The total value locked in decentralized finance (DeFi) projects hovers around $62 billion as of mid-August, down from a peak of over $250 billion in December 2021. Capital is fleeing the crypto space amid from war, skyrocketing inflation, and whatever other surprises 2022 may still have in store for us.
However, unlike previous crypto bull runs, it was not just retail interest that attracted this capital in the first place. Rather, major institutional players, who recently opened up to cryptocurrencies, quickly developed an appetite for the returns DeFi is known for. But now that winter is upon us, the pitfalls of high-performance platforms have become more apparent.
Value cannot come out of nowhere
In a sense, value is always subjective, defined by one’s personal considerations and goals. A photo from a family collection means more to a member of that family than it does to a random stranger. Consequently, a farmer would be quite willing to pay for a shipment of seeds, since they are crucial to his business, but a city dweller would probably prefer to pay for the end product.
Still, even the simple examples above show how value often depends on real-world circumstances and processes. In the farmer’s case, it is also quite quantifiable, thanks to the free market that brings together entire industries, governments and consumers into a sophisticated and more or less functional system. Definite value in money creates definite value in yield, whether it be crops or fruits, and the great economic life cycle continues as these products make their way onto the market.
“Yield” is a word beloved by the blockchain industry, especially its DeFi sector, whose total value locked has lost billions of dollars since May amid the ongoing downtrend. Still a largely nascent industry, crypto as a whole doesn’t have as much exposure to the real-world economy, especially when it comes to anything beyond speculative trading. And as lucrative as DeFi returns seem, the question is always where they come from.
Related: Terra contagion leads to over 80% decline in DeFi protocols associated with UST
The sad story of Anchor’s demise is a perfect example of how unsustainable the business models behind DeFi protocols can be. Its returns of almost 20% officially came from on-chain loans, but it received an injection of cash to continue operating, a clear sign that the loans were not enough to maintain the returns. Given Anchor’s prominence as a pull factor for the entire Terra blockchain, the downfall of the entire ecosystem can be blamed on its questionable returns.
Equally telling is the fact that on-chain lending tends to remain on-chain within the largely isolated blockchain ecosystem. An on-chain protocol can only lend you an on-chain token, and as we know, on-chain assets are not very integrated into the real-world economy. So whether you’re looking for an arbitrage opportunity or staking your loan on another yield protocol, your loan, unlike traditional financial loans, creates little in terms of real-world value. And healthy returns never come out of nowhere.
There is life outside the chain
This lack of real-world value to back the returns and the entire supply is a huge Achilles’ heel for the crypto scene. Many have compared Bitcoin (BTC) to digital gold, but gold has use cases other than being in a bank safe, from the jewelry industry to electronics. And while it will never be able to replicate Bitcoin’s wild shot at the moon, its use cases will keep gold afloat even when its guise as an inflation hedge fades.
The crypto space must try to abandon its internal baseball mindset and look beyond on-chain activities to seek to establish a broader foothold in the real-world economy and processes. The blockchain industry needs to experiment with use cases geared towards competing with financial and other services in traditional markets, as well as advancing the blockchain space itself.
Some of the biggest names in the DeFi space have already seen the writing on the wall. DeFi titans are already seeking exposure to real-world assets, transitioning to a business model with a clearer risk-reward ratio and healthier returns produced by business-to-business lending. The entire blockchain industry should continue in this direction.
Related: Do Kwon reportedly hires lawyers in South Korea to prepare for Terra investigation
This search for real-world use cases must go beyond the basic set of financial services. It should power a wide range of services, from decentralized data storage and identity solutions to the Internet of Things and mobility applications. The world of machines is an especially interesting use case, as machines running 24/7 present a great source of liquidity generated by real-world value. This liquidity could unlock a whole range of new DeFi business models and offer an opportunity for some of the existing protocols to switch to healthier returns.
The time for uninhibited performances aiming for the moon may be over, but there are plenty of real-world activities generating interest and waiting to be brought onto the chain. All of them offer more familiar business models, allowing projects to increase their risk management gain while offering investors returns based on real tangible results. Blockchain adoption should be more than just exchanging Bitcoin from your bank account – it is a process that can and should transform entire industries and business models.
By carving out a presence across multiple industries and sectors of the real economy, the blockchain space has more than just healthier returns to gain. In the long run, and with enough effort and polish, it’s ultimately about turning the Web3 dream into a self-fulfilling prophecy. A blockchain-based internet must start with a host of decentralized applications and services slowly but surely taking over from their centralized competitors, and the current bear market is just the right time to start building them.
Till Wendler is co-founder of peaq. Previously, he worked as COO at Advanced Blockchain AG from 2017 to 2020 and also served as CEO at Axiomity AG, a blockchain services company.
The views, thoughts, and opinions expressed here are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.