The Bearish Case for DeFi Tokens

Why DeFi is not a good long term store of value.

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The Bearish Case for DeFi

I’m bullish DeFi, but don’t hold a single token. Why?

A core thesis I hold in crypto is that a utility token is NOT a store of value. 

Therefore, it stands to reason that a protocol can have a use case without its native token being the best use for capital allocation.

Let me be clear. That’s not to say utility native tokens (such as DeFi) can’t perform well - they can - however my benchmark for every investment I make is the ‘risk free crypto’ opportunity cost of simply buying and holding Bitcoin. 

When it comes to opportunity costs for DeFi, I believe it’s prudent to use the benchmark of simply buying and holding Ethereum, since most of DeFi is built on there. 

So, the real question is, how have DeFi tokens fared in comparison to simply buying and holding Ethereum?

Token Performance: YFI vs. ETH

Let’s look at a few examples. YFI was arguably the single most hyped coin during DeFi summer in 2020. With its fair launch, I vividly remember it was the talk of crypto Twitter.

But how did YFI perform vs. ETH?

ETH = red. YFI = blue.
As you can see from the chart, the only way you could have broken even from purchasing YFI was if you bought on the day it was listed.

That’s assuming you bought the absolute bottom, which few did. Most bought in the $20,000 range. At that time, ETH was around $400. 

So while ETH did a 4x since then, YFI is down ~75%. That means for the vast majority of investors, ETH has outperformed YFI by 10x or more. In short, if you bought YFI anytime except on the first few days, you’re absolutely rekt.

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Token Performance: AAVE vs. ETH

AAVE was another massively hyped DeFi token when it launched. If you bought on Oct 3rd, the first day it’s charted, you’d be up ~60%.

Had you bought ETH on the same day, you’d be up more than 300%. Of course, it gets worse for most investors who purchased AAVE at higher prices.

Again, you’re rekt.

I could use other examples too, but every DeFi coin I’ve studied over the ‘long term’ (several year) sample size has underperformed ETH.

But we’re just getting started. 

It should be obvious that buying a speculative ALT is exponentially more risky than buying ETH, the blockchain which the dApp is built upon.

Put another way, the dApp can fail and ETH can succeed, but if ETH fails, the dApp is guaranteed to fail with it. 

It’s debatable what the risk multiple is on a dApp vs. ETH, but it’s at least twice as much. I personally think it’s 5-10x as high, but let’s be ultra conservative just to prove my point. 

To justify taking on double the risk, one would need MORE than double the upside, otherwise you’re breaking even in EV while taking on additional volatility. That’s just plain silly from a risk-reward standpoint.

So what’s the justified number? 3x at least, but 5x is more realistic. However these DeFi token speculations have underperformed by 3x or more, whereas they would need to over perform by 5x. 

And remember this is based on the ultra conservative assumption that a DeFi token is only 2x as risky as ETH.

If it were 10x as risky, you’d need something like a 20x or 30x return to justify the investment. That delta gap between the returns of DeFi and the risk premium is why I don’t HODL on DeFi.

That doesn’t stop me from buying DeFi tokens. I’m happy to trade something, but ultimately what I’m really after is the store of value. In this case it’s Ethereum, but ultimately it’s Bitcoin.

Remember my original point, a platform with utility is not a store of value. Just because DeFi performs a useful function does not mean the value will ultimately accrue to the native token. 

DeFi, like 99% of the rest of crypto, is a trade. How long is the trade? It depends. For some it’s weeks, for others months, perhaps some can stretch for years.

Ultimately, there comes a point with all of these protocols where the risk adjusted return of holding these tokens is no longer justified, at which point the game theory optimal solution is to sell the speculative token and move into a better store of value, which I believe is Bitcoin.

I talk more about the Bitcoin store of value use case in my series ‘The Future of Money.’ It surmises 1,000+ hours of research into Austrian Economics, money, history, time and value. 

Read the first installment here.

What are your thoughts on DeFi?
Let me know in a comment below. Good luck out there.

Alec