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Ponzi Or DeFi?

To casual observers, much of today’s Decentralized Finance (DeFi) might look like a collection of Ponzi Schemes.

Projects bootstrap by offering high APYs for their token and design complex systems around them to attract DeFi power users who are rushing in to capture short-term high returns. The high APY leads to more and more tokens being released which in turn destroys the price of the project’s coin and leads to a long decline. This sounds like a ‘How to Ponzi’ playbook but of course, the truth is more complex.

Projects that manage to gain sustainable traction and develop use-cases around them can, in theory, escape the downward price spiral.

A controversial yet popular example for this is LUNA, a project developed by Terra Labs. As the chart above shows, LUNA, the system’s governance token, has substantially outperformed both the overall Crypto Markets as well as the NASDAQ recently.

This is mostly due to the popularity of its Stablecoin UST that pays a market-beating ~20% APY. In a bearish market, such a high yield on a Stablecoin is extremely attractive to traders.

LUNA and UST are deeply interconnected. Each time $1 of UST is created, $1 of LUNA is burned and vice versa. The more demand for UST, the more scarce LUNA becomes and the price is pushed up. No other backing for UST exists other than that. It is the market’s 4th largest stablecoin. The ~20% yield comes from various operations such as lending and staking income which the underlying projects generate.

Is this sustainable? Some within DeFi don’t think so. But the LUNA/Terra ecosystem is backed by large funds and its mobile payments platform CHAI is used by thousands of merchants in Korea. Also, the project could decide to decrease its yield at any time, once it moves from bootstrapping to a more mature stage.

In the end, DeFi is a large experiment on economic incentives. What looks like a Ponzi could easily turn out to have been one in hindsight but just as easily it could see the adoption growth required to become sustainable over time.

Whichever way it will turn out, it will seem ‘obvious’ later on. As a popular saying in Crypto goes: ‘DYOR: Do your own research’.