Collateral locked in DeFi is falling - is it a sign of weakness?
Last week we saw some tweets stating that collateral (ETH) is leaving MakerDAO, increasing concerns that lending on Ethereum is in a downfall. Stats pulled from the DeFi Pulse website show that locked collateral in DeFi has decreased by 30% since late June of this year.
Although these statements are true, I want to show that actual DeFi lending activity is currently at an all time high.
First, lending metrics aren’t supposed to be measured by collateral value, but by origination of loans. Even if we want to consider collateral value as an important input variable for measuring DeFi activity, we would normally want to measure it in nominal terms and not USD value. The amount of locked collateral in ETH terms has indeed decreased by 10% since it’s all time high. Yet, we need to consider the circumstances and what caused this amount to fall.
As discussed on a recent MakerDAO governance and risk call, most of the collateral that left MakerDAO was removed due to refinancing and deleveraging over the last 6 weeks, mainly by large CDP holders (those with more than 10k ETH locked). Some of these large holders transferred collateral to cheaper secondary platforms such as Compound, but importantly, some also removed collateral, as their collateralization ratio reached more than 600% (4x above the threshold of getting liquidated). Also note that Compound requires lower collateralization ratios, hence we would normally expect borrowers who refinanced or moved their loans from MakerDAO to Compound would lock less ETH in collateral.
Further, when analyzing smaller CDPs (those with less than 10k ETH locked at Maker) – where most of the lending activity occurs – we can see that they haven’t reduced their collateral value as drastically as CDP whales. A far better way to measure collateral locked in lending platforms and its relation to lending activity is to look at the median locked amount. As seen below, the median amount of ETH locked in CDP hasn’t decreased as heavily as the average, due to the adoption of CDP/lending among retail users – which I find is a better metric when trying to assess DeFi activity.
Now, as mentioned, DeFi activity is better determined by the loan origination metric. If we sum up all the DAI being borrowed among three major platforms (MakerDAO, Compound, Dydx) the number currently stands at 110m. That’s a record number and keep in mind we are counting only DAI borrowed. If we add USDC, we end up close to 130m of stablecoins borrowed, again a record.
To conclude, we believe DeFi continues to grow, particularly among retail users which is great news. Not saying collateral metrics aren’t important... and of course, less collateral means the system is less safe... but note that MakerDAO had around a 20% lower collateralization ratio in 2018 when ETH was in a bear market, caused many liquidations and the system did well. Also, always expect higher volatility of outstanding collateral amounts as a large part of collateral consists of borrowed stable coins exchanged for ETH. Recently we saw a drop in leveraged behaviour, supported by a stop of the ETH bull run.