Ethereum Enters New Phase of Adoption

Prices of ETH have gone bearish following the Merge's successful execution, which upgraded the Ethereum network from PoW to PoS in September. This shifted the narrative back to other macroeconomic factors. This DeFi market report evaluates vital performance metrics before and after Ethereum's Merge on September 15.

The cryptocurrency markets recovered alongside the global markets from June bearish trend, with ETH exhibiting a considerable improvement rebound compared to BTC. As traders intensified spot purchases in light of possible airdrops (ETHPoW) and the dynamic tokenomics brought by the PoS upgrade, the price of ETH peaked at $2,000 in August. ETH prices have since plummeted to ~$1,350 as earnings set in, and the narrative shifted back to the macroeconomic environment.

Source: Coin Market Cap

DeFi tokens also followed the overall market trends but with greater price volatility. DeFi dominance is a helpful metric that evaluates the market cap of the top DeFi protocols as a percentage of the entire crypto market. During Q2 which marks a bearish market, DeFi dominance declined and later improved from 0.8% recorded in June to ~1.2% in recent months due to the market rebound. The rationale behind this could be because DeFi protocols rely on more prominent layer 1 ecosystems and, as such, exhibit similar leverage to the layer 1 native tokens.

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Regardless of the dynamic dominance, metrics indicate users are generally cautious about DeFi. Its TVL (Total Value Locked) across chains falls below $55 billion, a -22% decline from its August peak. The decline resulted from the regulatory crackdown on Tornado Cash when it was investigated by the OFAC (Office of Foreign Assets Control) in August.

A Tornado Cash suspected developer was arrested in Amsterdam, and smart contracts related to the protocol were sanctioned, leading to pervasive effects. These effects include banning 38 wallet addresses associated with Tornado Cash by Circle (the organization behind USDC). Furthermore, the MakerDAO community also proposed reducing the centralized collateral levels of their DAI stablecoin.

Another recent event responsible for the DeFi market downtrend is the Wintermute $160 million hack. The exploit focused on a vulnerability discovered in the Profanity-generated vanity address (a unique wallet address used by Wintermute to interact with third parties and to avoid expensive gas fees on the Ethereum network). Though Wintermute claimed its solid balance sheet would handle the damage caused, the hack weakened investors' trust in the market maker.

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The low trading event was glaringly evident on decentralized exchanges with a low trading volume in recent months. This is due to investors preferring blue-chip digital assets to altcoins during periods of more significant uncertainty. This explains why DEXes keep losing their trading share to centralized exchanges (CEXes), as depicted in the DEX to CEX spot trading volume below.

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The chart below depicts DEX trading volume and how it has declined.

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This trend might continue with August's recent Consumer Price Index (CPI) data. Daily index from liquidity pools indicates that users are re-staking their assets into DEXes after the Merge. Weeks before the Merge, DeFi users have been withdrawing liquidity from pools for two probable reasons: 1. To benefit from the potential Ethereum airdrop (ETHPoW) or

2. Due to the loss of confidence owing to the Tornado Cash controversy.

However, recent data indicates that the trend is reversing and could bring staking levels back to the stronger levels recorded in July.

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Though trading volume plummeted across DEXes, smaller exchanges like Curve were adversely affected. Due to that, Uniswap enhanced its volume share and recorded ~64% in contrast to the ~48% recorded in July. One of the factors responsible for Uniswap's resilience is its deep liquidity (which lowers slippage) compared to its contemporary DEXes (and some centralized exchanges).

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DeFi lenders experienced an increase in borrowing prior to the Merge, with daily net borrowing (depicted as negative net borrowing) hitting a 3-month high across lending protocols in September. The possibility of an ETHPoW airdrop fueled the increase in ETH borrowing on Aave. Investors allegedly borrowed 100% of the available ETH at rates as high as 190% APY. However, lending has balanced after the community pioneered a vote to halt it. Euler Finance and Hop Protocol both experienced similar borrowing events, while lenders, like Compound, have a limit on the amount that can be borrowed from their protocol.

Source: Dune Analytics

Source: Aave

On a final note, due to the decline in TVL and trading volume on exchanges, monthly DeFi protocol revenue dropped towards a Year to Date (YTD) low of $60 million in September. Despite the overall decline, Aave profited in August from the upsurge of activity on its platform, with almost three times the revenues recorded in the previous month (July).

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ConclusionWeeks before the Merge, some significant market trends regarding users' activities in DEXes and lending protocols occurred. It was observed that the short-term effects of the Merge on token prices are diminishing, and attention is switching back to broader fiscal policy. Regardless, DeFi innovations exhibited persistence and are already showing signs of liquidity returning to exchanges. With energy consumption down by 99% and a deflationary native currency, the future effects of a successful Merge on Ethereum cannot be exaggerated; the ecosystem is now entering a new phase of adoption.