Decentralized finance (DeFi) has been one of the fastest-growing sectors in the crypto space since its emergence in 2018. However, like many other sectors, DeFi has seen a negative impact in the current bear market.
While 2022’s downturn has taken its toll on many DeFi projects — and the cryptocurrency space in general — some continue to build.
Bear markets, while difficult for investors, can spark game-changing breakthroughs in the industry, and a new era of creativity seems inevitable if past events are any indication.
This leads to the question: Which protocols will usher in DeFi’s next generation of technological advancement, and which won’t?
The fable of the ant and the grasshopper may give some indication.
While the ants are busy storing food for the winter, the grasshopper is busy playing his fiddle and singing away the summer. Finally, when winter arrives, the grasshopper goes to the ants for help because he is freezing and hungry. Unfortunately, the ants don’t want to help him and tell him that he should have spent his time getting ready for winter instead of wasting it on other things, so he’s on his own now.
The moral of the story is that it pays off to make diligent use of one’s time in order to prepare for the future.
Similarly, many projects that fueled the euphoria that led up to the present market downturn did not significantly advance the underlying technology of DeFi. They employed over-leveraged tokenomics to concentrate on cash flow creation instead.
So, it seems reasonable to think that the protocols focused on hype and profit are the most likely to fail during a bear market, while projects focusing on creating real user value are more likely to survive.
John Patrick Mullin, co-founder of SOMA.finance — a decentralized marketplace for digital assets and compliant digital securities — told Cointelegraph:
"Many founders of DeFi projects seem to focus on riding the hype train and doing more of what has already worked to earn a quick buck. However, I believe that what the space and its users actually need to flourish, regardless of the market situation, is more foresight and innovation from industry leaders."
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While it’s clear that some projects in the space seem to be driven mainly by profit, some believe that there are more sustainable-minded founders.
Linh Han, CEO of Hectagon — a DAO-based investing platform — told Cointelegraph, “The pressure and characteristics of the market force project to achieve short gain. In addition, it also makes founders have to compromise more. However, founders in the DeFi space are not short-sighted. Truly, no one who comes to crypto space to build this early is short-sighted.”
A portion of the DeFi sector, most notably the lending market, has shown its ability to weather the ups and downs experienced by the industry overall. The aggregate quantity of loans created demonstrates that there is still a substantial demand for these DeFi protocols.
Despite the current market conditions, DeFi lending platforms continued to grow in user engagement. According to data from DefiLlama, the amount of money locked into DeFi platforms rose over 500% since last year.
In addition, Aurora — an Ethereum Virtual Machine-compatible network on the Near Protocol — launched a $90 million fund to support DeFi apps on the network. This will help developers to continue building within DeFi, potentially bringing new platforms into the space.
Aurigami, a liquidity and lending protocol on Aurora, raised $12 million to help them build out their platform during the current market conditions. The platform currently has the highest TVL on Aurora, and they conducted a risk analysis and simulation of worst-case scenarios for the protocol.
Building during a bear market enables platforms to gain loyal users and set a foundation for themselves before the next bull market. However, there have been some negatives during this period too.
For example, the Terra blockchain ecosystem collapsed earlier this year, dropping over 80% and leading to over $40 billion in investor losses. During a previous interview with Cointelegraph, Mike McGlone, a senior commodity strategist at Bloomberg, said that Terra’s collapse was part of a natural purge in the crypto space that occurs in every bear market.
This leads back to the point about some protocols being unprepared to deal with market downturns, especially when large, coordinated sell-offs have been suspected as one of the causes behind Terra Classic — formerly Terra — and its stablecoin, TerraUSD (USTC), collapsing.
Bear markets can help legitimate projects that continue to build and innovate stand out, while hype-based projects slow down or fail. Mullin agrees with this viewpoint, telling Cointelegraph:
“Bear markets tend to weed out the weaker projects and founders looking for a quick buck. If projects are to not just survive but also thrive during the bear market, they have no other options than to innovate and create real value to the space and its community.”
Lucas Huang, co-founder of Aurigami, told Cointelegraph, “The market has always been cyclical in nature, and no matter the circumstances, there’ll be opportunities to capitalize on. This market slowdown serves as a chance for platforms to build, refine, and innovate — all without the excitement and distractions of a bull market.” Huang continued:
“Experienced investors will always find value no matter the market conditions, and we see this bear market as simply a shift in user behavior. Does the bear market have a negative effect on DeFi platforms? Of course. But DeFi is dynamic enough to provide utility in both bull and bear; the question is, what can you do to capitalize on it?”
Projects that continue to build during bear markets can also gain long-term users who are more likely to stick around, instead of the fair-weather investors who only show up during the bull markets.
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The bear market is a great time for new technology to come into the crypto space. Indeed, some great innovations have emerged from crypto winters. For example, Ethereum had its token sale in the bear market of 2014, while the decentralized swap platform Uniswap was deployed on Ethereum in the bear market of 2018.
Milana Valmont, founder and CEO of KIRA — a decentralized network for hosting DeFi applications — told Cointelegraph:
“The best innovations happen during a bear market because teams are head deep in developing revolutionary technology. Standards are high during the bear market, so new ideas are tested under pressure and not kept alive by bull market liquidity. Innovation during a bear market is exactly how the renaissance period came to fruition.”
Vid Gradišar, CEO of NewsCrypto.io — a social and educational crypto platform — told Cointelegraph that the bear market is like a “self-care routine” for the cryptocurrency space, in that “the excessive noise of unsustainable business models is silenced, giving everyone the opportunity (and the need) to focus on what counts in the long term.”
“Some of the best innovations in crypto happen in bear markets, but when you look behind the scenes, this shouldn’t come as a surprise. In a bull market, incentives are often skewed towards unsustainable business models. At the same time, those that want to build something truly long-term are more attracted to the relative calm and rationality that comes with a lack of excessive mainstream interest in crypto.”