The decentralized finance (DeFi) market suffered throughout October. Despite the strong uptrend of Bitcoin, DeFi tokens dropped continuously, showing no signs of resurgence or recovery.
Following this month of correction, there are three catalysts that could facilitate the rebound of the DeFi market:the low risk to reward ratio of DeFi shorts, the rising total value locked (TVL) across DeFi protocols, and the extremely negative sentiment around the DeFi market.
Sentiment is Becoming Extremely Negative
In October, the top three DeFi tokens Chainlink (LINK), Wrapped Bitcoin (wBTC) and Maker (MKR) performed slightly better than the rest.
According to market prices from Binance, Chainlink, the top DeFi token in terms of market capitalization, rose 13% in October. Maker MKR dropped by 8%, recording a much smaller pullback than other major DeFi tokens. Since Wrapped Bitcoin is a token that mimics the value of BTC on Ethereum, it followed the price of Bitcoin.
Yet, the price of major DeFi tokens apart from the top three saw a capitulation-like correction. The performance of YFI, UNI, COMP, and UMA—the largest DeFi tokens behind the top three projects— from October 1 to 31 are as follows:
YFI: $23,858 to $10,492
UNI: $4.1554 to $2.2662
COMP: $133.80 to $90.83
UMA: $8.878 to $6.738
Due to the underperformance of DeFi tokens in October, the sentiment around the market has become increasingly negative. When market sentiment becomes overly bearish, the chances of a trend reversal could increase.
This is typical with past price cycles in the cryptocurrency market. When Bitcoin plunged below $3,600 on BitMEX in March 2020, the market sentiment reached its lowest point. Traders in the futures market capitulated, but the spot market’s volume was starting to increase. That marked the bottom of Bitcoin at the time, causing it to rally over the next six months.
Matt Kaye, the managing partner at Blockhead Capital, said the DeFi market is showing signs of recovery as the market sentiment “gets most bearish.” The investor pinpointed the rising volume of YFI and other large DeFi tokens, like Synthetix (SNX), in the spot market.
In cryptocurrency trading, the spot market refers to the crypto-to-crypto or crypto-to-fiat market that has no leverage or margin. Investors can buy and sell cryptocurrencies but are unable to borrow funds to take higher risk trades, like the derivatives market. Typically, a rising volume in the spot market points toward a real increase in retail demand.
DeFi Fundamentals Are Still Intact
Atop the rising volume of the DeFi market, the fundamentals of DeFi protocols are still strongly intact. The total value locked (TVL) across DeFi protocols is still around $11 billion.
This means that around $11 billion worth of capital, mostly in Wrapped Bitcoin and Ethereum, are used on DeFi protocols.
On September 1, when most DeFi tokens reached their peak in terms of market price, the TVL of DeFi was at $9.66 billion. The value locked in DeFi has actually increased since then, despite the correction of DeFi tokens.
DeFi Shorts are No Longer Attractive
In October, shorting DeFi or betting against DeFi tokens was attractive. As the price of Bitcoin rose, it vacuumed the volume from the cryptocurrency market, causing altcoins to stagnate.
But shorting DeFi has become less compelling simply due to the risk/reward ratio. Many DeFi tokens have fallen by 40% to 70% in the last two months, and the room for significant downside is smaller.
Su Zhu, the CEO of Three Arrows Capital, who has been vocally optimistic about Bitcoin since September and skeptical about the short-term outlook of the DeFi market, said:
“A roller coaster update: I don't think defi shorts have good r/r at this point, versus usd. Long defi/eth cross could make sense. Top-tier projects are approaching levels where long-term investors will look to deploy fiat. I expect 95% of coins to be down versus btc over the next few months.”