DeFi, No Utility = No Future

Have you ever made a bundle in crypto and then asked yourself what to do next? Perhaps you could spend some of that profit on a nice little treat. What about splashing out on a new phone or taking the family on holiday? Sound good? But wait, how are you going to pay for that treat? Er, well, not with the tokens you’re holding, that’s pretty much for certain. No, it’s time to do some selling.

In the world of DeFi there are a growing number of projects offering big and, in some cases, even huge payouts and all you usually need to do is simply buy and hold. Titano, Vapor, Strong, Olympus, Wonderland, the list goes on and on. Whether they are styled as DAOs, nodes or whatever else, the underlying arrangements are essentially the same: you buy, hold and watch the profits mount up. However, there is one other thing they (almost) all share and that is a spectacular fall from the vast, lofty heights of apparent success.

Now, I’m not going to go into the debate about the ponziomics some of these projects are said to incorporate, other than to note that some of these have admitted to there being an element of this involved. I will also only briefly note that the volume*fee based approach to profit generation some projects use does, surprisingly, appear to hold water when you crunch the numbers (so long as the volume is maintained). These things are important, but they risk steering us away from the argument I am putting forward in this post, so I won’t linger on them. So, what is the argument I’m putting forward?

Liquidity, Liquidity, My Kingdom for some Liquidity

Well, before we get to that, let’s take a look at another perfectly good argument made by some people to explain why these types of project fail.

The argument goes something like this. New project starts up, offering a very attractive rate of return. All you need to do is buy some of the project’s tokens then sit back and watch the profits roll in. Note, however, that these profits are invariably paid out in more of the same tokens.

Now, people might do some digging in an effort to work out whether or not the project and the team behind it are reliable, but that juicy pay out is eventually too tempting and so an ever-growing number of profit-hungry folk start to pile in. Happily, the project is good to its word and the promised pay-outs are steadily made. People start making profits, then those profits get big, maybe very big. And then? Ah, well, goes this line of thought, that is precisely the point at which things go pear-shaped.

You see, some people decide it’s time to take some of those easily-won profits and promptly start selling. Then more people make the same decision. There’s more selling and more and more, all of this given added momentum by the inevitable downward trend of the token price, which then starts to fall dramatically. And it is only now, as hordes of people head for the door marked exit that they realise there is no where near enough liquidity available to cope with the volume of selling. At this point the project is doomed, consigned to the graveyard, along with all the funds that token holders couldn’t get shot of quickly enough. Thus, it is a lack of liquidity that leads to the inevitable demise of these sorts of projects.

This argument makes perfect sense and I have no real problem with it, other than to note that some of these projects have been struggling back on to their feet (more on this later). Except, that is, that I don’t believe it is the lack of liquidity that is the underlying problem here. The liquidity issue is, in fact, a symptom of something else more fundamental.

Utility is All

So, just what am I going on about? Let me explain.

The important thing here is to ask why it is that people are choosing to sell their tokens. The obvious answer is to say it’s because they want to cash out on a profit, which is fair enough. But in that case why not simply move the tokens out of the investment pot and put them somewhere else? After all, that’s what you would do with fiat. And this is the crux of the matter. People sell their tokens because there is nothing else they can do with them. In effect, they either remain invested or they sell, the result of which is a guaranteed endless run of sales orders which, sooner or later, are not going to be balanced by matching buy orders. Hence, liquidity becomes a big problem. It is this lack of utility that is the underlying cause of the problem and why so many of these projects are doomed to failure.

There seems to have been some recognition of this underlying issue across the DeFi space and we have seen some of these projects taking steps to introduce some sort of utility to their tokens. Typical examples thus far include lotteries, games and investing in start-ups. Whether or not these will prove adequate, only time will tell, though I suspect they are unlikely to be enough. Perhaps these projects can address this issue by offering people an exit route that keeps them within the overall ecosystem, maybe by swapping one token for another (those projects developing stable coins may have a potential solution here).

One final thought I will add, is that I am convinced what won’t address the current issues are the steps some projects are taking to lock in token holders through the use of ever higher fees or very long staking periods (some of which are several years in length). All these measures will do is simply put off the inevitable day of judgement.

Would steps to introduce utility be enough to persuade you to keep hold of your tokens in one of these projects? If not, then what, if anything, would or are they doomed from the start?

Until next time…

Renaissance Man

Earnathon – get paid to learn about crypto

The Usual Disclaimer

Please don’t take any of the above as financial or investment advice. It is intended to be nothing other than a little entertainment and information sharing. Always, but always, do your own research before committing your money to anything.

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