On September 28, Andre Cronje, the influential and unpredictable developer behind Yearn.Finance, which turns users’ cryptocurrency investments into (often) large financial returns, retweeted an image.
It was from a recently created account called Eminence.Finance, and it read, simply, “Spartans.”
— eminence.finance (@eminencefi) September 28, 2020
At that point, a single Yearn Finance token was worth over $28,000 and Cronje was a decentralized finance god who had helped make crypto traders a lot of money. The tweet, which referenced a gaming project Cronje was reportedly working on, was the only encouragement traders needed to get in on the next big thing.
A little over 24 hours later, $15 million in crypto had flooded into Eminence. There was only one problem: It didn’t exist.
“There was no U/I, just a bunch of untested smart contracts, and hype on Twitter,” a DeFi farmer who goes by the handle Eth Maximalist told Decrypt. “We had to dig up the smart contracts and figure out how to get access to the tokens. Just shows how crazy everything was at the time. People racing to find the slightest edge.”
The next day, the bottom dropped out; due to a flaw in the code, someone was able to take the entire $15 million (though $8 million of it was later returned to Cronje). But the craziest part of all? The “DeFi degens”—the traders and builders who are pushing the limits of decentralized finance—barely blinked.
With insanely great rewards come insanely enormous risks. And the story of DeFi that defined the volatile and topsy-turvy crypto year of 2020, had equal parts of both. An almost ruinous March, when most of the DeFi degens got “rekt,” was soon followed by the DeFi summer, which saw values increase exponentially. Stories of people making 100% annual rates of returns on loans were so commonplace as to be unremarkable. The DeFi bubble—if we can call it that—has yet to implode.
"DeFi is full of experimentation. In some ways the smartest people here are trying to recreate the financial system on a decentralized blockchain like Ethereum,” said Eth Maximalist, who, like many of his contemporaries, prefers pseudonymity. “Sure, there are a lot of crazy leveraged bets, but we are also seeing some real financial products emerge."
Sten Laureyssens, a strategic advisor with the Waves Association, told Decrypt recently, “It means that we're capable of offering something back to Turkey, to Vietnam, to Tunisia, to Brazil, where you're going to see the currencies that are much more volatile and where people usually don't have access to banking with even normal interest, let alone high interest.”
It’s hard not to be on board with such lofty goals when there’s so much money to be made.
Cronje’s Yearn.Finance token, for instance, was introduced in July and surged from $31.65 to $32,345 by the end of August. That, for anyone keeping score at home, is a 77,000% increase. (It now sits comfortably at a somewhat more modest $25,000.) This despite Cronje himself calling it “valueless.”
AAVE, Compound, Uniswap, and other projects have seen similar success and stampeded like a herd of unicorns, with market caps above $500 million. And the race, it seems, has only begun. At the time of this writing, the total value locked in DeFi is at $13.8 billion, slightly off its record high of $14 billion, which it reached December 19.
Decrypt’s People of the Year
The “DeFi degens”—a term that has come to describe the self-styled degenerate-gambler traders and builders who are pushing the limits of decentralized finance—are Decrypt’s first-ever People of the Year. We believe that the degens represent the most important and defining movement that occurred in crypto in 2020.
If you were trying to explain the degen phenomenon to a crypto newbie, you’d start by explaining DeFi, sometimes known as “open finance,” itself. The terms encompass a range of financial products built atop a blockchain. A blockchain offers an immutable transaction ledger that’s cryptographically secure enough for people to send money directly to each other without a financial middleman taking a cut.
DeFi, then, does to finance what the Internet did to media: It disintermediates it, unlocks new value, and creates new business opportunities while disrupting the traditional format.
Instead of banks and loan officers and Wall Street bros in Brooks Brothers suits, DeFi relies on computer code, known as smart contracts, which execute independent of human intervention. Its DIY, peer-to-peer nature cuts down on overhead, which saves the substantial fees that traditional finance institutions impose. DeFi also routes around regulators and governments, which allows it to push limits, but also can create enormous risks for the naive.
When all is said and done, however, the ability to print one’s own tokens means anyone can seemingly create new value with a keystroke. Compared to traditional finance, there is an enormous amount of money to be made.
“Traditional finance is boring,” a former Wall Street trader known as DeFiDegen.ETH told Decrypt. “I couldn’t go back.”
You can use DeFi to get a loan quicker and easier than you could at a bank. You can use it to make a loan and collect interest way beyond the traditional market rate. You can collect interest on your crypto savings. You can use it to purchase other cryptocurrencies without providing a social security number.
DeFi is the bleeding edge of fintech. It is the nuclear power from the Ethereum blockchain. Should it become big enough, a meltdown would take years to clean up. But, boy, it’s producing a lot of heat in the meantime.
