Why ETH Price And DeFi Adoption Are Not in Sync?

In his 1991 book, “Crossing the Chasm,” management consultant Geoffrey Moore described a gap between those who adopt new technologies early and a larger audience which comes later. Now decentralized finance (DeFi) may face its own gap, as ETH price is not correlated with DeFi adoption.

This article analyzes DeFi services which use deposits of Ether (ETH), Ethereum’s native token, as collateral for loans issued in DAI, a dollar-tethered stablecoin. Lending is decentralized, as it is controlled by the network itself and its participants. Borrowers can use these stablecoins to earn income, convert them to cash or make leveraged investments in ETH and other crypto assets.

Gains from DeFi lending are astonishing, but their correlation with the ETH price is of particular interest.

Demand for Ethereum-based DeFi lending services is in reverse to the price of ETH. When Ether price is declining, the amount of ETH locked in DeFi increases. Recent data suggests that this correlation works the other way as well. (Data source: DeFi Pulse).

If such relationship persists, it may show circular user adoption of DeFi lending which can be limited to a small fraction of ETH holders. This means, that current DeFi lending offerings may not be attractive enough to bridge the gap and bring new users to Ethereum.

The early adopter in this article is the one who holds ETH for a long period of time, being confident that Ether’s value will grow in the future. For such individuals, DeFi lending proposes a way to earn income or free up capital, as stated above.

Some of these uses, like income-earning deposits and cash conversions, may speed up during falls in price, explaining the apparent inverse correlation between ETH price and ETH locked in DeFi lending. A falling price boosts the cost of selling under pressure.

Leveraged buying may be an exception, and DeFi lending enthusiasts say so. Mariano Conti, head of smart contracts at MakerDAO, explained:

“What DeFi is creating is a virtuous cycle where investors who have higher risk tolerance are locking up ETH to generate Dai and leverage long ETH.”

Currently, Maker, a major DeFi lending service by ETH deposits, has a minimum collateralization ratio of 150%, which means that in order to borrow $100 in DAI you need to deposit $150 in Ether. The leverage implied by this ration is 1.67X.

Liquid derivatives markets such as BitMEX, Huobi and OKEx propose up to 100x leverage on crypto assets including ETH. With such options, how many long-term ETH investors can opt for DeFi lending as a means to leveraged trading?

It is also hard to predict adoption among a wider audience not yet ready for crypto investing. Would a Main Street borrower buy ETH in order to get a cash loan worth less than ETH mentioned before? It would be possible, if DeFi lenders could accept non-crypto collateral. This will not be a trivial development.

Kyle Samani, managing partner of Multicoin Capital, said:

“I see lots of startups playing with identity type solutions to reduce collateral requirements, but I think these are a long ways out from meaningfully impacting the market. There are a lot of hard, intertwined problems to make this work.”

Getting back to inverse correlation between Ether price and Ether deposits in DeFi lending, if it persists it may show that an adoption limit is near. If the correlation is broken or reversed, it may meat that DeFi lending has found use cases which are able to bring it, and Ethereum, to a mainstream market.