Management fees are also high. Middle men are plenty, as protocol composition has become the norm. In fairness, there are the same intermediaries in crypto than in TradFi: originator/broker, underwriter/arranger, and they naturally take their cut.

Transparency is there on-chain for those who can read endless pages of code. Let’s face it, there is only transparency in A transacts with B, not what A and B do in the background. And don’t get me started on the stewardship of DAOs, which have seriously under-delivered on their democratic ambitions. DAOs are usually run by a handful of key stakeholders and governance is unplugged when they see fit (e.g. Tribe, Solana, Maker…).

The combination of computing power, transparency, and efficient markets was supposed to give birth to exquisite risk management. The recent crypto crash proved that in fact everybody and his sister was swimming naked and running risk monitoring on xls spreadsheets.

As far as higher yields are concerns…well, hum, unless you are directional on cryptos every time they reach bottom, there is not much yield to speak of. Convex 3 pool plugs in 1% and higher-risk convex MIM + 3Crv 9.3% VS 2-year US treasuries 3.37% and Asian high yield at 8.11%. There is at best an argument for diversification, not better risk-adjusted performance.

In short, DeFi is miles away from challenging effectively TradFi, but large opportunities remain.

– Protocol composition is of great use in financial derivatives.

– Contract commands in collateral liquidation has proven dramatically more efficient than procedural processes at banks.

– Web3 (ownership and freedom) combined with Pooling (setting up your own flavour of risk assets) are great tool to be used to diversify portfolios and get them to work for specific purposes. As such, they are the future of asset management, and embed the opportunity to democratize investment for all.

Despite its current shortcomings, the future of DeFi is bright. Just work harder on it.

About –

360 Advisory LLC is a Boston-based RIA managing investments, including crypto