The birth of the degens
Not all DeFi users are degens; the habitués of the decentralized finance world exist on a continuum. On one end are casual users—the set-and-forget types who have money tied up in a project for the long haul and aren’t compulsively checking on it. In the middle are traders, who are actively working to make money. And on the other periphery are the degens.
The name “degen” is a play on “degenerate gambler,” which implies a certain level of intimacy with the prospects of financial ruin. However, many who are classified as degens would instead describe themselves as traders. They can “experiment,” “speculate,” or “take a calculated risk”—all without losing sleep over any potential losses.
“Degens are traders willing to go above and beyond the normal risk appetite of trading a shitcoin by putting absurd amounts of capital on the line to farm, buy or trade brand new tokens with extreme degrees of risk and even higher returns,” The Defiant contributor and DeFi Rate editor Cooper Turley told Decrypt.
That’s actually a good thing. “Degens are helping to test the fringe use cases of DeFi by pushing it to its limits. It encourages development and experimentation which is a positive.”
In that regard, they’re akin to Arctic explorers or volunteers in medical experiments. But, Turley warned, there’s a dark side, because the outsized rewards can encourage others with less experience to invest in projects they’ve done little research into.
That goes with the territory, suggested Eth Maximalist. “These are guys who know that this is a new frontier.”
According to analytics site DeFi Market Cap, decentralized finance tokens represent about 3% (or $18.8 billion) of cryptocurrency’s total market capitalization of $625 billion. But it is the sector that is pushing the envelope forward by creating new ways to generate, save, invest—and lose—money. It has the potential to bring investment strategies to people who don’t qualify for securities purchases, to get loans into the hands of those who struggle to get bank accounts, and to build savings for a generation that has known only debt.
The crazy money Lego machine
Decentralized finance projects use a concept known as “composability.” Take a whole bunch of different protocols, or systems for communicating with other computers, and mix and match them to compose something new.
At its best, it’s like “money legos.” At its worst, it’s like stacking dominoes atop Jenga blocks. The story of Fulcrum, an online margin trading platform, is a pretty good illustration of the best— and worst—of this new way of building a finance business.
On a Friday evening in mid-February, Tom Bean was walking into an investor meeting in downtown Denver when he got a phone call. As the founder of Atlanta-based Fulcrum, which was experiencing hockey-stick-shaped growth, Bean was feeling pretty good.
The company was an active part of the DeFi ecosystem. According to Bean, the bZx protocol that Fulcrum is built on, was integrated with decentralized exchanges (DEX) like Kyber and Uniswap and DEX protocol 0x, so people could bet on and trade a whole range of digital assets in real time, even exploiting arbitrage opportunities. As of February 14, users had locked $16.6 million worth of crypto into the protocol—a new high for bZx.
“We were likely days away from closing [an investment] round,” he told Decrypt. “We...were pretty psyched about the traction we had on Fulcrum so far and the prospect of VC investment—up until the attack.”
The attack? Phone in hand, Bean and the team ran back to their Denver hotel rooms to do damage control on an exploit that threatened to destroy the decentralized finance startup they’d built.
In the coming hours, they’d discover that the bZx protocol had been drained of $350,000 worth of Ethereum, the second-biggest cryptocurrency by market cap. And before they could fix it, another $645,000 in ETH disappeared days later.
Both attacks were the result of a series of transactions and arbitrage plays so complex that some wondered whether it wasn’t just an example of a customer outsmarting the creator.
But DeFi’s structure—what made it relatively desirable to build Fulcrum/bZx in the first place—allowed it to happen.
Funds are SAFU:
1/*All users have ZERO losses*. Last night there was a widely reported attack that took place against our protocol. From the perspective of the protocol, someone simply took out a loan. From the perspective of the lender, this loan is like any other.
— bZx - Fulcrum & Torque (@bZxHQ) February 15, 2020
The bZx attacker wasn’t just using one protocol, but also several others that protocol interacted with—Compound, Kyber, Uniswap, and dYdX—borrowing money on one to collateralize on another, shorting the price here and swapping there, causing the price to slip so he/she/they could profit.
A perfect storm was brewing. All this was just a few weeks before the world started locking down. The novel coronavirus, at that point thought to be limited to China and cruise ships had, in fact, already started circulating across the globe. Italy instituted a nationwide quarantine on March 9. On March 17, California—the home of Silicon Valley—became the first US state to lock down, followed by America’s financial capital, New York, three days later.
And while DeFi is far from traditional finance and tech, it was not immune. The price of Ethereum, the blockchain most decentralized finance tools are built upon, plunged from $283 on February 13—the night before bZx was attacked—to $111 on March 11.
As a result, the total value of the currency sitting in DeFi protocols was cut in half, with the people who use them on the brink of financial ruin.
