Don't Board the HYPE Train!
Decentralised Finance (DeFi) and Yield Farming have been the biggest and largest splash of this year in the Cryptocurrency World. However, like many things... by the time you hear of these things... it is way too late to board the train and you are more likely to be the last one holding the bags when the entire thing comes back down to a more reasonable valuation.
I had toyed around with the Decentralised systems last year, mostly on the liquidity provision side of things... with little forays with Uniswap, Compound, Dharma and Ampleforth... they are interesting systems, and the automated market maker based systems were a huge improvement over the DEXs that they were aiming to displace. Pure order book based DEXs suffered from slow times, uncertain slippage and most critically poor liquidity... in my eyes, they were dead in the water when they launched.
However, it was quite clear from the point of view of a small player... that these Defi platforms were definitely playgrounds for the whales and not really that impressive for a small player. So, I quickly lost interest (Haha...) in actively managing the liquidity provision and just left assets in the smart contracts to hoping accrue some interest over time. I became much more interested in the things that smart contracts would need to interact with the real world... such as oracles!
Now, as the yield farming craze has taken off... it is really gotten out of hand and I fear that many people will get burnt. It is an interesting game for the whales, but I am a little dubious about the long term sustainability for this sort of reward for liquidity provision.
My first worry is that people seem to have too much trust in smart contracts and computer code. Any quick look back into the short history of smart contracts reveals that they are just as prone to critical bugs and all of that unforeseen glitchiness as any other code. Just because they are public, open-source and on a blockchain doesn't change any of that... Locking up large amounts of liquidity onto these smart contracts carries quite some significant risk that I don't think people price accordingly in their race for quick money... after all, high short term interest gains are worthless if you lose the capital that you invested in the first place!
So, many of the new protocols for yield-farming are really rushed out to the public... slower moving protocols like Uniswap and Compound have stood the test of time (also not a guarantee...) and been audited (also not a guarantee...)... one high profile casualty has been YAM, which shot to the moon and equally spectacularly self-combusted.
My second worry is the actual use-case for which these liquidity mining tokens derive their value. They seem to fall into two categories... governance and future "community ownership". I'm not entirely sure that either of these categories are really sustainable at all, which lead me to think that the short-term skyrocketing valuations are a recipe for disaster!
Governance... is really a game for people who actually know what they are doing. There are many unforeseen consequences that can result from lots of people doing little things in their own "best" interest... which are often short term and with no eye for the future consequences on the ecosystem as a whole. Think about the current incentives of the real economy and the implications for resource consumption and environmental degradation.... not to mention the perverse rewarding of "rent-seeking" over real production. It is easy to think that those are the preferred choices of the elite few... but we have all been complicit in the game by selecting our own short term preferences over a long sighted view.
Community Ownership is also a highly problematic one... in which early "investors" (how I hate that word...) are rewarded with fees from later trading and usage of the protocol. This means that either fees will be higher (dis-incentivising the use of the protocol on the trading side...) or that the "reward" is taken from future liquidity providers (which dis-incentivises the liquidity providers...). Of course, there is a sweet spot where the usage is still large enough such that the future liquidity providers still flock to the biggest game in town... but with forks of protocols been relatively low in cost, and loyalty to protocol been thin... I don't see that as a stable situation.
Still... I could be wrong about this... but I fear that we are going to see some pretty spectacular flame-outs in the DeFi space pretty soon! A combination of rushed products, overwhelming greed and crazy hype is always a recipe for disaster!
Personally... I'm looking at interoperability... let's see where that takes us!
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