Decentralised Finance in Distress

With decreased activity across exchange and lending applications, along with lowering prices across governance tokens, Decentralised Finance (DeFi) yields are primed for correction.

The estimated annualised rates displayed throughout the DeFi ecosystem are often a reflection of (1) the fees users pay for accessing the financial services offered by an application (i.e exchange, lending, asset management, etc.), and (2) the value of any governance tokens paid as an extra incentive.

Yields in recent history have perhaps been unusually high with droves of new users experimenting with the functionality and service offerings of the DeFi space, resulting in protocols accruing a continuous stream of fees as revenue. This comes in parallel with many DeFi projects having allocated large swaths of governance tokens to be rewarded alongside these fees, further encouraging users to support the bootstrapping phase of a project as well as distribute ownership to early adopters.

In a period of less speculation however, trading volumes and loan activity are likely to decrease and the dollar value of governance token rewards are likely to fall, pushing DeFi yields down along with them. This could potentially damage the earnings strategies of certain investors in the DeFi industry, especially those sometimes referred to as “yield farmers” and “liquidity miners”, who tend to deploy capital based on the highest yielding applications at any given time.

Also in these less speculative periods, developers will likely need to be more creative to attract demand from investors for their governance tokens, especially projects with highly inflationary supply schedules, and those that prioritise allocating protocol revenue to a treasury rather than its token holders. It is too early to tell which design mechanisms are most effective to deliver value to investors, however, we suspect governance tokens without any means to accumulate cash flows are unlikely to capture the growth of their accompanying applications beyond speculation.

Disclosure

The information contained in this document is for general information only. Nothing in this document should be interpreted as constituting an offer of (or any solicitation in connection with) any investment products or services by any member of the CoinShares Group where it may be illegal to do so. Access to any investment products or services of the CoinShares Group is in all cases subject to the applicable laws and regulations relating thereto.

This document is directed at professional and institutional investors. Investments may go up or down in value and you may lose some or all of the amount invested. Past performance is not necessarily a guide to future performance. This document contains historical data. Historical performance is not an indication of future performance and investments may go up and down in value. You cannot invest directly in an index. Fees and expenses have not been included.

Although produced with reasonable care and skill, no representation should be taken as having been given that this document is an exhaustive analysis of all of the considerations which its subject-matter may give rise to.This document fairly represents the opinions and sentiments of CoinShares, as at the date of its issuance but it should be noted that such opinions and sentiments may be revised from time to time, for example in light of experience and further developments, and this document may not necessarily be updated to reflect the same.

The information presented in this document has been developed internally and / or obtained from sources believed to be reliable; however, CoinShares does not guarantee the accuracy, adequacy or completeness of such information. Predictions, opinions and other information contained in this document are subject to change continually and without notice of any kind and may no longer be true after the date indicated. Third party data providers make no warranties or representation of any kind in relation to the use of any of their data in this document. CoinShares does not accept any liability whatsoever for any direct, indirect or consequential loss arising from any use of this document or its contents.

Any forward-looking statements speak only as of the date they are made, and CoinShares assumes no duty to, and does not undertake, to update forward-looking statements. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Nothing within this document constitutes (or should be construed as being) investment, legal, tax or other advice. This document should not be used as the basis for any investment decision(s) which a reader thereof may be considering. Any potential investor in digital assets, even if experienced and affluent, is strongly recommended to seek independent financial advice upon the merits of the same in the context of their own unique circumstances.

This document is directed at, and only made available to, professional clients and eligible counterparties. For UK investors: CoinShares Capital Markets (UK) Limited is an appointed representative of Strata Global Limited which is authorised and regulated by the Financial Conduct Authority (FRN 563834). The address of CoinShares Capital Markets (UK) Limited is 82 Baker Street, London, W1U 6TE. For EU investors: Napoleon AM (napoleon-am.com) is a French asset management company regulated by the Autorité des Marchés Financiers (AMF), registered under number GP-19000015 since 27/03/2019. Its office is located at 11 rue Paul Lelong, 75002 Paris, France.

The CoinShares Astronaut is a trademark and service mark of CoinShares (Holdings) Limited.

Copyright © 2022 CoinShares. All rights reserved.