Is Ethereum’s DeFi Boom Setting Itself Up For DeFi Bust?

Ethereum isn’t all about decentralized finance…but it’s darn close to it. Last month, Ethereum’s founder Vitalik Buterin warned that DeFi may be becoming too much of a gambler’s den — with derivative on top of derivative, trying to capture yield, and not much else.

“Ethereum has to expand beyond just trading tokens and helping to create other tokens,” he said, standing thin in a brown T-shirt and blue jean shorts at the EthCC [4] conference on July 20-22 in Paris. “If you just take DeFi and push it into infinity, you’re just going to get tokens that give you profit from yield farming, and prediction markets on top of yield tokens,” he warned. “That’s good up to layer two, but once you start getting up to layer six you’re setting yourself up for a collapse and potentially getting a lot of regulators angry.”

Buterin’s mid-summer presentation at EthCC 4 shed light on the goal for Ethereum projects to be incentive-oriented and serve more as a public good rather than just being used to tokenize derivatives on top of tokens. He essentially described that type of DeFi as not any different than another financial instruments, questioning the need for them if there was no real public good — namely, allowing for a decentralized financial system to take true shape and function beyond the existing centralized one.

Layer 6 is when new tokens built on Ethereum’s network become concentrated as financial derivatives that serve no other purpose other than as another liquidity avenue for other tokens that are also financial derivatives. 

“The risk here is an imminent collapse of the Defi system, where we’re seeing an influx of new tokens being built merely for the sake of trading them without adding any utility,” says A On, founder of Everest Coin, a Play-to-Earn GameFi platform launching on Binance Smart Chain’s BEP20 platform this month.

For Buterin, the current DeFi system is basically creating a bunch of tokenized derivatives on top of tokens to generate yield and sell yield. It was all fine at Layers 1 and 2, but the higher up it goes, it invites the scrutiny of regulators.

“Regulation of the DeFi segment is inevitable anyway,” says Igor Dyachenko, co-Founder & CEO Studyum, a blockchain-built education platform for students and educators that actually incentivizes learning by using NFTs as reward payments for studying.

Dyachenko thinks that DeFi will be scrutinized closer before the casino blows up. And regulation, of course, is no guarantee that it won’t.

“The regulation is most likely to target the administrators of the protocols. Because layers upon blockchains are somewhat centralized, the operator of the validators can be somewhat accurately targeted for regulatory action on the protocol level,” he says.

Iron Finance comes to mind as a blow up. Once worth billions, your used car is now worth more.

“There are plenty of high risk, high yield protocols that offer little added value in the market,” says Dyachenko. “Most of these platforms are copycats of existing innovations, so there’s little risk to someone who has done their homework as to which are the original movers and shakers, and which aren’t. Just like with the altcoin markets in previous years, fundamental research and reading the whitepaper, studying the team and measuring product-market fit are important aspects before making the choice to invest.”

This makes perfect sense, actually. The entire crypto market is building yet another market: the crypto analyst working for the investment firm selling crypto assets to investors.

They surely have their hands full.

“I call the dark side of the moon on some of these DeFi projects. Regardless of audits, we face the real fact that they are deregulated, which means what happens if something goes wrong? Who will protect you?” asks Alejandro Estrada, CEO and Founder of Synthesis Bank Company, a crypto investment bank located in the Cayman Islands. “If you don’t do good homework, smart contracts may become a nightmare for you.”

Buterin didn’t spend all of his time lamenting DeFi and telling the crowd how Ethereum plans to scale up. A lot of DeFi players are looking for alternatives as Ethereum becomes an increasingly expensive place to operate.

But Buterin, in this regard, seems confident that Ethereum will survive, talking up the tech side of things, a subject I reserve for the true tech nerds out there.

As for investors in Ethereum, and the big DeFi coins, Buterin doesn’t want to be the playground for derivatives traders and yield farmers necessarily. He wants functionality, not just a way to move traditional, old school futures traders to the blockchain. And he wants to do other things, beyond DeFi.

“It’d be interesting to see Ethereum move beyond a Defi ecosystem,” says Everest’s On. “Ethereum is still the single most important infrastructure the Defi world has seen, and if any entity is ready to move Defi beyond price, I think it is Ethereum,” he says.

Buterin agrees.

“Moving beyond DeFi is not about being against DeFi,” he says. “It’s best to combine elements of finance and non-finance. We have been wanting to go beyond that and you see that now in some successful DeFi projects,” he named a few names, including Uniswap (UNI). “Defi is not all that Ethereum was designed to do. Centralized finance has problems, but centralized other things also have problems. Can we go beyond finance and start building the other tings we have wanted to decentralize?” he asked.

Still, one shouldn’t take Buterin’s speech as being entirely bearish on DeFi. Maybe a pause in the exuberance?

“Ethereum will continue to outperform Bitcoin in 2021 and will, ultimately, exceed Bitcoin’s value,” says Nigel Green, one of the growing group of traditional investment house CEOs now putting client money into crypto. Green is the founder of the deVere Group out of London. “Ethereum is outperforming Bitcoin and will continue this trend for the rest of 2021.”