The total value locked in decentralized finance (DeFi) projects hovers around $62 billion in mid-August, down from a peak of over $250 billion in December 2021. Capital is fleeing the crypto space amid war, soaring inflation and all the other surprises 2022 may still have in store for us.
However, unlike previous crypto bull runs, it was not just retailer interest that attracted this capital in the first place. On the contrary, major institutional players, who have recently opened up to crypto, have quickly developed an appetite for the returns that DeFi is known for. But now that winter is upon us, the pitfalls of high yield rigs have become more apparent.
Value can’t come out of nowhere
In a sense, value is always somewhat subjective, defined by personal considerations and goals. A photo from a family collection means more to a member of that family than to a random stranger. Accordingly, a farmer would be quite willing to pay for a shipment of seeds, as these are crucial to his business, but a city dweller would probably prefer to pay for the final product.
Yet even the simple examples above show how value is often based on real circumstances and processes. In the case of the farmer, it is also quite quantifiable, thanks to the free market which brings together entire industries, governments and consumers in a sophisticated and – more or less – functional system. Definite value in money creates definite value in output, whether in crops or fruits, and the great cycle of economic life continues as these commodities work their way through the marketplace.
“Yield” is a word dear to the blockchain industry, especially its DeFi sector, which has seen its total value locked lose billions of dollars since May amid the ongoing bear race. Still a largely nascent industry, crypto as a whole isn’t as exposed to the real-world economy, especially when it comes to anything beyond speculative trading. And as lucrative as DeFi returns may seem, the question is always where they come from.
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The sad story of Anchor’s demise is a perfect example of how the business models behind DeFi protocols can be unsustainable. Its nearly 20% returns officially came from on-chain loans, but it received a cash injection to keep it operating – a clear sign that loans were not enough to sustain returns. Considering the importance of Anchor as a pull factor for the entire Terra blockchain, you can attribute its questionable returns to the downfall of the entire ecosystem.
Equally telling is the fact that on-chain lending tends to remain on-chain within the largely siloed blockchain ecosystem. An on-chain protocol can only lend you an on-chain token, and as we know, on-chain assets are not very integrated into the real-world economy. So whether you seek an arbitrage opportunity or stake your loan in another yield protocol, your loan – as opposed to traditional financial loans – creates little real value. And healthy returns never come out of nowhere.
There is life off the chain
This lack of real value to support returns and overall supply is a major Achilles heel for the crypto scene. Many have compared Bitcoin (BTC) to digital gold, but gold has use cases besides staying in a bank vault, from the jewelry industry to electronics. And while it may never duplicate Bitcoin’s savage shot for the moon, its use cases will keep gold afloat even when its inflation hedge veneer wears off.
The crypto space must seek to abandon its internal baseball mentality and look beyond on-chain activities to seek to establish a greater presence in the real-world economy and processes. The blockchain industry needs to experiment with use cases aimed at competing with financial and other services in traditional markets in addition to advancing the blockchain space as such.
Some of the biggest names in the DeFi space have seen the writing on the wall before. DeFi titans are already seeking exposure to real-world assets, shifting to a business model with a clearer risk-reward and healthier returns produced by business-to-business lending. The entire blockchain industry should follow this direction.
Related: Do Kwon allegedly hired lawyers in South Korea to prepare Terra investigation
This quest for real use cases should go beyond the basic financial services set. It is expected to power a wide range of services, from decentralized data storage and identity solutions to the Internet of Things and mobility applications. The world of machines is a particularly interesting use case, as machines running 24/7 present a great source of liquidity through real value. This liquidity could unlock a whole range of new DeFi business models and provide an opportunity for some of the existing protocols to transition to healthier yields.
The days of unfettered returns aiming for the moon may be over, but there are plenty of real interest-generating activities waiting to be chained. All offer more familiar business models, allowing projects to increase their risk management payoff while providing investors with returns based on real tangible results. Blockchain adoption should go beyond simply exchanging Bitcoin from your bank account – it’s a process that can and should transform entire industries and business models.
By carving out a presence in several industries and sectors of the real economy, the blockchain space has more than just healthier returns to gain. In the long run, and with enough effort and polish, it’s ultimately about turning the dream of Web3 into a self-fulfilling prophecy. A blockchain-based internet must start with a slew of decentralized apps and services slowly but surely taking over their centralized competitors, and the bear market at hand is just the time to start building them.
Till Wendler is co-founder of peaq. He previously worked as COO at Advanced Blockchain AG between 2017 and 2020 and also served as CEO of Axiomity AG, a blockchain services company.
The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.