A lot of people are scratching their heads in disbelief that amazing DeFi projects are falling so much from their highs.

While you may be surprised it’s happening now, you shouldn’t be surprised it was going to happen.

Firstly, I was in the camp that thought we’d see retail dollars flood into the market in 2020Q4 and re-create some of the conditions for a surge.

That clearly hasn’t happened.

It is also clear that isn’t about to happen.

Coinbase, Binance and other CEXs have not done enough (often, nothing) to enable users to participate in new token offerings or yield farming.

It’s hard enough for people to make the mental jump into crypto. It’s even harder for most IMO to go from CEX to on-chain.

Many who would be the most willing to make that jump got burned in 2017 and haven’t come back in the same size.

Secondly, it’s worth stressing that the total capital in DeFi is actually quite small. DeFi may have been valued at $10-12B at its September peak, but there’s only a few hundred million unique dollars actually sloshing around trading DeFi daily.

And there’s even less capital in DeFi that sits on the sidelines looking to scoop up actively traded tokens.

So when major DeFi players like @kyled116 of Three Arrows and @QwQiao push a narrative of a hard rotation into BTC, three things happen.

1) Three Arrows and Qiao reallocate more of their own funds into BTC
2) Smart traders, anticipating group 3, rotate more of their funds out of DeFi (but not necessarily into BTC)
3) Many investors blindly following influencer recommendations rotate out of DeFi into BTC

In total, maybe only $50M rotates out of active trading in DeFi.

It’s insignificant to pump up the BTC price (which has risen more from traditional capital entering than rotating from ETH and DeFi) but can ruin the liquidity of DeFi.

Holders are still holding, but it’s important to remember that it’s the marginal buyer and seller that matter when setting prices.

Seriously, don’t forget this point. The price can go infinitely high or to 0 without the underlying value changing.

Third and finally:
While there is a small amount of VC capital in DeFi, there just isn’t an established ecosystem of to carry a DeFi project through multiple capital raises.

There are probably fewer than 10 VC firms willing to write $10M checks for DeFi projects.

This really becomes a problem when tokens don’t generate and distribute enough cash to support a growing team.

This lack of access to follow on capital has stunted some amazing projects.

It took me a while to understand that while these teams were seeing insane PMF and hyper growth, they couldn’t expand their teams.

Founders can’t even sell their personal token allocation to pay for new hires or themselves for fear it will trigger an exodus from their project as the community fears a Chef Nomi-style rug pull.

While a traditional startup with a bit of demonstrated PMF can raise a $10M Series A with little fanfare, there are several DeFi protocols that IMO have hair-on-fire PMF that can’t even raise an additional $5M.

Even Uniswap only raised $11M total in August from multiple VCs.

Normally, when the private capital markets are exhausted, companies would raise by selling to the public.

Unless the SEC clarifies rules and enables more widespread participation, raising by selling directly to the public seems off the table.

So while I expect innovation will continue at a rapid pace, it’s only the projects that can raise enough initial funding and then start generating cash flows from their launch that will thrive until the VC ecosystem expands or Public sale resume.

None of this means that DeFi is in trouble. The protocols will keep chugging away block by block.

While it may not be a fun time to be an unhedged long, it may also be an amazing time to build some conviction positions as everyone else runs for the exits.

While I don’t know if the recovery will be soon, I also get the sense it will happen very quickly once it is underway. https://twitter.com/cryptoyieldinfo/status/1323024442658754560?s=21