How Bitcoin May See An Unexpected Boost From A DeFi Token Bubble Burst

Decentralized finance—better known as “DeFi”—has become a buzzword in the cryptocurrency industry over recent weeks. Migrating financial services to a decentralized platform has been viewed by many as a killer use case for cryptocurrency, specifically Ethereum.

Jon Jordan, communications director at DappRadar, said in an interview late last year: “DeFi certainly is the first category of dapps to attract significant amounts of value… Yes, DeFi is the first killer dapp category on Ethereum.”

According to data provider DeFiPulse, the cumulative value of tokens locked in DeFi applications has surged from $1 billion on Jun. 15 to $1.65 billion on Jun. 26—growth of 65% in eleven days.

Simultaneously, the prices of tokens related to this cryptocurrency sector have seen rapid growth.

Taha Zafar, a crypto analyst, shared the table below on Jun. 18, showing Bitcoin’s performance in comparison to DeFi tokens such as Aave (LEND), Kyber Network (KNC), and Maker (MKR).

The data indicates that while Bitcoin is up 80% in the past three months, DeFi tokens have done even better, registering performances in excess of 100% over that same time frame.

Although DeFi is still in vogue, analysts expect Bitcoin to experience a rally once this cryptocurrency market segment undergoes a necessary correction.

How DeFi Can Boost Bitcoin

After surging by over 150% from March’s lows, Bitcoin has stalled in the $9,000s. Since early May, the leading cryptocurrency has traded in a tight range from $8,500 to $10,000, barely deviating from these levels.

The chart below from crypto trader Josh Rager depicts Bitcoin’s lack of momentum.

It’s a much different story for DeFi tokens, which have strongly outperformed Bitcoin over recent weeks as shown in the table above.

Even today, on Jun. 26, CoinMarketCap reports that six out of the ten best-performing cryptocurrencies in the top 100, are DeFi focused.

Yet the higher these tokens rally, the more Bitcoin could gain once DeFi goes through a correction.

Kelvin Koh, a partner at cryptocurrency advisory and investment fund Spartan Group, observed on Jun. 9 that once “smaller altcoins” reach valuations that are deemed frothy by investors, Bitcoin will experience strong capital inflows. Referencing the strength of tokens such as MKR, LEND, and their contemporaries, Koh said:

“We have seen a major re-rating in many of the smaller altcoins (esp DeFi ones) in the past 4-5 weeks while BTC has been range bound. At some point, the valuation of these alts will start to look frothy and the capital will flow back to BTC.”

This comment was echoed by a pseudonymous Bitcoin trader, who said that Ethereum and Bitcoin could see a “small pump” when “it”—referencing the recent DeFi bubble—“all comes crashing down.”

This sentiment is based on the fact that most smaller altcoins trade against Bitcoin or Ethereum, not the U.S. dollar. That means that if traders want to realize the unrealized profits they made on altcoins, they will need to acquire either Bitcoin and/or Ethereum.

And with data site DeFi Market Cap indicating that the cumulative value of all DeFi tokens is now in excess of $6.5 billion, these tokens retracing even by 10-20% could correspond with millions of dollars worth of capital flowing into Bitcoin and Ethereum.

A Bubble Waiting To Pop

The growth of DeFi as of late can largely be attributed to two trends: support of blockchain-based finance projects by crypto exchange Coinbase and the launches of two new DeFi coins, Compound (COMP) and Balancer (BAL).

On Jun. 10, Coinbase revealed that it is looking into supporting 18 cryptocurrencies. Although the company does this every few months, this time, a sizable percentage of the tokens the exchange identified are DeFi centric. LEND, Bancor (BNT), COMP, Keep Network (KEEP), Ren (REN), and Synthetix (SNX), which were mentioned by Coinbase on Jun. 10, are either largely focused or entirely focused on enabling decentralized finance.

While the exchange is still evaluating whether or not the tokens should be added, the seven aforementioned coins have experienced rallies since the announcement. On the day of the announcement alone, some of the coins gained 10%.

These tokens are benefiting from what is colloquially known as the “Coinbase Effect,” whereas coins mentioned by the exchange temporarily boom as listings on Coinbase often lead to increased adoption.

Shortly after Coinbase gave DeFi that boost, Ethereum-based finance protocols Compound and Balancer publicly launched their respective native tokens, COMP and BAL, respectively.

These launch events generated hundreds of millions of dollars worth of value as speculators were quick to throw money at these tokens and their respective protocols.

A running theme through these two trends is that the growth of DeFi may not be sustainable.

Tokens listed or mentioned on Coinbase often retrace once hype dies down. Also, many expect the Compound and Balancer bubbles to eventually deflate.

Weiss Crypto Ratings, market research firm Weiss Ratings’ cryptocurrency division, wrote on DeFi’s “ludicrous” growth in relation to the rest of the industry:

“DeFi is one of the most exciting things going on in crypto right now, but the idea that sector will decouple from the rest of the market is ludicrous. Eventually, the mania will end, and DeFi will trade in line with the rest of the market.”

Yet when that correction takes place and how far this segment falls remains to be seen.

What’s Next For DeFi?

Stepping back, decentralized finance is facing down longer-term roadblocks that may worsen the upcoming correction should it ever arrive.

Multicoin Capital’s Kyle Samani recently argued that DeFi is facing down “invisible asymptotes” that are a byproduct of how Ethereum currently works. He opined:

“You just can’t build global scale trading systems for lots of users on POW chains. It just doesn’t work. High latency –> all kinds of negative second order effects. So I think for now we are near a plateau for DeFi – measured in ETH terms (not USD) – until the core latency problems are solved.”

This comment was made in reference to Ethereum’s ~13 second block times, which disallows blockchain developers from building decentralized applications that mimic Wall Street financial instruments and products.

Samani added that crypto also has issues with a lack of fiat on-ramps and high transaction fees, which slow adoption.

Analysts expect Ethereum’s budding DeFi sector to correct as valuations become overvalued and users face latency problems; in turn, Bitcoin and Ethereum may rally as capital from those overvalued altcoins returns to the crypto sector’s “reserve assets.”