Bitcoin is on a tear. But it’s shooting well beyond that $100,000 ceiling, driven by a perfect storm of causes. While Bitcoin enjoys a bullish eye this time around, the Decentralized Finance (DeFi) space appears to be the one left in the shade. This divergence raises a critical question: Why isn't DeFi fully capitalizing on Bitcoin's success? BlockTraderHub.com looks forward to digging into why this gap exists. We’ll be sharing our predictions about the future of both markets.
Bitcoin's Bullish Run: What's Driving the Surge?
This recent price surge of Bitcoin isn’t a bubble or a speculative spike. There have been a few foundational trends that have coincided to deliver a perfect storm of bullish momentum. Understanding these three factors are key to understanding exactly why Bitcoin is currently crushing all other sectors of the crypto space.
Accumulation by Long-Term Holders
We believe one of the strongest signals of Bitcoin’s strength and something we didn’t see in previous bull cycles is long-term holders’ return to accumulation. These investors are long-term holders of Bitcoin. Their long-term commitment often sends the signal that they have real confidence in the asset’s long-term prospects. When long-term holders start accumulating, it suggests they believe the price will continue to rise, further fueling the upward trend.
Growing Institutional Confidence
Bitcoin Exchange Traded Funds (ETFs) have changed the face of money. They provide a way for institutional investors to get exposure to Bitcoin without needing to buy or hold the asset themselves. These ETFs through massive, rapid capital inflows can attract hundreds of millions of dollars of new capital at a time. This increase demonstrates how institutions are growing more confident in Bitcoin’s legitimacy as an asset class. This institutional adoption is a significant force behind Bitcoin’s remarkable price growth.
Macroeconomic Factors
Here are some macroeconomic reasons that are fueling Bitcoin’s bullish momentum. The decline in the US dollar strength index (DXY) makes Bitcoin, which is often seen as an alternative to the dollar, more attractive. The expectation of forthcoming rate cuts by the Federal Reserve is providing a massive shot of liquidity to markets. Consequently, the dollar value of Bitcoin and other risk assets is at increasingly higher values. This makes market sentiment more positive, which is good for Bitcoin, with easing trade tensions (Donald Trump, let’s negotiate!)
DeFi's Struggles: Why the Underperformance?
As Bitcoin is moving up significantly, the DeFi market is having a bit of a bearish storm. Contrary to the crypto market’s general positive and optimistic sentiment, DeFi has not seen similar growth and excitement. Much to blame, there are a number of reasons for this underperformance, from security issues to the underlying weaknesses of some DeFi ventures.
Scams and Security Risks
This is mainly due to the DeFi space being riddled with scams and security breaches, destroying investor confidence. In 2021, DeFi scams took more than $10 billion. That astounding number has been revealed in a recent case study by Elliptic, a blockchain analytics company. These events further serve as a reminder of the substantial risks in investing in unaudited or poorly designed DeFi protocols. The looming perception of hacks and exploits leaves investors hesitant to place a large amount of capital towards the DeFi space.
Lack of Decentralization and Utility
One big criticism of these DeFi projects is that many of them are not actually decentralized. Whether one speaks with forked tongue, they are often under the control of a very small group of individuals or companies, leading to increased centralization and risks of manipulation. Many DeFi projects have been sued or otherwise accused of being unregistered securities. Critics point out that they typically lie or mislead about their decentralization and value. This lack of true utility and transparency is a double whammy as investor confidence continues to be eroded.
Risky Business Models
The explosive expansion of stablecoins, the bedrock of the DeFi ecosystem, has caused alarm. While many stablecoins are fully backed by traditional assets, such as the US dollar, others are backed through crypto-collateralization and incentive structures. Instead, crypto-collateralized stablecoins like Liquity and Zero rely on algorithms and economic incentives to maintain their dollar-pegged value. Yet, they are riskier than conventional stablecoins. If the value of that collateral drops suddenly, these stablecoins can break their peg. This has led to billions of dollars in investor losses.
NFT Market Collapse
During its peak, the NFT market was one of the largest motivators of volume and excitement within the DeFi ecosystem. NFT volumes and prices have plummeted over 99% from highs a year ago. This decline may indicate a loss of interest in DeFi, as many early DeFi projects were closely linked to the NFT market. The decreasing demand for NFTs has impacted the entire DeFi environment, dragging its performance.
High Risk of Loss
The inherent risks that come with DeFi investments pose a major obstacle for investors. Making profits of 1000% returns sound super attractive having basically experiencing a 100% loss in a DeFi project being a very real concern. This risk isn’t limited to the winter months. This risk compounds from year to year and makes most investors shy away. They would rather deploy that capital into Bitcoin which they see as a more stable store of value with more long-term growth potential.
The Interplay Between Bitcoin and DeFi
Bitcoin and DeFi are not mutually exclusive. Bitcoin’s explosive growth has brought sudden attention to DeFi. These two sectors are intimately linked in a variety of ways.
Bitcoin's Influence on DeFi Adoption
Bitcoin is still the on-ramp for most people heading into the crypto ecosystem. Like most crypto users, most people will learn about Bitcoin before reading up on other digital assets like DeFi projects. As Bitcoin's popularity grows, it naturally leads to increased awareness and adoption of DeFi. Thus, Bitcoin’s overall success can indirectly help to grow and sustain the DeFi sector by attracting new users and capital.
Correlation and Market Sentiment
There is a very high cross-correlation between Bitcoin and altcoins, even those that are heavily used in DeFi projects. A significant drop in Bitcoin can result in a cascading market sell-off, which may devastate altcoins just as easily. A vigorous Bitcoin market can buoy the whole crypto ecosystem along with it, which would include DeFi. The recent divergence further demonstrates that DeFi has failed to benefit from Bitcoin’s bullish momentum. This is an early sign that there are deeper problems in the DeFi industry.
