Concept of DEFI.

As noted in prior publications, bitcoin has disappointed many onlookers with muted price action, post-halving, for which multiple narratives have taken blame. However, despite the aforementioned finger pointing, no analyst has suggested that bitcoin price could be much lower without one large phenomenon occurring over the past 3 months: DeFi explosion.

DeFi, also known as Decentralized Finance, comes in many forms, including lending, derivatives, exchanges, and payments. The nascency and excitement around the space makes new protocol tokens susceptible to boom and bust cycles.

The most recent boom cycle is around liquidity mining. Liquidity mining is an incentive program set up by new DeFi protocols to attract users, i.e. liquidity. These programs typically distribute, so-called governance tokens to these liquidity providers, commonly known as yield farmers.

Though not new, DeFi incentive programs are cleverly orchestrated growth hacks, which have resulted in incredible spikes in network participation, total value locked, and market cap of governance tokens.

The most prominent example being Compound, a decentralized lending protocol that allows users to borrow and lend from a pool of assets, without permission. Per Delphi Digital and DeFi Pulse, Compound saw its value locked and market cap skyrocket once liquidity mining and governance tokens (COMP) distribution began, currently sitting at $668 million and $497 million, respectively.

https://defipulse.com/compound

On the surface, liquidity mining has little correlation to bitcoin price movements, but a deeper look reveals the connection. In order for yield farmers to receive governance tokens as compensation, they must participate in the network as either borrower or lender, which requires a deposit into a pool that borrowers can withdraw from provided they post sufficient collateral, and allows users to earn above market interest rates on their holdings, plus capital gains from COMP token appreciation.

https://www.tradingview.com/chart/Uud5EVbi/

The largest amount of value locked in DeFi comes from Ethereum (ETH) tokens, $715 million, at the time of writing, followed by bitcoin, $141 million.

https://defipulse.com/

Additionally, Saniya Moore notes, one of the hottest tokens on Ethereum right now is WBTC, or wrapped BTC, an ERC-20 token backed 1:1 by bitcoin, because of a massive rush by yield farmers to buy WBTC, in order to participate in the Compound network, thus earn COMP governance tokens.

https://defipulse.com/wbtc

Combining both value locked up by BTC and WBTC equates to $241 million of bitcoin currently locked up within DeFi, diminishing trading supply on the open market, thus buoying bitcoin price.

Last, the impressive participant and price growth seen within the DeFi space over the past 3 months, has coincided with or helped enable alt season, aptly dubbed for alternative small cap coins rapidly increasing in price. The majority of alt coins trade on BTC pairs, which means any new speculators entering the space will need to acquire bitcoin first, before trading. In essence, providing a subtle undercurrent of buying support for bitcoin.

For all the positives DeFi has brought bitcoin over the past 90 days, it also offers several risks. For example, the crypto market is highly reflexive, meaning the same sentiment that drove value locked up and price to unprecedented heights, will inevitably reverse, potentially spilling over onto bitcoin. Likely reversal catalysts are code exploits within decentralized protocols, commonly seen over the years, or an abrupt end to alt season.

How this particular chapter of irrational exuberance ends, it is too early to tell, but bitcoin will likely not be immune.

Disclosure: The author owns bitcoin and ethereum.

See the article here:

DeFi Boom Has Saved Bitcoin From Plummeting - Forbes