Macroeconomic changes and US Federal Reserve (FED) interest rates impact investors’ risk appetite and therefore decentralized finance (DeFi) activities.
Every time the Jerome Powell-led organization made cuts, the DeFi sector benefited. When interest rates fall, risk appetite resurfaces and more deposits flow in. Loans, Staking, and yield agriculture,
As usage of the pool increases, the interest rate curve pushes up the effective interest rate, which in turn increases the protocol’s interest and fee income. It’s not automatic or linear, but the DeFi sector tends to benefit in situations like this.
But let’s review to understand How the DeFi sector acted in response to the FED’s monetary policy decisions.
2020 interest rates
During the pandemic, the Fed lowered benchmark interest rates to historic lows to stimulate the economy. This environment of cheap funds and abundant liquidity sparked a DeFi boom as investors sought profitability in a situation where traditional products had near-zero returns.
Difference between DeFi returns and traditional financial system returns It fueled a speculative wave that increased the total value locked (TVL) by 15x. With protocols such as Aave, Compound, and Uniswap.
“DeFi returns have far exceeded the near-zero interest rates of traditional finance (TradFi), making a notable difference in attracting significant capital inflows to the sector and raising the TVL of decentralized finance from less than $1 billion at the beginning of 2020 to $15 billion at the end of the same year,” the report authored by Aave Labs highlights.
In the following graph, you can see the relationship between interest rates (green line) and DeFi ecosystem activity, measured through TVL and Aave deposits.
Aave Labs believes that this period yield agriculture. The user They lent, deposited, and provided liquidity to earn tokens and special profits.
“In 2020’s near-zero interest rate environment, demand for yield was a key catalyst for ‘DeFi Summer.’ “This period was a critical period driven by yield farming and liquidity mining programs that attracted new participants and substantial liquidity to DeFi protocols,” the report highlights.
“DeFi Summer” ends after rate hike
Following the inflation caused by monetary expansion during the pandemic, the Federal Reserve began an aggressive interest rate hike cycle in 2022, leading to significant capital outflows and beginning the so-called “cryptine winter.”
but, The DeFi ecosystem has passed through a maturation stage. The inflated profit model has been replaced by a more sustainable model based on the real profits generated by economic activity itself.
“This has led to the creation of new yielding assets such as liquid staking tokens and restaking tokens (LST and LRT), along with yield-producing stablecoins (a feature not found in USDC and USDT). Rising interest rates have prompted fund managers and crypto allocators to optimize their idle holdings of ETH and stablecoins, as rising interest rates increase the opportunity cost of holding non-yielding assets,” the experts explained.
In other words, investors want money. “Work” even when you are not actively workingeach token is utilized to generate some sort of return through mechanisms such as staking.
As reported by CriptoNoticias, in October the Fed cut interest rates by 25 basis points to 4%. It remains to be seen whether this marks the beginning of a new cycle of financial flexibility. However, unlike in 2020, interest rates are not expected to return to near-zero, although conditions are once again favorable to assets considered at risk.
If the easing trend continues, funds may flow into DeFi again, but this time A more selective and less speculative market And we focused on projects that have a good combination of stability, transparency and profitability.
