Observation: Speculation leads to market bubbles, and DeFi needs continuous optimization to go further
Editor's Note: This article comes fromGolden Finance, reprinted by Odaily with authorization.
Editor's Note: This article comes from
Golden Finance
Golden Finance
, reprinted by Odaily with authorization.
The total value of DeFi locked positions has exceeded 8 billion US dollars, the transaction volume of Ethereum is approaching the level of 2018, and the gas fee has also hit a record high. The frenzy of the entire market does not seem to show any sign of weakening. But although the DeFi industry has good long-term development prospects, the current market is still driven by "hype". No matter from which point of view, DeFi looks like a bubble.
We can see that although the number of DeFi users is growing rapidly, the relative number is still very small. The entire market is mainly dominated by giant whales and speculators who dare to take risks. It is actually the blockchain industry that can subvert the traditional economy. large companies in this field.ETHSo why did it attract so many speculators to enter the market, and what activities did these giant whales and speculators do to earn high profits?
The first thing I have to mention is DeFi borrowing and lending. The most mature lending platform in the field of DeFi borrowing is Compound, which allows users to lock up collateral such as ETH and then acquire other token assets. The upper limit of token assets that users can obtain depends on the collateral. This concept of over-collateralization has led to a significant reduction in the range of potential use cases for borrowers, so borrowing in the DeFi space at this stage is basically short-term speculation like leveraged trading.
Since DeFi protocols are essentially smart contracts, these protocols do not know who the users are, so many DeFi platforms choose to use an over-collateralized loan policy, which can ensure that they will not suffer losses during market price fluctuations. Not only that, although a large number of incentives are provided, the liquidity of DeFi is still very limited, coupled with high transaction fees, the entire market environment is actually not very friendly to institutional and retail investors. It can be said that the liquidity of this niche market of DeFi is still not enough to support institutional activities. In addition, Ethereum’s expensive transaction fees prevent many retail players who hold small amounts of cryptocurrency from entering the DeFi market.
And DeFi loans are like a "proxy" for investors' fixed income, users can lend on platforms such as Compound or Aave
tokens, and then lend the funds to others for interest. Compared with traditional high-yield savings accounts, the annual yield (APY) profits provided on DeFi platforms are more substantial. In addition, DeFi platforms like Compound will also incentivize users by allocating COMP governance tokens. Under normal circumstances, the annual rate of return including COMP token incentives can be close to 6%. More importantly, the loan interest rate in DeFi comes from the needs of margin traders and arbitrageurs, and lending usually requires a mortgage that locks in 150% of the loan size. Therefore, apart from short-term speculation, there is actually not much to try to borrow funds through DeFi significance.
It is worth mentioning that some blockchain industry participants very much hope to expand the scope of DeFi lending services to real-world applications, such as commercial credit and consumer credit. However, this area is still in the exploratory stage for now, and it is unlikely that we will see any meaningful progress, at least in the current market cycle.
Second, speculators will also combine loans and borrowings to build leveraged positions on DeFi, increasing the market’s upside potential. In fact, DeFi's ever-expanding total locked-up volume is achieved through internal and external leverage and speculation. Total locked-up volume (TVL) is often used to evaluate the growth of the DeFi industry, although locked on various DeFi platforms The number of ETH tokens has grown, but it is really insignificant relative to the growth in US dollar valuations, thus distorting people's perception of the size of the DeFi industry. Of course this will bring more risks. Therefore, you must be extremely cautious when using leverage, because even if ETH will gradually appreciate in the long run, short-term fluctuations may trigger the liquidation mechanism and cause your funds to be lost.
In addition, we will also find a new arbitrage operation in the DeFi market: flash loan. One of the biggest advantages of flash loans is that it eliminates the risk of counterparty holding assets. The reason for its appearance is largely due to the programmability of Ethereum. Since most DeFi platforms are smart contracts, the interaction between them can automate many complex transactions. If a trader finds that there is a price difference between DeFi platforms, he can directly create a complex transaction and use a service provider such as Aave to initiate a flash loan to complete the arbitrage of funds. If the price changes suddenly during the execution of the transaction, the transaction will end in failure. At this time, the trader will only lose a little transaction fee, and there is no need to worry about the risk of price decline caused by holding coins. Still, arbitrage trading isn’t in everyone’s favour, given the ever-increasing gas transaction costs on Ethereum. If you want to ensure that your potential loss is not so large, you have to increase the transaction size, otherwise a smaller portfolio may cause the arbitrage transaction to fail if it encounters spread problems.