Bitcoin DeFi: A Nascent Ecosystem
Now, the unexpected arrival of Bitcoin DeFi has unlocked a new frontier on this strange crypto planet. Now, developers are working to bring DeFi functionalities to the Bitcoin network. Their mission is to create new avenues and possibilities for Bitcoin users and holders. In reality, the novel Bitcoin DeFi ecosystem is still nascent, and it houses a multitude of challenges.
Conflicting Signals in Bitcoin DeFi
The state of the Bitcoin DeFi ecosystem is sending mixed signals, revealing both opportunity and risk. By analyzing key metrics, we can develop a better understanding of the current state of Bitcoin DeFi and where it’s headed.
TVL Decline
Perhaps the most alarming sign is the drop in Total Value Locked (TVL) in Bitcoin DeFi. USD-denominated TVL has fallen 20% to $179.9 million, while Bitcoin-denominated USD TVL has decreased 7.2%. This drop signals a loss in confidence and that capital is fleeing Bitcoin DeFi. Perhaps worries about risk and perhaps a lack of attractive investment opportunities are pushing this change.
User Activity Slowdown
User activity on Rootstock, the most popular Bitcoin-based DeFi platform, has begun to decline. Active addresses are down 26.5%, and new addresses are down 54.7%. Although daily transactions are up slightly – only 4.3% – the overall trend paints a picture of waning user engagement, adoption and overall growth.
Market Dominance
Bitcoin’s market dominance has recently soared past 60%, reflecting a more bullish sentiment overall towards BTC. The market dynamics for DeFi are highly fragmented, where no one stablecoin has more than a ~30% market share on Rootstock. This fragmentation illustrates an absence of clear leadership within the Bitcoin DeFi ecosystem. It pretty clearly lays out the case for the dire need of stronger, more resilient, and more dependable projects.
The Future of Bitcoin and DeFi
Even with the current bearish tides, the future does look bright for both Bitcoin and DeFi. Five factors in particular might fuel future expansion and collaboration between the two sectors.
Increased Adoption
The launch of Bitcoin DeFi is sure to spur even greater adoption by the DeFi projects. Bitcoin’s massive user base and market capitalization—by far the largest of any crypto asset—can attract new users and liquidity to emerging DeFi ecosystems. If a new wave of Bitcoin holders start accessing DeFi use cases, the sector might be in for another boom in growth and activity.
Improved Liquidity
Providing a bridge between Bitcoin and Ethereum, Bitcoin’s entry into DeFi can greatly increase liquidity in DeFi markets. Bitcoin provides a new influx of capital and increases trading volume. This provides a simpler method for users to open and close positions, protecting them from sudden and extreme market movements. Boosting liquidity across the DeFi space is a critical component for the long-term health and sustainability of DeFi projects.
Enhanced Credibility
Bitcoin’s participation in DeFi can help establish a stronger credibility signal for DeFi projects. Bitcoin is known as the most secure, decentralized and reliable cryptocurrency. That intersection with DeFi is uniquely positioned to address the mistrust and cynicism that surrounds the sector. Aligned with this, enhanced credibility can draw more institutional investors and mainstream users to DeFi.
New Use Cases
The integration of Bitcoin into DeFi can enable new use cases, such as lending, borrowing, and trading of Bitcoin-based assets. By introducing these new use cases, the activity on-chain can broaden the scope of DeFi services and attract more users from deeper waters. Users can borrow against their Bitcoin holdings to jump into DeFi yield farming. Or, they can post their Bitcoin as collateral for loans in stablecoins.
Technical Challenges
Beyond liquidity creation, the integration of Bitcoin into DeFi presents potentially enormous technical challenges, including scalability, security, and interoperability. All of these challenges must be overcome for Bitcoin-based DeFi projects to have seamless user experience and functionality. Developers from various ecosystems are actively developing or deploying solutions, including layer-2 scaling solutions and cross-chain bridges, to address these technical hurdles.
Navigating the Crypto Landscape: A Balanced Approach
As Bitcoin continues its upward trajectory and DeFi seeks to find its footing, investors need to adopt a balanced approach. Diversification, due diligence, and an awareness of the risks involved are the keys to navigating the crypto landscape successfully.
Diversification
Having a diversified portfolio that diversifies risk across various asset classes, including offices, Bitcoin, and DeFi projects will reduce risk. By not putting all their eggs in one basket, investors can reduce their exposure to the volatility of any single asset.
Due Diligence
As always, comprehensive research and due diligence is key before investing in any DeFi project. Investors must perform diligent assessment of an underlying project’s team, technology, security and tokenomics are all critical. Reading technical whitepapers, auditing smart contracts, and thoroughly understanding the project’s governance model can arm investors with information that helps them make smart investment choices.
Risk Management
The importance of looking at, understanding, and managing risk can’t be overstated in the crypto space. Investors are encouraged to only invest what they can afford to lose and be prepared for the risk of losing their entire investment. Establishing stop-loss orders and other risk management tools allow investors to mitigate losses and preserve capital.
Conclusion
Bitcoin is on a new bullish momentum due to a confluence of factors. Long-term holders are holding, institutions increasingly confident, and macroeconomic conditions are looking favorable too. DeFi has missed the boat in taking advantage of the opportunity that Bitcoin’s victory has afforded. Scams, security concerns, and decentralization aside, the crystal ball is still bright. Bitcoin DeFi is growing quickly, driving more adoption and better liquidity. New use cases will only continue to accelerate this trend and promote excitement for the convergence between the two sectors. By taking the right approach, investors can profitably find their place in this new crypto frontier. With a little bit of research, they can fully enjoy all the benefits that come with both Bitcoin and DeFi.