Fulcrum, like many traders, just managed to hang on. The initial investment deal fell through, said Bean, but after redoubling their security efforts, it came to terms later. There’s over $18 million in funds locked into the bZx protocol today, a little over what it had in February, and (unlike with some other high-profile exploits) users didn't lose any funds.
It wasn’t just bZx, which represented a relatively small portion of the DeFi market. Users across the board got hit with the money flu. “Lots of people got rekt in March,” DeFiDegen.ETH told Decrypt.
See, in DeFi, if you want to borrow one type of currency, you put up funds in a different type of cryptocurrency—so that it can be a self-contained ecosystem free of regulatory scrutiny or, at least, fiat. To be “safe” in case of price drops, many protocols ask that DeFi traders “over-collateralize,” or put in more money than the loan is worth.
Let’s say you wanted to take out a $1,000 loan in some new digital asset. You already bought some ETH when it was at $283, and you wanted to be super safe, so you put up $2,500 in ETH as collateral.
As the COVID-19 crisis emerged, the price of ETH fell 60% in less than a month, and that ETH on March 11 became worth $980—$20 less than what you would have owed. Your ETH would be liquidated to pay back the loan.
“So you thought you were kinda safe, but you were not,” said DeFiDegen.ETH.
With great risk comes great reward
Why would anyone put up so much collateral in the first place? That’s where the “degens” came in.
“I come from a traditional finance background and the risk in crypto/defi is absolutely crazy,” agreed DeFiDegen. “The thing is: so is the reward.”
The reward, it turns out, flowed like an endless oil well as the degens hit on something known as yield farming.
Basically, yield farming involves lending out cryptocurrency you own in return for interest. There’s a whole cottage industry for people willing to chase crypto rewards at different locales—locking up their funds in one spot until a new shinier spot pops up.
“It’s been fluctuating between 10 and 11% for the last two weeks,” Waves Association’s Sten Laureyssens told Decrypt. He was talking about the annual percentage yield (APY), or the amount of interest people can receive by holding on to Waves’ Neutrino stablecoin. “If we’re going to add more yield on top of that, I think, in the near future we won’t really have any competition in terms of pure yields.”
At least not from banks. The best most traditional savings accounts can offer is a 0.5% annual return. Laureyssens is talking about 20 times that, denominated in a type of crypto meant to hold its value relative to the US dollar.
But Waves is on the more respectable end of DeFi. And 10% is nothing.
According to bZx’s Bean, “New ones lately offer 4000+%. That’s insane.”
The long, hot DeFi Summer
DeFiDegen.ETH explained how insanity came to rule: “People were kinda hung over after March. But then we had ‘DeFi Summer,’ a period where some assets in decentralized finance experienced very strong price growth. This led the market to overextend again, and that also gave rise to the ‘degen culture.’”
So how did DeFi summer happen?
It started with the advent of yield farming, which got a huge boost from Compound, a protocol for generating interest on deposits. Compound released a governance token in June. With governance tokens, anybody who uses a platform or protocol receives a digital asset representing voting privileges.
It’s not much different from holding shares in a public company. The more shares you own, the more power you have. Moreover, just like shares, the price of governance tokens go up or down based on the perceived value of the endeavor.
Yet the philosophy is different. As Compound founder Robert Leshner told Decrypt, “The COMP token created a playbook for decentralizing a protocol which is being used, and improved, by most other teams in the space.”
When COMP was released, nothing much had changed for DeFi since February. The total value of the DeFi market (as measured by user investments in the protocols rather than by the market caps of DeFi tokens) was still around $1 billion on June 1. Over the course of that month it doubled, then doubled again in July. Then again in August.
In other words, in just three months, DeFi had become an $8 billion industry. It’s now at nearly $14 billion.
“I think we'll look back on that moment as kind of being this industry's Netscape moment, which sets off this frenzy of tokens, liquidity mining, yield farming, whatever you want to call it,” said Michael Anderson, co-founder of DeFi-centric VC firm (and Compound investor) Framework Ventures, of the COMP launch. “I think what we've proven in 2020 is that when you have the right financial incentives in place, the power of how you can direct users and engagement is just unencumbered.”
“There were new defi tokens launched every day,” said DeFiDegen.ETH. He noted that the launches provided “very lucrative yield farming opportunities, offering annualized returns of 100-1000%, most of which were completely unsustainable or at times even outright scams.”
It was as if the gold rush had hit right after the Great Depression.
Stani Kulechov, founder and CEO of Aave, a DeFi protocol that lets users earn interest on their funds, said that people quarantining at home helped provide the rocket fuel for yield farming, and governance tokens to take off. “People just were locked down, looking for new things,” he said. “But I think one more important thing is that during this summer, I think we saw more and more inflation-based incentives.”
