Has Decentralized Finance Hit Bottom?

While decentralized finance as a sector has had poor price performance this year, the ecosystem has strong fundamentals, causing some to speculate whether DeFi is due for a turnaround.

Year-to-date, the decentralized finance ecosystem has seen an 11.1% drawdown in its total market capitalization, decreasing from $80.1 billion to $71.2 billion at the time of writing, per CoinGecko.

As a result, its dominance – the ratio between DeFi’s market cap and the entire market cap of crypto – has dipped by over 28.3% in the same time period, from nearly 4.5% to 3.2%. That marks a three-year low for the sub-sector of the crypto space known for providing financial services, such as lending, without centralized intermediaries.

The native tokens for top oracle protocols Chainlink and Pyth have seen their tokens, LINK and PYTH, decrease 31.6% and 16.8% since the start of 2024, respectively. Similarly, the governance tokens for decentralized exchange Uniswap and lending platform Aave have both dropped more than 16.2%.

LDO, the governance token for the dominant liquid staking provider Lido, has fallen 63.0%, from $2.92 on Jan. 1 to $1.08 at presstime, while CRV, the cryptocurrency that governs popular venue to swap stablecoins Curve Finance, has declined about 50.9%.

Some DeFi tokens have bucked the trend, however. For example, MKR, the governance token for stablecoin issuer MakerDAO, and JTO, a different governance token for Solana’s leading liquid staking provider Jito, have both appreciated by about 24.8% so far in 2024. Leading the pack was AERO, the native token for Aerodrome, the largest decentralized exchange on Coinbase-incubated L2 Base, which skyrocketed by almost 1,300%.

DeFi’s Challenges

The overall weak price performance of DeFi tokens stems in part from the challenges for the tokenomic models of smart contract protocols. DeFi projects are still fine-tuning their mechanisms for distributing value to token holders.

DeFi protocols also face regulatory hurdles. “For DAOs with significant U.S. operations, risks may arise if the DAO has control over protocol revenue or intermediates the economic activity of the protocol and making such activity programmatic,” according to a16z Crypto in a report published last week. “Combining voting and economic rights may raise concerns under U.S. securities laws, particularly with simple and direct mechanisms like pro-rata distributions and token buy-and-burns.”

Meanwhile, the U.S. Securities and Exchange Commission has implied in a lawsuit against Ethereum software provider Consensys that Lido’s flagship product, stETH, is an unregistered security. A different lawsuit, initially filed last year in the US District Court for the Northern District of California, claims the protocol’s governance token, LDO, is also a security that hasn’t been registered with the SEC.

Others have pointed to the zero-sum relationship between DeFi and the ongoing memecoin frenzy, where resources such as attention and capital are split between the two.

DeFi bottoming out “would require the memecoin cycle coming to an end, which I’m not sure when it’s going to happen,” Paul Vaden, a core contributor for the Lyra Foundation tasked with developing derivatives trading platform Lyra, told Unchained in a text message. Pump.Fun, a platform that enables people to create and gamble memecoins, is the 8th highest-fee-generating crypto project in the past 30 days, amassing $28.57 million ahead of Aave, Maker, Aerodrome, and Curve Finance, data from DefiLlama shows.

Strong Fundamentals to Bounce Back?

According to the Alt Season Index, which tracks the percentage of the top 50 cryptocurrencies that outpaced BTC in the last 90 days, AAVE is the only DeFi token that has performed better.

“Despite the tokens of many DeFi projects underperforming BTC and ETH throughout 2024, the underlying fundamentals remained strong with resilient DeFi activity,” Toe Bautista, Research Analyst at crypto market maker GSR, told Unchained via email.

“For example, Q2 DEX volumes reached $520 billion, outstanding borrows hit yearly highs of $16 billion in July, and the cumulative stablecoin market cap increased 28% year-to-date. Moreover, DeFi has gained market share, with the DEX vs. CEX spot volume ratio hitting an all-time high of 14% in July.” Bautista added.

A number of DeFi protocols are also looking to revamp their tokenomics. MakerDAO is overhauling its ecosystem with its Endgame launch, and is expected to introduce a new stablecoin, governance token, and sub-DAOs among other changes.

Aave passed a snapshot governance vote ten days ago aimed at creating “a clear path and roadmap related to the protocol ‘fee switch,’” which is intended to increase the utility of Aave’s token by enabling it to collect rewards from the protocol’s revenue.

Curve Finance has also seen a reduction in its CRV emissions from an annual inflation rate of 20.37% to 6.34%, according to the protocol’s documents and X account. Per CoinGecko, CRV is the top gainer among DeFi tokens, growing 34.3% in the last seven days to trade at 30 cents.

“DeFi as the sector with the strongest product-market fit in crypto reached [a] 3-year low lately relative to global crypto market cap. I expect this to bottom out over the coming months and make a great comeback as we enter a new interest rate cycle,” wrote CEO and founder of venture firm DeFiance Capital Arthur Cheong on X.

On the other hand, “most DeFi tokens are never going back to all-time highs,” Lyra’s Vaden argued. “I’m not really sure when DeFi will bottom, a lot of it still looks unattractive.”

And yet Vaden and GSR’s Bautista pointed out DeFi’s reflexive behavior. “DeFi metrics are super reflexive,” says Vaden. ”As tokens start going up, metrics (volume/TVL/etc) go up and reinforce the narrative, so [there maybe a strong pump if ETH performs well.” In the same vein, Bautista noted that DeFi’s reflexive behavior suggests a potential upside if prices rebound.

Chris Eberle, a crypto angel investor, told Unchained over Telegram that “If there’s one thing I’ve learned in nearly eight years in crypto, [it’s that] you never know if the bottom is truly in at least not in terms of price, but in terms of DeFi’s current state vs its potential, I am incredibly bullish.”

“Every time there’s an outage in mainstream finance, like last week’s debacle with Schwab, Fidelity, and TD Ameritrade [temporarily halting trading on their platforms], DeFi looks appealing… So, no clue where the markets go from here, but the use cases for DeFi look stronger everyday.”

The price of ETH has jumped 8.5% in the last seven days and 15.4% year-to-date to trade at $2,715, giving it a market cap of $326 billion at presstime, per CoinGecko.