DeFi’s High Yields are Over
The recent crypto market downturn has cascaded down into DeFi. We’ve seen the collapse of protocols in the Terra network, as well as large asset managers that were active in different protocols becoming insolvent. These events have challenged DeFi’s entire value proposition, especially the value of yields.
Jesus Rodriguez comments in Coindesk that the total value locked in DeFi protocols has shrunk about 70% from its all-time high to $74 billion today and the native yields in DeFi protocols have contracted significantly. One of the areas most affected are what the folks in DeFi refer to as ‘Alpha’ (above-market returns). Risk management is another factor that needs attention.
The appeal of easy yields
Easy yields were an enticing feature of DeFi in its early days. As Rodriguez says, “An overleveraged environment for stablecoins as well as aggressive incentive programs enabled traders to capture astronomical yields.” However, those high yields have proved to be unsustainable, and there was also a lack of attention given to risk management mechanisms. As a result the DeFi ecosystem is now reviewing these with an eye to the future.
In traditional markets, risk and return is extensively studied. There are ‘alpha’ returns to be made, but you need a very sophisticated strategy and market knowledge to take advantage of them. There are also strong regulatory frameworks in place to ensure balance in risk conditions. The situation in DeFi is quite different.
A more balanced risk-reward structure
DeFi started out with a high risk-high reward environment. This was very appealing for those with strong appetites, and it sounded good to the less well-informed investor as well, and that proved to be a problem when the crypto market collapsed. What is happening now is that DeFi “is starting to alter the relationship between risks and returns in a trajectory that is closer to other financial markets.” What we are likely to see as DeFi evolves is that high yields powered by incentive programs will no longer be the norm; they will be the exception. Investors will need sophisticated strategies to achieve high returns, and risk management is predicted to be simplified as DeFi protocols and other components of the infrastructure enable native protection against known economic risks.
All this does not mean that DeFi will not be so appealing in the future: it is likely to be more appealing as it delivers a more mature economic structure.