The DeFi ecosystem has been growing at a rapid pace, with investors jumping on board to take advantage of the opportunities presented. However, this environment has also created its own set of risks. As the value of crypto assets fluctuates, DeFi projects are becoming increasingly susceptible to liquidation events which could lead to sudden and significant losses for investors.
Following the 45% decline in the crypto market since November’s all-time high, investors are now focusing on the impact of leverage on earnings. Platforms such as DAI provide platform users with the ability to liquidate collateral put up as collateral for borrowings.
Data from The Defiant Terminal showed that liquidations spiked to 1,692 on Jan. 23, the highest level since late May 2021 when DeFi’s largest protocol crashed.
Aave experienced its highest level of liquidations since late May with 95, as did MakerDAO, the second largest protocol in the DeFi family.
Defiant Terminal data shows that while Aave liquidations topped Maker’s in terms of overall volume, Maker’s dollar value of liquidations peaked at $118.8M on Jan. 21 compared to $61.13M for Aave on Jan. 22.
On Jan. 21, the Maker protocol’s founder rane Christensen discussed the Maker liquidations on Twitter, saying there was over $600M in ETH at risk at the time. The liquidation story in this selloff is important because it represents a big test for DeFi in a high-stress period. The $600M in ETH hasn’t all been liquidated, but it represented the highest amount liquidated in Maker in the past year. Even though users have been hit by liquidations in the past week, DeFi has continued to function as intended, which is a good sign for the long run.
DeFi Protocols for lending (MakerDAO)
DeFi protocols such as Aave and Maker put users at risk of liquidation when they borrow against collateral. Essentially, these lending protocols allow users to borrow assets, such as Maker’s USD-pegged stablecoin DAI, if they are willing to lock up assets such as ETH.
In Maker’s most popular vault, users can borrow a maximum of 145% of their collateral which means they can borrow $68,966 of DAI against $100,000 of ETH before they are liquidated.
Users often borrow in order to “lever up” on their crypto positions. Leverage on ETH is achieved by depositing ETH into Maker, borrowing DAI against it, and then trading the DAI for more ETH, essentially increasing a user’s storage of the cryptocurrency in exchange for liquidation risk and Maker’s interest rates.
What’s Next For Ethereum?
The value of tokens may continue to drop, which will put pressure on the market and worsen liquidations. Ethereum has declined by 25% over the last week, coming down to $2,401. This is a price level web3 enthusiasts haven’t been at since July when cryptocurrency was recovering from a brutal sell-off in May.
Other major L1s (layer 1) are also experiencing losses – In fact all major L1 smart contract platforms have lost 20% of their worth in just seven days according to CoinGecko data. The exception is that Traw’s LUNA token has only dropped 16%.
Finally Cosmos’ ATOM – arguably categorized as an L1 though not classified as a smart contract platform by CoinGecko – drops 8% during this time span too.
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Author
Chris Munch is a professional cryptocurrency and blockchain writer with a background in software businesses, and has been involved in marketing within the cryptocurrency space. With a passion for innovation, Chris brings a unique and insightful perspective to the world of crypto and blockchain. Chris has a deep understanding of the economic, psychological, marketing and financial forces that drive the crypto market, and has made a number of accurate calls of major shifts in market trends. He is constantly researching and studying the latest trends and technologies, ensuring that he is always up-to-date on the latest developments in the industry. Chris’ writing is characterized by his ability to explain complex concepts in a clear and concise manner, making it accessible to a wide audience of readers.
