Posted 8 months ago | by Ben Armstrong
DeFi is Blasting Higher – is the Market for New Ideas Overbought?
Investors must be making some serious money in the DeFi space.
According to some estimates more than $7 billion is locked up in the most popular DeFi platforms, which is an increase of 1,000% since the beginning of the year.
It should come as no surprise that the value of DeFi tokens are also blasting into bubble territory. Many of them have risen by more than 10 times so far this year, which is far higher than any of the major tokens.
The real question that arises is one of relative value. Specifically – can these projects keep building on their on-market success?
As exchanges add new tokens, as well as create new tradable products to track the DeFi space, there exists the chance that a DeFi bubble could grow to portfolio-shattering proportions.
No one likes to hear that the part may end, but if you have been making piles of money in DeFi this year, it might be time to start locking in the gains.
DeFi isn't a Mature Market
Much like the Bitcoin ecosystem wasn't especially developed when the 2017 rally hit, the DeFi market of 2020 is still pretty green. This Op-Ed isn't a knock on DeFi, far from it. We think that the DeFi products that are getting love today are great – it's just that some of these valuations might be a little bit extended.
Traders love a growth story, and when that narrative leads to doubling a position in a month or less, it is easy to see why markets might be bidding up tokens that aren't going to be able to hang at their current levels on a sustainable basis.
There are also a LOT of new tokens that are entering the marketplace. Platforms like ChainLink and Polkadot have great teams behind them, but it would be impossible for all the platforms that are rising in price to be winners in the long term. Start-ups work the same way – just how businesses grow (or fail).
Exchanges Are Opening the Door to More Speculation
Many of the major exchanges are listing new tokens that have a connection to the DeFi space as a result of this year's incredible rally in the sector. The mentality behind this isn't difficult to understand, but it may lead to a market where speculators are buying new names based on hopes of big returns – much like what happened in 2017.
From the perspective of an exchange, adding new tokens is a great idea. People want to jump on these tokens, and there is a lot of money to be made from fees. In addition, there is competition to think about. If new tokens aren't listed, an exchange will lose active traders – not a great idea.
Unlike 2017 with its massive crop of scam ICOs, the DeFi boom isn't as likely to have the same level of scammyness. A company may not make it in the long run, but there probably is value to be had in many of these companies – at what price level is the big question.
Crossing the Line Into Securitization
Innovation in the crypto sphere is amazing. Major exchanges are not only listing new tokens, they are also creating derivatives that track different aspects of the DeFi space. This sort of arrangement isn't possible in the older markets, and it opens up some risks to both the exchanges and traders.
When an exchange becomes the issuing authority for a derivative that is based on a wide range of assets that it also trades, the counterparty risk that it acquires is magnified. In essence, the exchange is taking on a massive short position that may or may not be able to be offset in the markets.
Said simply, depending on how big a DeFi market derivative issuance is – and how hard the market rallies, the chance exists for an exchange to come up without the needed funds to monetize a mass exodus from the contract.
Exchanges are likely able to offset some of this risk – but if many of the larger exchanges are effectively short the DeFi market as a whole (sold it long to the traders), plugging that hole via short sales or offsetting derivatives positions within the marketplace could prove very tricky if traders decide to lock in gains, and exist their positions quickly.
Don't Panic – But Don't be Too Greedy
Bull markets end in euphoria, and the DeFi space may be getting to that phase.
ChainLink is up more than 700% over the past 12 months, and one look at that chart would make many portfolio managers rush to sell down their holdings.
Is it the end of the DeFi boom (at least in terms of massive price gains) – we simply don't know.
If you are sitting on some big winners, it might be a good idea to sell a little off, and wait to see what happens next.