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Decentralized exchanges
have been around for a while now, but it’s only been since the grip of
decentralized finance mania has taken hold that they’ve come into their
own. The growth in DEX use has been nothing short of exponential, with volumes pretty much doubling in August and September compared with the preceding months.

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But
is volume alone telling the whole story? Amid the DeFi frenzy, some of
the biggest winners have been DeFi governance tokens. Kicking off with
Compound’s COMP token in June, other projects that followed suit have
seen similar patterns. Yam Finance’s YAM, SushSwap’s SUSHI and
BurgerSwap’s BURGER have all seen massive popularity at launch, only for
their price to start dropping once the initial hype dies off.

Given
the current data, it’s relatively easy to trace a direct correlation
between the meteoric rise of DEX volume and the craze for issuing
governance tokens that, so far, have not been able to hold on to their
value beyond the initial hype.

Echoes of the IPO craze? 

Cryptocurrency
has always borrowed terms and concepts from traditional finance. The
idea of an initial coin offering is derived from its traditional cousin,
the initial public offering. But while an IPO is a signal of investor
confidence in the future of a company, ICOs were a free-for-all,
allowing anyone to mint tokens, regardless of whether or not there was
any demand that would generate value.

With DeFi tokens, there is
an already-established product that’s providing some value to market
participants. DeFi’s governance tokens offer holders a future stake in
the development of the product. In this way, DeFi tokens are more
comparable to the concept of an IPO than ICO tokens ever were.

However, after the lockup period of an IPO ends, most investors dump
their shares on secondary markets, according to findings from financial
services firm UBS. This trend doesn’t bode well for any early
recipients of DeFi tokens, as they usually HODL. Of course, DeFi is very
much in its infancy, so it’s too early to draw any concrete
comparisons. COMP, the token that kicked all this off, is only three
months old. Omri Ross, chief blockchain scientist at trading platform
eToro, believes that DeFi tokens should still be approached with
caution:

“The jury is still out on the valuation
fundamentals for DeFi governance tokens. Given the novelty of the space
and the many complex factors going into evaluating the fundamental value
of a token, the pricing of governance tokens remains highly
speculative.”

A lack of BTC correlation?

DeFi
tokens may show eerie correlations with IPOs, but they buck a bigger
trend within crypto markets. With a few exceptions, most coins tend to
follow the price movements of Bitcoin (BTC).
Currently, DeFi tokens are an anomaly in that respect. While BTC has
been trading within a relatively narrow range over the last month or so,
DeFi tokens have shown price movements entirely uncorrelated to BTC
markets. Curis Wang, co-founder and CEO of Bitrue — an exchange that
recently started offering both decentralized and centralized finance options — told Cointelegraph:

“I
don’t believe that their prices will end up following BTC. Most users
and investors of these DeFi coins are pretty knowledgeable about DeFi,
cryptocurrencies, and finance in general, and they understand that the
functions that these projects are facilitating are going so far beyond
what BTC was ever aiming to do.”

 

All of these points
raise some intriguing questions about the future direction of DeFi token
markets. The concept of the IPO has sustained for decades. Investors
still get excited enough to apply for an initial allocation of stocks,
even if the numbers indicate they can expect to lose out. However, stock
investors can, in some cases, hold their positions for decades. For
example, Berkshire Hathaway has held stocks of Coca-Cola and Wells Fargo for over 30 years.

In
the notoriously fickle world of crypto investing, it seems a stretch to
think that any investors would hold onto DeFi tokens for that long,
particularly if their value continues to decline. Furthermore, there’s
also the question of whether the law of diminishing returns will kick
in, which would mean that each new DeFi token entering the market would
become progressively less valuable than its predecessors.

In a
segment that seems to be propelled by hype, it appears to be more than
just a possibility. If this does happen, then DeFi tokens may start
behaving more like longer-established altcoins. This behavior would see
them quickly settling into a place in the token rankings that more
accurately reflects their longer-term value and mirrors BTC prices more
closely.

A looming specter

All of this speculation
doesn’t consider the one factor that could kill investor appetite for
DeFi tokens entirely: regulation. Despite DeFi’s ambitions toward
decentralization, few projects can claim to be truly decentralized.
There are teams of people that maintain the underlying codebases, pay
for the hosting of app data and take care of the user interfaces.

All
the DeFi tokens in the world won’t stop the United States Securities
and Exchange Commission or the Financial Crimes Enforcement Network from
coming after anyone they believe to be responsible for contravening
U.S. regulations, if and when the time comes. However, Wang still
believes that the time has yet to come and that no regulation will be
implemented in the short to medium term:

“First of all,
BTC has been around for a decade already and received widespread public
attention at the end of 2018, but there is still almost no regulatory
clarity around it in 2020. [...] Secondly, the whole point of DeFi is
the decentralization aspect of it and when a project is open source,
even if you somehow stop a team from working on a protocol, you can’t
stop others elsewhere from forking or building on top of it.”

The recent charges against BitMEX
have already highlighted the potential dangers crypto companies and
platforms may face if discovered to be lacking in Know Your Customer and
Anti-Money Laundering checks — DeFi included. Furthermore, CipherTrace
has also stated that DeFi could make an attractive haven for money launderers.

The fact that funds drained from the recent KuCoin exchange hack have made their way through Uniswap
lends further credence to the idea. If the worst-case scenario happens,
DeFi could go the way of the ICO, rendering DeFi governance tokens
worthless as a result. EToro’s Ross thinks that this issue will
eventually slow down the current DeFi craze: “DeFi products will likely
face regulatory scrutiny as applications of blockchain technology find
increasing adoption amongst a broader community of users.” He added:

“As
the space will attract more funding, attention and regulation, which I
think will be positive for the space, it may also require future
protocols to integrate some KYC and AML building blocks.”

But
for now at least, DeFi tokens offer dizzying returns for yield farmers
who continue to make hay while the sun shines. What’s more, the craze
shows no immediate signs of dying down, even though token prices are
currently declining. However, those who’ve been around long enough to
remember the post-ICO freeze of crypto’s long winter would do well to
remain cautious of history repeating itself.