What Does the Market Correction Mean for DeFi?

As turbulence shakes the sector, let’s take a look at what the future of DeFi will draw from the corrections.

Introduction

After a period of sustained growth, the DeFi market witnessed a heavy correction in the past 48 hours. Coingecko shows that the market capitalization of the top 100 DeFi projects dropped 29% from $132 billion on May 19th, to $94 billion on May 20th. The Total Value Locked (TVL) in the sector has also shrunk during this time. Following a short period of declining crypto prices, borrowers on lending platforms have extricated themselves from their smart contract positions to avoid the threat of liquidation.

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The DeFi Blip

The TVL chart of Defipulse, which is regularly used as a simplistic barometer of market health, shows that the dollar value of assets locked in Ethereum protocols fell from an all time high of $87 billion on May 12th, to $59 billion on May 20th – a 33% drop – before bouncing back to $64 billion. Even with the price recovery, this still represents a 27% market correction over the period, with that bulk of that loss occurring in the last couple of days.

Other important metrics from across the market draw a similar picture. On the BSC, the TVL trend was broadly the same, peaking earlier on May 9th at $53 billion. The BSC TVL contracted to $43 billion on May 13th, before tumbling to $29 billion on May 20th.

Data from wallet provider Debank shows that May 19th set the all time record for liquidations at $572 million, with Venus, Aave (versions 1 and 2), and Compound being the heaviest hit protocols of the DeFi borrowing exodus. May 17th and May 18th witnessed $44 million and $130 million in liquidations respectively, bringing the three-day total to $746 million. That is a significant increase when you consider that average daily liquidations are around or under the $3 million mark.

Why Is This Happening?

Since borrowing on DeFi platforms requires no identity or credit checks, the loans are approved through a simple algorithmic process of over-collateralization. The borrower locks their crypto assets into the protocol and receives a stablecoin in return. If the value of that crypto collateral falls below a certain level due to declining asset price, a liquidator can step in to trigger a sell off and personally profit from doing so. To avoid liquidators profiting from their misery, borrowers will instead end the loan themselves (providing they can return the borrowed stablecoins), and unlock their assets from the lending protocol.

As for the recent market volatility, this has been blamed on everything from Elon Musk’s reversal on Bitcoin due to climate impact, to a crackdown on crypto in China.

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Short of Long

In the short term, the DeFi asset price crash and the related reduction in TVL will undoubtedly fuel uncertainty in the market. Visitors to 4chan’s /biz/ forum can expect the image board will be freshly supplied with Pink Wojack’s and McDonald’s memes for days. While the average investor may be hurt from the sudden reversal in price action, and may point to ominous portents from TVL graphs, there are still reasons to stay optimistic about the DeFi sector in the medium to longer term.

Concluding Thoughts

Considered in perspective, the DeFi blip is a dent in the market rather than a collapse. DeFi has experienced massive success in 2021, with the top 100 DeFi projects recording 447% growth from January’s entry position of $21 billion. Ethereum, the chain which nurtured DeFi from out of its cradle, has demonstrated incredible strength over the course of the year, both an asset and as an ecosystem. Opening the year at $738, the price of ETH remains above $2,500, more than 3x increase. At the same time, DeFi has diversified beyond Ethereum and taken root in multiple other successful chains including BSC, Solana and Polygon. 

Price retraces are never welcome, but many investors are choosing not to jump ship from altcoins in favour of BTC. Since the start of 2021 Bitcoin’s market dominance has been significantly eroded, falling from 77% to 43%. More bullish is the fact that decentralized finance continues to retain a healthy 5% market share of the wider cryptocurrency industry. From across the market there are a number of reasons to believe that DeFi will cushion the shock of this recent market correction.

Source : bsc.news