DeFi risk-reward remains out of whack, TVL continues to dip

Key Takeaways

• The total value locked in DeFi is close to levels last seen in March 2021 
• Ethereum is a commanding leader with 57% of the market share, but the overall market has shrunk drastically
• Sky-high yields proved unsustainable, while trad-fi interest rates have risen sharply, with investors reallocating capital as a result
• The reputational damage of crypto could also be hurting the sector

The total value locked in DeFi continues to sink, currently close to levels last seen in March 2021. From peaking in November 2021 at nearly $180 billion, it has fallen 80% to $37 billion. 

The stark dropoff last year comes as no surprise. Cryptocurrency as a whole was decimated – the Terra crisis alone in May 2022 is evident on the above chart as causing a massive drawdown. Beyond that, token prices collapsed, and hence TVL has come down drastically.

Yet, thus far in 2023, crypto prices have rebounded strongly. However, by repurposing the previous chart by now zooming on 2023, we can see that TVL has failed to rise.

Digging into the different blockchains, Ethereum remains the commanding market leader. It holds 57% of TVL across the space, with Tron a distant second with 13.9%. BNB Chain, launched by the embattled Binance, is third with 7.8%, with all other chains below 5%. 

Bearing in mind that Ethereum holds such a commanding lead in the space, we can dig into its TVL trend to see that the dropoff is not solely a result of falling token prices. 

For this, in the next chart we present the TVL both denominated in dollars and ETH. While dollar-denominated TVL is what we have focused on thus far in this piece, it is obviously affected by virtue of the fact that much of the TVL is held in crypto rather than fiat. Yet if we analyse the TVL in terms of ETH, which is down 55% since the start of 2022, we see that it is also down substantially. 

If we focus on 2023, we see that the TVL in terms of ETH has fallen less than in dollars, which makes sense given the converse has happened; the denominator has become larger (i.e. ETH has increased, up 35% this year). 

Therefore, the decline is not solely a result of falling prices. In reality, the entire crypto ecosystem is still seeing suppressed volume, liquidity and overall interest. DeFi’s momentum has also slowed, not helped by the fact that the sky-high yields which drew so many to the space during the pandemic have proved to be unsustainable (granted, this is mainly to do with elevated token prices).  

In conjunction with this last point, trad-fi yields have gone the opposite way – steeply up. T-bills are the safest investment in the world, guaranteed by the US government, and they now pay more than 5%. The decision about where to allocate one’s capital in this environment is vastly different to the same proposition when interest rates were at 0%. 

With a slew of ETF applications coming online in recent months, there is optimism that crypto could soon turn a corner. Exacerbating this is the expectation that, finally, we may be approaching the end of the tightening cycle. 

If/when the reversal comes, DeFi will be in a stronger position to persuade capital to return. The reality is that, right now, with interest rates above 5% and DeFi yields coming down so sharply, the risk-reward ratio is just not where it needs to be for prospective investors.

Moreover, the reputational damage sustained by crypto (even if that was unfair on DeFi, which some would even argue presented its true worth in comparison to CeFi firms like Celsius and BlockFi), may have dented its progress further again.

Times will change, but the capital outflow from DeFi is not surprising in this context.