The Ethereum network has just turned five years old. Although the project was first announced at the North American Bitcoin Conference in January 2014, its genesis block was only mined on July 30, 2015. Since then, Ether (ETH) has become the dominating altcoin in market capitalization, popularity and network value settlement, having even surpassed Bitcoin in the latter.
Ethereum was created with myriad possibilities in sight, allowing for smart contracts, powerful tokenization, complex decentralized applications and decentralized fundraising campaigns. The latter of these became extremely popular in 2017, as initial coin offerings took over the crypto space and amassed incredible gains for participants.
Could DeFi be the new ICO?
Ether became the primary funding mechanism for ICO projects. As said projects and their underlying ERC-20 tokens left the ICO stage, speculation for their tokens grew, and so did the price of Ether, whose price reached an all-time high of $1,412 on Jan. 10, 2018. Although currently far from that number, ETH’s price reached a 2020 record of almost $357 on Aug. 1.
Although ICOs helped take the cryptosphere to new heights, the hype was short-lived, and the entire crypto market came crashing down at the start of 2018. Shortly before, the United States Securities and Exchange Commission had announced that ICOs were considered security offerings and began a crackdown to protect investors.
Now, some worry that Ethereum is heading down a similar path like in 2018 with the growth of DeFi. While regulatory oversight has pushed for improvements in the crypto ecosystem, in the short-term, it can have devastating consequences like the loss of funds for investors and lawsuits for the project operators.
DeFi really driving Ether’s price?
While price speculation seems to be rampant, it’s largely known that decentralized finance’s actual financial impact and liquidity are rather insignificant. With Ethereum recently becoming the biggest blockchain in terms value settled, how much of this activity in Ether can actually be attributed to DeFi?
ConsenSys estimates that DeFi protocols collectively hit an all-time high of 3.3 million Ether locked in protocols in the second quarter of 2020. Messari has suggested that the Ethereum blockchain settles around $2.5 billion every day. When comparing DeFi to the actual crypto market, it’s also easy to see that DeFi is still but a drop in the ocean, smaller than the market cap of XRP and Bitcoin Cash (BCH), and it makes up only 1.5% of the entire cryptocurrency market.
DeFi sector vs. BCH and XRP - Market capitalization. Source: Messari
Is Ether weathering a DeFi boom and bust cycle?
While funding rates for DeFi protocols are dwarfed by the 2017-era ICO-based funding campaigns, it could be concerning that a handful of DeFi tokens have rallied thousands of percent in a short period of time. For example, Aave (LEND) rose 7,300% from $0.0046 to $0.344, and Compound’s (COMP) price quadrupled in its first week of trading in June. In fact, more than 10 other DeFi-related tokens have rallied by over 100% in 2020. While impressive, this still pales in comparison to the return on investment provided by ICOs in 2017.
While DeFi has reached milestones, such as $4 billion in locked funds, the sheer size of investment obtained by DeFi protocols is way smaller than what ICOs gathered. Still, Ethereum co-founder Vitalik Buterin seems worried that people may be underestimating the risks associated with these protocols, which have been exploited by hackers in the past.
While another bubble is not ideal, it may be an inevitable part of the current crypto innovation cycle. Projects and concepts are prone to be hyped out of proportion before more organic adoption and investment comes in. This is exactly what happened with ICOs, security token offerings, Bitcoin and altcoins. As the DeFi sector continues to rapidly expand, its biggest challenge may come in the form of future regulation, much like it did with ICOs.
Ethereum’s future: Stablecoins, institutionalization and scalability
While only time will tell if DeFi is seeing a bubble phase, there are certainly other reasons for why Ether is outperforming Bitcoin, like becoming the basis for stablecoin transfers. According to ETH Gas Station, Tether (USDT) is the biggest gas spender on the network and continues to grow. While Ethereum did overtake Bitcoin in network activity, it was mostly due to stablecoin transfers, which were themselves overwhelmingly fueled by inter-exchange settlements.
This year, positive steps like the issuance of real-life securities within the blockchain and $1 billion in Ether futures volume were also reached. These factors contributed to Ethereum’s growing adoption in these last five years, but they also point to a looming dead end when it comes to scalability and congestion. However, Ethereum 2.0 staking has finally begun testing, and this brings hope for a new and improved network.
As time goes on, it’s likely that DeFi will continue to grow even if it does suffer some setbacks in the short term. This means that the Ethereum network will likely continue to ride on the back of that success.