DeFi Tokens are Booming. Why is This Happening and Will it Continue?

In recent weeks, DeFi projects like Uniswap, Aave, Curve, and Chainlink have seen their tokens increase significantly in value. This growth in DeFi has not been seen since the summer of 2020, and represents a new wave of DeFi excitement, fueled by Layer 2 solutions and big money.

In the Summer of 2020, DeFi experienced its first surge into mainstream cryptocurrency popularity. On June 21, there was about $1.5 billion of value in DeFi. By September 21, that value had increased nearly tenfold to $9.74 billion. This is due to a number of factors, including the proliferation of yield farming and its incredible three-to-four-digit returns, decentralized exchanges and liquidity pools, and the retail investors’ desire to find the next Bitcoin. All of these factors created a cryptocurrency market that is today nearly inseparable from the idea of DeFi, and now DeFi promises to democratize and decentralize the economy, and bank the unbanked. 

Naturally, this caused DeFi tokens to rise in price, as investors saw an opportunity to get in on the ground floor of these finance applications. For example, Chainlink’s LINK token increased 4x in value since the start of the summer, and Yearn.Finance’s YFI went from $1,000 to $40,000. However, for the majority of these projects, the hype tapered off, and the token prices fell back down to earth. Recently, though, these projects have seen another increase in their token price, and this time it appears to be due to more than just hype and speculation.

During the Summer, Ethereum fees spiked as network congestion due to the DeFi craze grew, creating a self-fulfilling prophecy where more hype created more congestion, creating higher fees and lowering the use-case for DeFi. As a result, users could expect to spend fees as high as $100 to do a simple Uniswap transaction. This demolished the potential for DeFi to bank the unbanked, as $100 is a transaction fee only acceptable for people making transactions worth tens of thousands of dollars. 

Current gas fee for a Uniswap transaction

Since then, Layer 2 scaling has become a viable solution to the problem of Ethereum’s high fees and long transaction confirmation times. Projects like Loopring pioneered the space, and created one of the first decentralized exchanges based on Layer 2 scaling technology, which allowed users to trade ERC20 assets for pennies, instead of hundreds of dollars. Their first-mover advantage caused their token to increase by twenty five times its value at its all-time low. 

Other DeFi projects have also begun preparing for Layer 2. Uniswap, for example, is planning on using a Layer 2 scaling solution in their V3 upgrade, which will significantly increase the speed and decrease the cost of their transactions, so much so that they will be able to possibly compete with the likes of Binance and Coinbase. When this happens, Uniswap can expect the value locked in their platform to increase significantly, which could increase the price of their UNI governance token, which effectively controls what happens to the funds locked in the platform. Holders of the governance token could vote on proposals that give them dividends related to how much value is locked in the platform or the volume of trading fees. These possibilities have led many investors to choose UNI as a long-term DeFi play that could potentially offer dividends in the future. 

Another project planning on implementing Layer 2 is Aave, the decentralized lending protocol. Typically, projects build on one Layer 2 solution, and each solution is incompatible with one another. For example, Matic Network Ethereum cannot directly interact with Loopring's DEX unless they go through the original Ethereum blockchain and pay the noraml fees. To mitigate this problem, Aave plans to make themselves available on multiple different layer 2 solutions, giving them the greatest exposure possible. Theoretically, AAVE holders could also vote on governance decisions to further their profit, and they can also stake their token in Aave’s built-in insurance platform. The more funds at risk, the more security is needed, thus the greater return for the AAVE staking.

Some projects have been able to indirectly benefit from the increased usability of DeFi projects. For example, Chainlink’s price recently hit an all-time high of nearly $25, cementing it as a top 10 cryptocurrency. When projects that rely on Chainlink begin to scale, their growth will indirectly correlate to Chainlink’s growth, since there will be more need for a decentralized oracle.  Similarly, the MKR token, which governs the DAI stablecoin, will also become more useful when the use of DAI becomes more prevalent. One final example will be Yearn Finance, whose aggregation of lending protocols will be effentizied by cheaper transactions, thus made more valuable.

Another possible explanation in the recent rise of DeFi is the cryptocurrency hype cycle. Traditionally, there has been a pattern to how the cryptocurrency market increases in value. First, Bitcoin booms, which brings lots of money and attention to the cryptocurrency space. Then, investors start looking for the next big thing, which leads them to invest in Ethereum. The cycle continues, and investors then turn their wallets to some of the more significant alt coins. In this specific bull run, those coins are the likes of LINK, UNI, and other DeFi tokens. Furthermore, when the big money that is investing into the likes of the Grayscale Bitcoin Trust look to further diversify into cryptocurrencies, they will no doubt find the DeFi movement quickly. In fact, Grayscale filed for the creation of an AAVE trust, among other coins, on January 27, which would undoubtly bring lots of institutional money into the DeFi space. 

The consistent and continual improvements to the largest and most promising DeFi projects has led their underlying tokens to skyrocket in value, and lead the total value locked in DeFi to reach upwards of $25 billion. Not only that, but also the potential for Wall Street investors and more regular people finding DeFi only further the potential for the fledgling industry. Though three-digit yield farming may have been a fad only seen by the incredible speculation of Summer 2020, investors seem to believe the possibility for anyone to cheaply invest, trade, and take control of their finance will certainly be here to stay.

By Lincoln Murr

Related Articles