Is There A Silver Lining in DeFi Yield Inversion?

According to experts, DeFi lending’s current operation is mostly limited to supporting leverage for shorter-term, speculative trading.

The DeFi space has experienced a significant decrease as the market continues to be pummeled as a result of Celsius’ liquidity crisis and this week’s butterfly effect. The capacity to create low-risk income in DeFi has decreased, resulting in a liquidity drain that has impacted stablecoin interest rates in the lending market.

As of Tuesday at 6 a.m. ET, USD Coin (USDC) interest rates on the money market protocol Aave were 0.76% and on Compound were 0.24%, both lower than the latest 1.18% yield on a four-week Treasury bill, reversing the trend from the bull market.

“Some people called it a utopian virtuous cycle. Others just called it greed,” analyst Ben Giovo wrote in Bankless’ newsletter. “The thing is: reflexivity cuts both ways.”

As prices plummeted, on-chain activity decreased, making capital deployment in DeFi less appealing due to lower returns, he explained in the essay.

The market value of the top four stablecoins plunged by roughly $7 billion in May as investors sought to cash in their tokens. After all, why assume the risk of holding stablecoins at all if there’s no way to earn a safe dividend higher than the risk-free rate?

Giovo, on the other hand, was unconcerned, claiming that “DeFi lenders are intersecting with meatspace businesses to get this jack out of its box.”

Dustin Teander, a Messari research analyst, agreed, believing that the lower deposit rates compared to traditional markets are attributable to a smaller serviceable market rather than a protocol structural flaw.

“At its present state, the business of DeFi lending is largely limited to funding shorter-term, speculative trading leverage,” 

Borrowers were willing to pay a premium for leverage during a bull market. Deleveraging, on the other hand, is now the norm.

“As we have seen prices decline, the demand for leverage and borrowing has significantly pulled back, ultimately lowering deposit rates in the process.”

With the extension of serviceable markets, Teander believes that DeFi rates will “come closer to being in-line, if not above, traditional markets” in the future. MakerDAO’s real-world-asset lending and Aave’s Arc protocol, for example, have already developed loan firms that are more connected with traditional markets.

“Over time, this will allow DeFi deposit rates to evolve away from being solely driven by speculative trading demand and toward being more commerce-driven, as seen in traditional markets,” he said.

DISCLAIMER: The Information on this website is provided as general market commentary and does not constitute investment advice. We encourage you to do your own research before investing.

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Patrick

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