DeFi Bubble Pops – Near Term Implications

The past 4 months had been a real rollercoaster for DeFi tokens, at first rising impulsively during the summer, only to drop by more than 50% starting from mid-August. This bubble and its burst had very likely caught many people on the wrong foot, given that managing volatility and taking critical financial decisions under stress is difficult even for the most experienced individuals.

We’ve already talked about Decentralized Finance (DeFi) and its potential in 2020 2 months ago, but today we would like to focus on what could this bubble pop mean in the near term.

#1 Less capital locked in DeFi apps?

Increasing capital had been locked in DeFi apps and the media had been covering this news many times. As investors were conducting “yield farming”, attractive potential returns made possible thanks to DeFi acted as a catalyzer for capital pouring in. However, now that DeFi tokens are down substantially, we could start to witness a reduction in new investments, considering the market usually takes a long time to recover from a bear market. Still, a meaningful drop in DeFi interest can’t yet be spotted.

#2 Longer time needed to restore trust

Bubbles are extremely dangerous because of their long-lasting effects on the market’s psychology. In the beginning, euphoria and rapid rising in valuations are making market participants overconfident. They overleverage and take excessive risks, even though the higher the market goes, the higher the chances it will ultimately take a step back.

In a crypto market dominated by emotions, the self-reinforcing series of events leading to the bubble acts as a headwind when everything collapses. The trust restoration takes much longer, as it can be noticed from historical price developments. Bottoming formations are large mainly because trust is harder to build as compared to panic selling. It is possible to see crypto traders and investors focusing on other tokens that had been underperforming for months, in case risk sentiment will improve meaningfully again.

#3 Attractive valuations for those who missed the first wave?

There had been a lot of buyers who missed the massive upward wave and now that we had a +50% bear market on most DeFi tokens, valuations are more attractive. Should these instruments start to rise again, it would be possible to find new opportunities to get involved in the DeFi growth.

Whether or not that would be the case it is hard to say right now, considering buyers are not so confident, judging by how tokens like Chainlink are performing. Erasing more of the losses in the weeks and months ahead would be a positive development.