We got some fireworks this week. Crypto prices plunged to as low as ~1750 ETH. This set off a wave of liquidations through DeFi and brought the CT bears out in force. Compound and Aave rates have normalized a bit and remain low. In other protocols, like Notional and Yield, the turbulence has resulted in significant dislocations.
When prices crash, DeFi users need cash to keep their positions from getting liquidated. That causes a lot of rebalancing activity throughout the space which can create dislocations. For example, Notional's interest rates moved substantially over the past week due to a few large liquidity redemptions following the price crash. Notional's 3M DAI rate got down as far as 0.33% in the wake of the crash before users came in to borrow and push the rate up again.
Just at the moment that all these dislocations and opportunities have been created, there has also been a major contraction in the supply of capital able to capture these opportunities. DeFi is built on leverage vs wBTC and ETH collateral. When the value of that collateral declines, the outstanding stablecoin supply declines with it. For example, the total outstanding DAI supply has declined by roughly one third over the past 2 weeks!
USDC, on the other hand, is less immediately reflexive. While DAI is explicitly generated via Maker CDPs that need to be closed out during market stress periods, a contracting USDC supply would mean that people are deciding to cash out to fiat. So far that hasn't really happened, and a less contractionary USDC supply has led to generally lower yields on USDC than on DAI over the last few weeks. However, with USDC yields on Compound now firmly below US treasury yields, we might start seeing some capital cash out to fiat.
With less available VC funding for DeFi startups and simultaneously less capital looking to deposit into DeFi protocols, we could see a real shakeout in the space and the death of a lot of projects.
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