DeFi must create real value if it wants to survive
The total value locked in decentralized financial (DeFi) projects hovers around $62 billion in mid-August, down from a peak of more than $250 billion in December 2021. Capital is fleeing the crypto space amid war, rising inflation and other surprises 2022 may still have in store for us.
However, unlike previous crypto bull runs, it wasn’t just retail interest that attracted this capital in the first place. Instead, major institutional players, having recently opened up to crypto, quickly developed a hunger for the returns DeFi is known for. But with winter just around the corner, the pitfalls of high-yield platforms have become more apparent.
Value cannot fall from the sky
In a sense, value is always somewhat subjective, determined by one’s personal considerations and goals. A photo from a family collection means more to a member of that family than to any random outsider. So a farmer would be willing to pay for a shipment of seeds, because they are vital to their business, but a city dweller would probably rather pay for the final product.
Yet even the simple examples above show how value often depends on real-world conditions and processes. In the case of the farmer, it is also quite quantifiable, thanks to the free market that brings together entire industries, governments and consumers in a sophisticated and more or less functional system. Value defined in money creates value defined in yield, be it crops or fruits, and the great economic life cycle continues as these products make their way through the market.
“Yield” is a word dear to the blockchain industry, especially the DeFi sector, whose aggregate value has lost billions of dollars in the ongoing bear run since May. Still a largely nascent industry, crypto as a whole doesn’t have nearly as much exposure to the real economy, especially when it comes to anything beyond speculative trading. And as lucrative as DeFi’s revenues may seem, the question is always where they come from.
Related: Terra Contamination Leads to 80%+ Decrease in DeFi Protocols Associated with UST
The sad story of Anchor’s demise is a perfect example of how unsustainable the business models behind DeFi protocols can be. Its revenues of nearly 20% officially came from on-chain lending, but it was given a cash injection to keep working — a clear sign that borrowing wasn’t enough to sustain returns. Given Anchor’s notoriety as a pull for the entire Terra blockchain, you can credit its questionable returns by taking down the entire ecosystem.
Equally telling is the fact that on-chain lending tends to remain on-chain within the largely compartmentalized blockchain ecosystem. An on-chain protocol can only lend you an on-chain token, and as we know, on-chain assets are not very integrated into the real economy. So whether you’re pursuing an arbitrage opportunity or putting your loan in a different yield protocol, your loan—unlike traditional financial loans—creates little in terms of fair value. And healthy yields never come out of the blue.
There is life outside the chain
This lack of real value to support the returns and the entire offering is a major Achilles heel for the crypto scene. Many have compared Bitcoin (BTC) to digital gold, but gold has other uses in addition to being used in a bank vault, from the jewelry industry to electronics. And while it can never replicate Bitcoin’s wild chance on the moon, its use cases will keep gold afloat even as its veneer fades like an inflation hedge.
The crypto space should try to give up its inside-baseball mentality and look beyond on-chain activities to gain a bigger foothold in the real economy and processes. The blockchain industry needs to experiment with use cases aimed at competing with financial and other services in traditional markets, in addition to advancing the blockchain space as such.
Some of the biggest names in the DeFi space have already seen the writing on the wall. The titans of DeFi are already seeking exposure to real-world assets and moving to a business model with a clearer risk-reward ratio and healthier returns generated by business-to-business lending. The entire blockchain industry should follow this direction.
Related: Do Kwon reportedly hires lawyers in South Korea to prepare for Terra investigation
This search for practical examples must go beyond the core of financial services. It should power a wide range of services, from decentralized data storage and identity solutions to the Internet of Things and mobility applications. The machine world is a particularly interesting use case, as machines running 24/7 are a great source of liquidity driven by fair value. This liquidity could unlock a slew of new DeFi business models and provide an opportunity for some of the existing protocols to switch to healthier yields.
The days of rampant returns shooting to the moon may be over, but there are plenty of interesting real-world activities just waiting to be brought up the chain. All offer more familiar business models, allowing projects to increase their risk management profits, while also providing investors with returns based on actual tangible results. Blockchain adoption should be more than just trading Bitcoin from your bank account – it’s a process that can and should transform entire industries and business models.
By being present in multiple industries and sectors with a real economy, the blockchain space has more than just healthier returns to gain. In the long run, and with enough effort and polish, it’s ultimately about turning Web3’s dream into a self-fulfilling prophecy. A blockchain-based internet must start with a myriad of decentralized apps and services slowly but surely taking over their centralized competitors, and the current bear market is just the time to start building them.
Till Wendler is co-founder of peaq. He previously served as the head of operations at Advanced Blockchain AG between 2017 and 2020 and was also the CEO at Axiomity AG, a blockchain services company.
The views, thoughts and opinions expressed herein are those of the author only and do not necessarily reflect or represent the views and opinions of TBEN.