Decentralized Finance (DeFi) applications are becoming what ICOs were in 2017-18 and what stablecoins were in 2019.
The advent of venture funds, increased social sentiment, and promises of world-changing technology are a “been there, done that” narrative in cryptocurrencies. This time, it’s DeFi applications with their huge chest-thumping — with some projects even promising 100 percent interest payouts.
But huge returns usually come with equal risks — despite what many projects would tell their users. This has been touched upon in recent times, with Ethereum’s Vitalik Buterin the latest to speak on the topic.
Risk education not present
In a tweet on Saturday, Buterin spoke on the risks that flashy DeFi projects bring to the table, one that may not be immediately apparent to newbie investors:
Honestly I think we emphasize flashy defi things that give you fancy high interest rates way too much. Interest rates significantly higher than what you can get in traditional finance are inherently either temporary arbitrage opportunities or come with unstated risks attached.
While thread commenters said the interest in DeFi also brought onboard new developers and investors, which overall helps the ecosystem, Buterin was forthcoming on the systemic risks at play.
Agree! But we can’t become dependent on those projects and must be mindful of the systemic risks at play.
Some of the benefits of DeFi projects are their ability to fully cut out middlemen, provide quick, and feeless, cross-border payments, and the ability to payout interests to investors in DeFi tokens.
However, focusing on price, high-yields, and a general “get-rich-quick” mentality without properly educating the end-users on the risks involved is not sustainable.
Decentralized finance should not be about optimizing yield. Rather, we should be solidifying and improving a few important core building blocks: synthetic tokens for fiat and a few other major assets (aka stablecoins), oracles (for prediction markets etc), DEXes, privacy….
— vitalik.eth (@VitalikButerin) June 20, 2020
“Users want the benefits of crypto (easy international payments, no annoyances involving traditional centralized finance characters, seizure-resistant store of value) plus the financial properties of existing assets. Stablecoins provide that.”
Dropping like a pack of cards
Earlier last week, ex-Messari product head Qiao Wang also chimed in with his general thoughts about the DeFi market. Wang noted the latter was bordering on how ICOs were in 2016, and the subsequent rise in Bitcoin and Ethereum prices was unlikely to follow.
The reason? Stablecoins are now a preferred onboard to both crypto-exchanges and DeFi projects. The USDT, in particular, has grown by leaps over the past two years and is now the world’s third-largest cryptocurrency by market cap.
Meanwhile, speaking on where those high-yields come from, Wang tweeted:
I’m amazed no one has ever asked where the yield in DeFi comes from. In case you are interested, the yield in DeFi is ultimately subsidized by the poor retail traders who consistently lose money on centralized exchanges.
— Qiao Wang (@QWQiao) June 20, 2020
So while DeFi is a zero-sum game, in theory, cascading liquidations may lead to huge risks for investors. MakerDAO suffered from this in March 2020, losing investors up to $4 million when Bitcoin dropped by 45 percent over two trading sessions.
In short, the “risk-free” yields that some DeFi projects promise come largely making from other traders reinvesting funds in other leveraged speculative assets. This is a point that must be propagated further in crypto-communities, especially if the crypto-market’s true financial inclusivity is to come to fruition
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