Will DeFi Consolidation Result in Centralization?

November 22, 2023 Profitable Investing Tips

Prior to crypto winter there was a surge in decentralized finance. The amount of money going into DeFi businesses rose as crypto went up with, as some believed, no end in sight. Since the losses of crypto winter there has been a wholesale sorting out across all of the crypto world. A major result is that DeFi is becoming less competitive. This has implications for investors and for the future of decentralization which has been the goal of crypto from day one. Will DeFi consolidation result in centralization or is the sector just regrouping?

InsiderFinance: Level the Playing Field

Fewer Players in DeFi

Bloomberg Crypto reports on the situation in decentralized finance. Their take on the situation is that large parts of DeFi are less competitive than they were just a couple of years ago. Less money is being invested. The bulk of the weaker players are gone. Part of this was because the majority of business startups do not succeed. Part was because of the crypto-always-higher mindset that infected crypto and drove bad business decisions. Part of today is because of the shock that investors felt from the collapse of FTX. What has happened has been a flight quality which typically happens after a financial crisis.

Breakdown of DeFi Categories by Degree of Centralization

Breaking down Defi into categories you get decentralized exchanges, lending, yield aggregators, derivatives, yield, bridges, algo stablecoins, collateralized debt CDP, services, cross chain, liquid staking, and synthetics. These are shown in the following graph. The graph indicates the percent of market share in any category held by the top four companies. Thus, algo stablecoins, services, synthetics, and cross-chain DeFi businesses are the most consolidated and therefore centralized while decentralized exchanges yield aggregators, lending, and derivatives are the least consolidated. Decentralized exchanges are the least consolidated but even there the top four comprise 54% of market share. The situation at the top of the graph with algo stablecoins and the others is tighter with the top four in each category holding close to 100% of market share.

Shrinking Pool of DeFi Investment Capital

It takes a given amount of money to run a business no matter what type. Thus, there can never be an unlimited number of companies in any given niche. Thus, when investors head for the door, there are bound to be both business failures and fewer startups. For those who sat on the sidelines as crypto melted down in 2022 it probably seems academic. But, for those who had real assets invested, dollars, or crypto tokens, the pain was real. Risk appetite has fallen in all investment arenas. Thus, many are becoming more conservative. It helps these folks that interest rates are up and inflation is coming down. Thus, they can put their money in cash equivalents like short term US treasuries, corporate bonds, or bank CDs while they wait for safe investment opportunities. This is a problem for DeFi if one is concerned about decentralized finance becoming centralized and giving up on an original crypto dream.

Who Gets DeFi Investments?

It would appear that Defi and all crypto investors are doing much better due diligence than they were a couple of years ago. Businesses with no history of hacks and good management of risk are favored these days by investors. Investments with a good story and little to back it up have fallen out of favor. Those of us old enough to have been adults during the dot com bubble remember how just putting dot com in your business name made your stock go up. We also remember how the entire niche deflated with the crash leaving only real businesses that made real money from real products or services. One example from that era is Amazon.com which is a tech giant today. There are likely similar stories waiting to happen in the DeFi survivors today that provide and will continue to provide useful services in the digital sector. However, the Amazon.com story is instructive. Those folks have been responsible for driving untold numbers of brick and mortar stores out of business. This kind of sorting out is likely to be the case in DeFi as well. How this bodes for the dream of crypto and DeFi decentralization remains to be seen.