DeFi Tokens Market Cap Declined Due to Macroeconomic Uncertainty, Malinvestments within Crypto Sector: Report

The team at Coinmetrics has released the State of DeFi Tokens in 2023 Report.

Authored by Matías Andrade and Kyle Waters, the Coinmetrics report reveals that decentralized finance (DeFi) is “a rapidly growing application of blockchain technology that aims to provide financial services, such as access to crypto-collateralized loans, yield on investments, and derivative products, with billions of dollars worth of cryptocurrency locked up in various DeFi protocols.”

The Coinmetrics report points out that at the heart of these protocols are DeFi tokens, which are digital assets that are “used to facilitate governance and economic incentives within these protocols.” In Coinmetrics’ issue of the State of The Network, they take a look at the latest developments of tokens in the DeFi space, “including market dynamics, supply statistics and measures of adoption.”

As noted in the update, the aggregate market cap for DeFi tokens “has experienced a significant decline over the past few months.” This decline can be “attributed to a number of factors, including rising interest rates which introduce competition against yield-bearing DeFi products, overall macroeconomic uncertainty and tech rut, and recent unwinding of malinvestments within the crypto space.”

Despite the recent decline, the DeFi ecosystem “has seen tremendous growth over the past few years.”

Coinmetrics puts recent and past developments into perspective:

“In January 2020, the overall DeFi ecosystem was worth under $2 billion. Today, it is worth around $18 billion, although it is still below its peak valuation of around $100 billion. The previous bull-run likely helped spur investment in protocol development and, in spite of the decline, had a huge impact in helping fund ecosystem development.”

The report points out that it’s important to note that while the aggregate market cap may fluctuate, “the underlying innovation and infrastructure development spurred by these lofty valuations is likely to create persistent value among some (but probably not all) of the projects.”

As mentioned in the update, one of the interesting dynamics playing out on the Ethereum blockchain—the smart contract platform with the most significant amount of DeFi activity—is the weight of the tokens’ market cap “compared to the base-layer asset, ETH.”

The report also mentioned that as a consequence of recent months’ market performance, savvy investors have parked their wealth in stablecoins while eschewing riskier assets, “as seen in the increasing share of total value that stablecoins command.” During the 2021 spring bull market, DeFi tokens’ share of market capitalization “bulged on Ethereum.”

In spite of this development, it is also worth noting “the relative performance of ETH compared to various DeFi tokens.” According to the Coimetrics report, it is clear “that investors’ risk appetite has tightened considerably, but as they reconsider their holdings they are growing more selective as well.” So far, ETH has held its value “more effectively than DeFi tokens.”

As mentioned in the update, the number of addresses “interacting with DeFi tokens has fallen since the beginning of 2021.” However, when measuring the adoption of DeFi applications, looking at active addresses interacting with DeFi tokens is a very rough proxy.” This is because protocol usage is “generally separate from protocol governance (usually in the form of a decentralized autonomous organization, or DAO).”

For example, “a user of Uniswap does not need to own the UNI token to interact with the Uniswap smart contract and trade assets (unless UNI is a one of the tokens being traded).”

As an emerging industry with uncertain cash flows, DeFi tokens “suffered through a period of investor de-risking in 2022.”

The report added that there “are some possible catalysts that might help reboot interest in DeFi tokens in 2023.” Firstly, some projects might “continue to experiment with underlying token dynamics.”

Last year, the MakerDAO community “debated revisions to the dynamics of the MKR token including the addition of a staking mechanism.”

On the regulatory side, any movement towards clarification on the issue of token securities vs. commodities “would be welcomed progress in the industry, including the potential adoption of new disclosure frameworks for token issuers.”

The report also noted:

“With the acute awareness of centralized agents’ recent failures, expectations are high for DeFi to excel in 2023. Indeed, the CMBI Decentralized Finance Sector Even index (CMBIDFIE)—an even-weighted basket of all assets in the decentralized finance sector of datonomy—is up 14% to start the new year.”

The report concluded:

“DeFi observers will be watching token performance closely—but … it is important to detach DeFi tokens from the underlying adoption of the protocols. With DeFi token data, it is possible to paint a broad picture of the space but more fine-tuned protocol data is needed for proper due diligence and adoption analysis. To this end, we look forward to expanding our breadth of DeFi analyses in 2023.”

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