DeFi needs to start creating real-world value if it wants to survive
Total frozen value in decentralized finance (DeFi) projects is hovering around $ 62 billion in mid-August, down from a peak of more than $ 250 billion in December 2021. Capital is fleeing crypto space amidst war , rising inflation and any other surprises 2022 may still have in store for us.
However, unlike previous cryptocurrency bullish runs, it wasn’t just retail interest that attracted this capital in the first place. Rather, major institutional players, who have recently opened up to cryptocurrencies, have quickly developed an appetite for the returns DeFi is known for. But now that winter is upon us, the pitfalls of high-performance platforms have become more evident.
Value cannot come out of nowhere
In a sense, value is always somewhat subjective, defined by one’s personal considerations and goals. A photo from a family collection means more to a member of that family than to a random stranger. As a result, a farmer would be quite willing to pay for a shipment of seeds, as they are crucial to their business, but a citizen would probably prefer to pay for the final product.
However, even the simple examples above show how value often relies on real-world circumstances 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. Defined value in money creates definite value in yield, be it crops or fruit, and the great economic life cycle continues as these products make their way into the market.
“Yield” is a word dear to the blockchain industry, particularly its DeFi sector, which has seen its total locked-in value lose billions of dollars in value since May due to the ongoing race to the bottom. Still a largely nascent industry, cryptocurrencies as a whole don’t have the same exposure to the real-world economy, especially when it comes to anything beyond speculative trading. And as profitable as DeFi’s returns may seem, the question is always where they come from.
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The sad story of Anchor’s demise is a perfect example of just how unsustainable the business models behind DeFi protocols can be. Its nearly 20% yields officially came from chain lending, but it received an infusion of cash to continue trading, a clear sign that the lending was not enough to maintain yields. Given Anchor’s importance as a pull factor for the entire Terra blockchain, you can attribute its questionable returns to the culling of the entire ecosystem.
Equally significant is the fact that on-chain lending tends to remain on-chain within the largely isolated blockchain ecosystem. An on-chain protocol can only lend you an on-chain token, and as we know, on-chain assets aren’t very integrated into the real-world economy. So whether you’re looking for an arbitrage opportunity or aiming your loan at another yield protocol, your loan, as opposed to traditional financial lending, creates little in the way of real-world value. And healthy crops never come out of nowhere.
There is life off the chain
This lack of real-world value to support returns and the entire supply is a major Achilles heel for the crypto scene. Many have compared Bitcoin (BTC) to digital gold, but gold has use cases as well as being kept in a bank safe, from the jewelry industry to electronics. And while it can never replicate Bitcoin’s wild blow to the moon, its use cases will keep gold afloat even as its inflation-covering patina wears off.
The crypto space must try to give up its internal baseball mentality and look beyond chain activities to try to establish a broader foothold in the real-world economy and processes. The blockchain industry must experiment with competition-oriented use cases with financial and other services in traditional markets as well as advance the blockchain space as such.
Some of the biggest names in the DeFi space have already seen the writing on the wall. The DeFi titans are already seeking exposure to real-world assets, moving to a business model with a clearer risk-reward ratio and healthier returns from business-to-business loans. The entire blockchain industry should follow this direction.
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This search for real-world use cases should go beyond the core set 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 world of machines is a particularly interesting use case, as machines that run 24/7 are a great source of liquidity determined by real-world value. This liquidity could unlock a whole host of new DeFi business models and offer the opportunity for some of the existing protocols to transition to healthier returns.
The time of uninhibited returns of shooting for the moon may be over, but there are many real-world activities generating interest waiting to be brought into the chain. All of them offer more familiar business models, allowing projects to increase the return on risk management while offering investors returns based on actual tangible results. Adopting blockchain 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 making a dent in a presence in multiple sectors and industries of the real economy, the blockchain space has more than just healthier returns to win. In the long run, and with enough effort and sophistication, it’s ultimately about turning Web3’s dream into a self-fulfilling prophecy. A blockchain-based internet must start with a series of decentralized apps and services slowly but surely taking over their centralized competitors, and the bear market at hand is just the time to start building them.
Till Wendler is a co-founder of peaq. He previously served as chief of operations at Advanced Blockchain AG between 2017 and 2020 and also served as 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 Cointelegraph.