In a selloff which saw Ethereum’s ETH and the DeFi Pulse Index basket of DeFi tokens dropping over 20% in an hour and more than 40% overall yesterday, DeFi protocols never stopped running and generally behaved as designed.
As DeFi grows to hold $100B in assets with millions of users, yesterday was a test on whether the space that aims to become the future of finance can withstand extreme volatility without breaking –and it passed. DeFi’s resilience shows it has strengthened since the latest similar crash in March 2020, when flaws in MakerDAO’s liquidations system caused the protocol to become under-capitalized.
DEXs vs CEXs
Decentralized exchanges like Uniswap, SushiSwap, Curve and 0x didn’t experience any downtime and were able to handle record volumes, according to data compiled by Dune Analytics.
Centralized exchanges like Binance, Coinbase, and Kraken however, didn’t fare so well, with users reporting issues with simple functions like logging in and adding to leveraged positions so they don’t get liquidated.
As some users were prevented from adding to their collateral or closing out their loans, centralized exchanges offering crypto futures liquidated almost $7.6B worth of positions Wednesday, according to bybt, the second-highest ever.
Centralized crypto company BlockFi also lost trading functionality, taking hits from users accusing them of “removing the trading button from [their] website,” while also mistakenly sending ~100 clients the same number of Bitcoins as they intended to send USD-pegged assets.
DeFi protocols liquidated over $700M between May 18 and 19, a record. But the protocols’ smart contracts functioned as programmed ––albeit at very high gas prices. This contrasted sharply with Black Thursday last year when liquidators made off with $4.5M in ETH for essentially free as they were able to take advantage of Ethereum’s congested network, high gas fees and lags in oracle price feeds.
Users like flubdubster, as they go by on Twitter, celebrated DeFi’s robustness too, saying “when everything else was on fire and down – i added some collateral on @Aaveaave to be safer.”
This Time it’s Different
When asked for his take, Nik Kunkel, who as the head of backend services at the Maker Foundation had an intimate look at the problems Maker faced on Black Thursday, offered two main factors for DeFi’s resilience: more on-chain liquidity and flash loans.
“Onchain liquidators are in a very tricky position,” Kunkel explained. “Typically they need to hold stablecoins, and wait for a very infrequent liquidation event. There is a cost of capital associated with not putting those stablecoins to a more productive use.”
Now, “flash loans enable anyone to be a liquidator because there’s no more barrier to entry of holding millions in stablecoin reserves,” he said.
The importance of on-chain liquidity comes in once users buy the liquidated assets. “In order to be effective, there needs to be deep pools of on-chain liquidity to sell distressed collateral into, so the flash loans can be repaid,” Kunkel said.
The DeFi has also “standardized around auctions that can be atomically settled,” he said, calling the fact a third critical factor in the ecosystem’s demonstrated resilience.
Stablecoins suffered some volatility as high demand drove Tether, the number one stablecoin in market cap, up to $1.08, before the USD-pegged asset settled back down to $1.01 at the time of writing.
The remaining other top five stablecoins also deviated from their peg with USDC hitting $0.89, BUSD $0.90, DAI $0.93, and UST $0.86, according to CoinGecko. Sam Trabucco, trader at Alameda Research pushed back on the data provider’s numbers, saying that the large deviations from the peg were “seconds-long blips on single markets,” rather than massive arbitrage opportunities.
ETH has recovered from its drop to below $2,000 and is now testing $3,000 while the DPI index is up 24% from its Wednesday low. Proof that the DeFi ecosystem can function despite 50% drops in asset prices may be more important than short term price action.