Another week of low, low interest rates. But for the first time in months, that might actually be interesting. This week, it might mean that Compound and Aave are losing their core use case.
For a long time, organic stablecoin borrowing demand on these platforms has been thought to be tied to the overall "demand for leverage". The idea is that in a bull market people want to bet on prices going up, so they deposit their crypto, borrow USDC, buy more crypto, borrow more USDC etc. In doing this, users get levered long ETH or wBTC prices.
So here's the thing - over the last few weeks we've gotten a bear market rally in ETH on merge speculation, but stablecoin interest rates on DeFi lending protocols have barely budged. What gives?
One of two things is probably true - either the demand for leverage in this past rally was pretty low, or DeFi has figured out easier, more efficient mechanisms to provide users with leveraged, open-ended price exposure. My money is on some combination of the two.
I think it is probably true that leverage levels were much lower in this rally than in past rallies. For one thing, ETH gas prices, another proxy of activity, haven't gone up too much either. But there was certainly more demand for leverage in the last few weeks than there has been for months, and the fact that this demand didn't translate to ANY increase in borrowing demand would make me pretty worried if I was over at Compound or Aave.
The "going levered long" use case has always felt flimsy to me because lending protocols are not optimized to deliver this end product to their users. Realistically, perp or futures trading protocols are just going to do this better because that is their whole reason for being.
It's still a bear market, so it's hard to draw any real substantive conclusions from this episode. But this might end up being a canary in the coal mine if the bull market comes back around and DeFi lending protocols wind up underperforming as businesses.
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