#9 🟡
What is DeFi Summer and what led to its explosion? ⬇️
DeFi Summer is a term used to describe the period when the prices of decentralized finance (DeFi) assets skyrocketed, followed by a sharp downturn. It occurred mainly during 2020 and included Ethereum-based tokens, but a second hype cycle happened from December 2020 to early May 2021 and involved DeFi tokens on alternate layer one blockchains.
DeFi refers to decentralized financial products built on blockchains using cryptocurrencies. The term was first used in August 2020, but projects building DeFi products had been around since 2017. The early projects in DeFi include 0x, MakerDAO, Bancor, EthLend (now called ‘Aave’), Set Protocol, Augur, Uniswap, Compound, etc. These projects continued building throughout the bear market of 2018-19, and some of them already had tokens that crashed by 99% during the bear market.
We think that DeFi summer happened because of a few factors:
The build-up during the bear market
The macro backdrop
Reactiveness to the narrative
The bear market build-up ⬆️
In 2017, the ICO hype cycle led to over-promising and under-delivering on many projects, resulting in a lack of innovation in the Proof-of-Work and privacy coins space. As a consequence, many investors and developers left the space, and major assets crashed by 80%, while soft-scams crashed by over 99%. Despite the buggy nature of dApps in 2017-18, many of them implemented a p2p model that mirrored centralized processes on the blockchain. However, new innovation was happening in areas such as AMMs, pools, decentralized stablecoins, and oracles to support such products.
During the bear market that followed, many of these projects were building, testing, and fixing bugs, leading to a deep discount for smart money investors. By late 2018 to early 2019, some VCs, thematic funds, hedge funds, and other savvy investors began investing in the early DeFi projects. In contrast to current practices, project founders engaged with communities and answered their questions themselves on Discord and Telegram.
Innovation was also happening in other areas of the crypto space, including alternate layer ones, storage, infrastructure, gaming, and NFTs, but these areas were not yet user-ready or had not found their product-market-fit until Q4 of 2020. As a result, most of these areas only started seeing significant growth from December 2020 onwards and during 2021.
The macro backdrop ⬇️
The explosive growth of DeFi during the summer of 2020 was fueled in part by a flood of risk-on liquidity seeking higher returns in the wake of the global Covid crash. Central banks responded to the liquidity crunch with unprecedented levels of easing and money-printing, making debt cheaper and unleashing excess liquidity into the world's markets. As a result, riskier assets became more attractive to investors looking for yield, and crypto was no exception. Even with a total market cap of less than 200 billion USD at the time of the Covid crash, crypto was seen as an attractive option for those seeking higher returns. Within crypto, DeFi was particularly appealing because it represented a new and innovative space that could catch the attention of investors and hadn't yet been through multiple hype cycles.
Bitcoin saw a steady recovery from its Covid low of under 4k USD in March 2020 to 12k by September 2020. During this time, Ethereum started to outpace Bitcoin in terms of percentage gains, and DeFi tokens began to soar even higher. Within the crypto market, there was a clear hierarchy of risk, with Bitcoin being less risky than Ethereum, and Ethereum being less risky than DeFi tokens. However, it's worth noting that during the recovery phase of Bitcoin until 2020, there wasn't a significant influx of new money into the crypto space. Instead, it was largely sidelined money returning to the market, with only some new money coming in. Major inflows into Bitcoin occurred after news articles about Michael Saylor and Paul Tudor Jones started to circulate.
Narrative #️⃣
Innovation and liquidity have been key drivers of the crypto market, and the unregulated nature of the space has led to hype cycles fueled by various narratives. The period before 2018 saw hype cycles around Proof of Work coins and the ICO boom, with newly built projects gaining traction, followed by copycat projects and low-effort cash grabs. This trend has repeated with the DeFi Summer, the memecoin mania led by Dogecoin, the gaming and metaverse mania led by AXS, and the move-to-earn space.
While on-chain staking, decentralized stablecoins, and airdrops existed previously, they gained more attention through the success of projects like Compound, Yearn, Ampleforth, and Uniswap. Yam, a yield farm that gave out rewards in the form of Yam tokens, set the stage for the foodcoin mania during DeFi Summer 2020. Yam was followed by a wave of food tokens, and the quality of projects and returns diminished over time until the crash in September 2020.
However, legit projects that were innovating and building useful products still gained traction, with tokens like SNX, Link, and Aave making fortunes for those who held them. The alt-season that began in December 2020 brought in new money, with BTC's digital gold narrative attracting institutions to invest in Bitcoin and DeFi catching the attention of hedge funds and VCs. Projects like Project Serum and Pancakeswap launched during the last few weeks of DeFi Summer 2020, paving the way for DeFi on alternate layer one chains.
Ethereum maximalists played a big role in promoting and talking about DeFi projects during the bear market, putting up video tutorials, podcasts, and newsletters to bring more people to build on Ethereum. All in all, innovation, liquidity, and narratives continue to shape the crypto market, with hype cycles and waves of new projects emerging and evolving over time.
Conclusion ✳️
Ultimately, with the combination of macro backdrop (seeking for greater yield out of traditional markets) as well as the potential of flipping your investments by holding the underlying tokens has led to the growth in DeFi in 2020.
