After peaking last November, crypto markets have experienced turmoil throughout 2022, as a succession of negative macroeconomic and industry events halted its bull run and caused a collapse in asset prices.
In addition, as the macroeconomic environment worsened and inflation rose, major price corrections across all crypto assets and the contagion from Luna’s blackswan demise caused several blockchain protocols, venture capital firms, and exchanges to go underwater.
The decentralized finance (DeFi) space was not spared either, as it was also deeply impacted by the downward trend, as well as a series of devastating hacks and scams netting criminals billions. According to a recent quarterly report from CoinGecko, the DeFi space suffered a 74.6% decline in market capitalization during Q2, crashing from $142 billion to $36 billion in just a few months.
Is DeFi Dying?
No, according to the report it’s clear that the rumors about DeFi’s demise have been greatly exaggerated. Or maybe not quite so much. Still, after a long period of expansion, going all the way back to the “DeFi summer of 2020”, it was quite natural and healthy for the DeFi industry to have a considerable correction.
While the valuation of DeFi protocols and their tokens plummeted, the same cannot be said about their utility and user base. The same report from CoinGecko illustrates that the user base for DeFi protocols has remained strong despite the downturn. While they’ve taken knocks, it’s clear that the DeFi industry is by no means down and out for the count, despite growing regulatory attention and a lack of consumer trust in yield-bearing lending and staking protocols following Anchor Protocol and Celsius’ demise.
While the number of daily active users using DeFi protocols saw a significant reduction of 34.5%, falling from 50,000 to 30,000 users in Q2, these figures suggest that remaining investors still have a high degree of confidence in the potential of DeFi.
Cascading liquidations
As a result of the market condition and Luna’s crash, several crypto lending platforms and venture capital firms went into liquidation due to not managing their risk exposure adequately.
Celsius Network, a crypto lending platform, filed for bankruptcy protection and froze all customer accounts in June. Next, Three Arrows Capital (3AC), a Singapore-based crypto hedge fund, became insolvent after failing to repay a $665 million loan to crypto broker Voyager Digital, who eventually also capitulated and filed for bankruptcy.
3AC’s purchase of a $50m yacht is now nothing more than a symbol of hubris for this era of irresponsible crypto custodianship that has likely now been flushed out of the DeFi sector for the foreseeable future. It should remain a cautionary tale for the next generation of firms that crypto bull markets do not last ad infinitum.
USDT depegs, USDC surges
The Celsius bankruptcy caused $USDT to lose its peg and a significant portion of its market cap to rival stablecoins, as a rattled market still spooked by UST’s rapid demise gave in to a fresh round of FUD. Overall, the top 15 stablecoins lost almost a fifth of their market cap (-$33.9B) during Q2.
However, USD Circle ($USDC) became the only stablecoin to register growth (7%). While algorithmic stablecoins like FRAX and DAI remained resilient throughout the crisis, they also had a respective 48% and 32% decline in market cap.
DeFi Hacking on the rise
The CoinGecko report also stated that the increasing amount of hacks and exploits have also contributed to the downfall of DeFi in the first half of 2022.
In Q1 of this year, DeFi-related hacks made up for almost 91% of all cybercrime in the crypto space. That tendency has ramped up in Q2, as DeFi hacks saw a significant surge in May as registered by the REKT Database.
A Q2 security report by Certik pointed out several flaws in current DeFi security. A lack of expertise in smart contract coding and auditing has made it easy for hackers to find exploits and steal millions of dollars worth of crypto from protocols like Rari, Inverse, Saddle, Beanstalk, and others.
Ethereum and Decentralized Exchanges remain strong
On a positive note for ETH maxi’s, the CoinGecko report also showed that Ethereum is regaining some of its dominance over competing layer-1 blockchains, as its incoming Ethereum Merge event in Q3 begins to loom large. As altcoins began to shrink and its own gas prices came down dramatically, Ethereum surged from 54% to 60% of the total value locked (TVL) across DeFi protocols.
While the overall DeFi sector lost roughly 67% of its market cap in Q2, decentralized exchanges (DEXs) have remained fairly stable and with a strong user base throughout the year. A spike in DEX user activity was reported during Celsius bankruptcy and the Luna/UST crash. As centralized exchanges halted trading, DEXs like UniSwap and Curve Finance became the only option for investors to try and rescue their capital.
Closing thoughts
While the future of DeFi may seem uncertain at the moment, in all likelihood, faith in the market will eventually be fully restored, as protocols get back to basics and improve their offerings in terms of transparency and accountability. The disruptive use cases in DeFi are simply too much to ignore indefinitely and it is simply a genie that will never get put back in the bottle again.
Technology improves through iteration and problem-solving, and 2022’s setbacks have provided fertile grounds for learning that should benefit the whole decentralized finance sector. As the DeFi space matures, we should witness increased regulation, more institutional investment, and reduced cybercrime.
A shift towards sustainability and positive real-world impact is also taking place through regenerative finance (ReFi), a movement aimed at using web 3.0 technologies and DeFi tools as a way to solve social and environmental problems.
While it’s difficult to predict how the rest of 2022 will go, we should witness new trends and never-before-seen financial products being developed and applied for the better of the blockchain industry and the world before the next bull cycle is here.