A Deep Dive on the Lessons and Surprises of the Recent Crash

On-Chain Markets Update by Juan Pellicer, IntoTheBlock

DeFi protocols, apps and their stablecoins are a key area of the whole crypto markets. Even though the average daily trading values of DeFi are 80 times lower than in centralized exchanges, their smart contracts enable open financial services that impact the whole market by providing key functionalities like price stability and liquidity. This is thanks to primitives like lending, borrowing or trading protocols. 

For this reason it is worth taking a look at the data available to quantify the reaction within the blockchain with the biggest stake in DeFi, Ethereum, and some of its key DeFi protocols during highly volatile episodes like the ones of Sept. 6. 

In this piece, we’ll focus particularly on the effects the crash had on fees and total value locked (TVL). A variation in fees can explain how profitable  each of these different DeFi protocols or even Ethereum are during these types of rapid price moves. Additionally, TVL variations besides being mostly affected by price, can be used to estimate the impact in allocation and thus confidence that traders deposit in a DeFi protocol.

The Ethereum blockchain has a limited capacity and a spike in demand produces an excess demand where a higher fee needs to be paid to be able to have a spot for a transaction in the next block produced. 

In moments where the whole market moves fast, traders have the urge to use the blockchain to trade coins to take profits or cut losses and smart contracts start to stream transactions amid the price movements. This increase in utilization of the network is reflected in the increment of fees that Ethereum generates. The Ethereum blockchain has a limited capacity and a spike in demand produces an excess demand where a higher fee needs to be paid to be able to have a spot for a transaction in the next block produced. 

Furthermore the decision to pay an extra increment in fees can incentivize miners to include a transaction as soon as possible and therefore the transaction can be accelerated. This can become critical in moments of high price velocity when the urge to close a position arises. As it can be seen in the next charts, the Ethereum fees between the day prior to the market drop, September 6, and the day of the drop, September 7 increased from $48.2M to $75.7M, that is an increase of 57% respecting the previous day:

The fee increment was exacerbated in lending and borrowing protocols like Compound or Aave due to liquidations. In the case of Compound, while they usually gain in a normal day up to $10k in liquidations, on September 7 they gained $515K, around 50 times more than in an average day. Protocols that offer coin exchange services benefited from the surge in activity as well thanks to the ability of traders to provide liquidity and earn the trading fees: 

DEXes like Sushiswap or Curve gained 177% and 106% more fees than the previous day. Usually after a price drop and a stabilization of the volatility, the usage of the blockchain decreases and the fees tend to normalize. In this case the total amount of fees decreased from $75.7M on September 6, to $56.5M on September 8, which accounts for a decrease of 25%. Overall in these two days the fees increased 20%, which is something expected as the new price swings brings the need to rebalance positions or opportunities to open new positions arise. 

Similarly, and as expected, TVL figures took a hit, due to TVL being denominated in dollars and most of the assets deposited are crypto coins that are correlated in price and not having fully recovered yet. Ethereum TVL decreased from $135.8B to $123.0B, which is $12.8B less, a 9.4% decrease. Considering that the price drop was of 12.7%, DeFi was relatively unaffected by the recent crash:

The Ethereum TVL is divided between certain key protocols like Aave, Maker, InstaDApp, Curve or Compound, and all of them took relatively similar TVL reductions, not any taking a loss of more than $1.1B. The conclusion is that this market drop has not affected the key DeFi protocols as much, by just reducing their TVL to figures seen just two weeks ago:

Nevertheless not always the protocols more affected by a TVL decrease are those that account for a higher amount of TVL. Such is the case for example of Sushiswap, that curiously lost a 14% of its TVL, maybe due to traders removing liquidity expecting impermanent losses on some pools after this volatility period. Market volatility can be positive, such is the case of days like September 7, when these fee increases meant that both Miners securing the Ethereum network and traders that provide liquidity in DeFi protocols can get enormously benefited. Ultimately, this highlights the resilience of DeFi protocols, where fundamentals such as fees and TVL managed to increase relative to the severe crash in prices.