The flip side of the coin
Everything in DeFi lies on a spectrum of insane to just crazy enough to work. In crypto’s wild west, there are legit projects and venture capital-backed teams, like Compound. There are unaudited projects, such as Cronje’s yet-to-be-released Eminence. There are fly-by-night tokens looking for a sucker. Consumers get to sort them all out.
To DeFi researcher Chris Blec, bZx was the tip of the iceberg. At that point in time, the attack was seen as specific to bZx. But the economic exploits that take advantage of arbitrage and opportunities for price manipulation, he said, are scary. And they’re happening with such frequency—millions of dollars getting taken on a weekly basis—that they’re baked into people’s expectations of the entire industry.
“DeFi has sort of degenerated to the point where people see this as gambling. So they know the risks. They know they're putting money into something that they could lose. And so it's not banking now, it's not.”
Instead, he said, it’s about “‘how can I earn 1,000% of my money this month? How can I adjust that risk with the risk that I might lose it? How can I spread it out across 10 different projects that if two of them go down, I can still make money on the other eight?’ So, a lot of people think it's like there's these victims of these exploits, but they're not. They're willing participants, they know what they're doing, and they're just playing in a DeFi casino.”
Blec is one of the folks sounding the alarm on DeFi, but other crypto Cassandras are actual traders.
“I myself got rug pulled numerous times,” admitted the moderator of WARONRUGS, a group of self-described developers, auditors, and, yes, traders dedicated to exposing DeFi scams and saving dilettante degens from financial destruction.
A “rug pull'' is when someone puts out a new token, gets people to buy it, then exploits the code they themselves created to take off with the funds. It, along with market manipulation, is the scourge of the industry. And the scam is so effective because people often have no idea who they’re dealing with.
“Most of the scams have been done by anonymous owners so far,” said WARONRUGS. Frustratingly, when the group does publicly expose a scam, they said, “Most of the time people aren’t happy because they are a bag holder of that token in question.”
Smart DeFi users simultaneously respect *and* refuse to trust anonymous developers.
— Chris Blec (@ChrisBlec) December 26, 2020
The most famous alleged rug pull was SushiSwap. Spawned by a pseudonymous developer named Chef Nomi, SushiSwap was a clone of crypto token exchange Uniswap—with an elegant twist: It added its own governance token a la Compound. Anyone that staked funds to the project would be rewarded with SUSHI tokens, which were ostensibly useful for voting on changes to the protocol but became speculative assets in their own right. The total value of all SUSHI tokens surged from $6 million on August 27 to $285 million just five days later.
A few days after that, Chef Nomi cashed out of the project, $14 million in tokens in hand.
Then, over Twitter, he handed the administrative keys to the code to a young, rising star in the tech world, Sam Bankman-Fried.
“I was just sort of napping on the beanbag, and all of a sudden there’s some commotion in the office,” Bankman-Fried told Decrypt. “That sort of, like, ate my weekend plans, so to speak.”
In Bankman-Fried’s hands, SUSHI has recovered to become the second-most popular decentralized exchange after Uniswap. But the fact that it was never totally decentralized and trustless—residing in the hands of one person—is what worries many about decentralized finance.
“What I've seen is people in this space, if their first interactions are with Bitcoin, they assume everything is like Bitcoin,” said Blec. “So they assume that everything has this level of trustlessness...but with DeFi, that’s not the case at all.”
“Straight out scams and rug pulls sometimes give the impression that using DeFi is like walking through a minefield,” DeFi trader Limzero told Decrypt. “But I wouldn’t say that they ruin it.
You just have to be cautious where you are stepping.”
Taming the wild west
If 2020 was DeFi’s coming-out party, 2021 could be the last gasp of degeneracy. Where the scams and soap operas are subsumed by the money to be made—or what Framework’s Anderson calls the move from $15 billion to $150 billion.
To Vance Spencer, the other co-founder of Framework Ventures, regulations will help bring this technology to the masses. There will likely remain platforms for gamblers and darknet dwellers, he said. “But, you know, DeFi, if it’s really going to be large, it’s going to be regulated.”
Blec agreed. “The boring stuff—that’s the stuff that could evolve into a new system.” Because they’re not solely concerned with unsustainable yields, Aave and others like it could be here to stay, aided by institutional investment.
That said, he’s not necessarily happy about it. To Blec, that leads to more regulation, compliance with know-your-customer policies that fray away at crypto users’ anonymity, more synergies with banks, and a shift in business models that are antithetical to the libertarian ethos Bitcoin was founded with.
“Who cares about that?” said Spencer. “We’re in this for building this industry into something that’s real, into something that changes finance for the better, not to cater to some Bitcoin maximalist.”
DeFiDegen.ETH also sees it from an idealistic angle: “We are building a superior financial system that is open, inclusive, transparent, fair, and self-sovereign where you don’t need to ask anyone’s permission.”
And, for the right reasons or the wrong ones, it will be the degens that got it there.