After a prolonged bull run and cryptocurrencies finally going parabolic amid their mainstream attention, sentiments have rapidly changed in DeFi as cryptocurrencies have plunged in recent times. Billions of dollars have been wiped out in market capitalization within a matter of days and DeFi has been constantly blamed and looked at with skepticism, especially after the notorious algorithmic stablecoin, UST depegged and completely shattering the confidence of investors across the space as a result.
In times like these, it’s important to keep your head held high and not let the markets get the best of you. Cycles come and go and preparing yourself to adjust in times of adversity is of the utmost essence. As Charles Dow once said, “To know values is to know the meaning of the market.”
With that said, we’d like to present to you our take on how to behave in times of DeFi winter. Remember, this guide is written from an objective perspective and involves the author’s take on dealing with DeFi in times of bear and is written after their experience in DeFi.
We’ll start with the basics and some of the investing rules written in stone. To put it simply, half of your investments depend on your self-discipline, and the other half on your trades. From a psychological perspective, human actions can easily be determined and judged accordingly.
Step 1: Don’t Over-Invest
It’s important to judge your financial position before investing. Consult with a loved one or an experienced Financial Analyst on your optimal risk tolerance and use that figure as a ceiling, beyond which your investment in cryptocurrencies should not exceed.
Cryptocurrencies are notoriously volatile and your investments should be limited to only “what you can afford to lose.” Remember, if you need money for an upcoming expense, act accordingly and avoid investing that in crypto. The last thing that you need is to be short of a crucial expense. Moreover, always keep excess cash on hand in case you encounter an unforeseen expense.
Step 2: Avoid buying into a “Falling Knife”
Any experienced hedge fund trader will tell you to never buy into a “falling knife”. A falling knife in this instance refers to a sharp drop with no sign of a bottom. It is exactly for this reason that hedge funds buy into “strength” and perfectly time their positions — so should you!
Step 3: Don’t let the Market get the Best of you
As Sir John Templeton, an American-born British investor, and a pioneer in both financial investment and philanthropy, once said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” While trading, it is important to set your emotions aside and avoid making irrational decisions. Emotions are an important psychological feature of any human being and it is normal to have your emotions influence your behavior.
The infamous, “fight, flight or freeze” response is a good example in this case. The fight, flight, or freeze response refers to involuntary physiological changes that happen in the body and mind when a person feels threatened. The aftermath of such a response is taking steps to defend yourself when you feel insecure. This response is your body’s natural reaction to when exposed to danger.
However, DeFi is a whole different ball game and much more volatile than the stock markets. It takes great discipline, strength and determination to train your body to intuitively react in the most optimal manner. For example, a person may panic-sell when they see blood in the market. This is a natural reaction; however, in no way is this the most optimal response. Instead of panic-selling, an experienced trader would judge the market and depending on their outlook, would either hold till they expect a more swift support and bounce back or get out of their positions if they expect more blood.
This is just one of the examples where emotions drive your reactions and it is important to avoid this when aiming for better performance in your trades. To train yourself in preparation for volatility, it is important to take breaks from the charts. Going out for a walk, spending time with loved ones or merely watching a movie is what most people recommend. Knowing when to stop trading is also an invaluable lesson, time your trades and always use technology and the power of charts to judge your entry/exit positions.
Step 4: It is okay to sell at loss sometimes
Contrary to what most people will tell you, it is more than fine to sell at a loss sometimes.
“In this business, if you’re good, you’re right six times out of ten. You’re never going to be right nine times out of ten” — Peter Lynch
Succumbing to selling at a loss is a dilemma that only the strong can stomach. The harsh reality of trading is that you can never be always right and in times of crypto winters, markets are even more volatile hence this is likely to affect your success ratio on trades — no one can perfectly time the market, we are all humans and markets are driven more on just pure technicals. Fundamentals also play an important role here which makes trading even harder.
Constantly re-assess your positions and if you anticipate further weakness, it is okay to sell now and buy at a lower average. Remember, protecting your trading capital is quintessential and most traders use a stop-loss for this purpose.
DeFi specific: How to behave in DeFi
While the above was how to invest in general, the following is more specific to DeFi and contains insights on how to act during times of DeFi Winter.
Step 5: Minimize exposure to inflationary tokens
While it pains me to admit it, unfortunately, inflationary tokens take the most beating in DeFi. More of the same token being printed as “emissions,” increases the circulating supply. While this works fine in bull markets, this model has an inherent flaw and has been witnessing exactly this in fruition. Yield-Farmers are more likely to “liquidate” their yields in crypto winter as they maximize their stablecoin holdings. Furthermore, DeFi Prime indicates that trading volume in Decentralized Exchanges has massively fallen from a former ATH of $140B to a current $60B in volume.
The USP (Unique-Selling-Point) of Decentralized Exchanges is that fees earned from trading volume translate to more fees for token-holders. More volume equals more fees and hence, vice versa. Assuming that emissions remain constant and volume massively declines, token-holders are likely to have less incentive to simply “HODL.”
The above directly correlates to a lower token price for inflationary tokens as volume falls drastically. The effect on token prices is brutal with Sushi falling by around 16x from May 2021 to May 2022.
If you’re still a strong believer in DeFi, buying the gas token here might be wiser owing to fewer emissions (the emission schedule is restricted to what’s mined by validators). The gas token, in this case, is MATIC for Polygon, ETH for Ethereum and so on, so forth.
Sphere Finance is a good example here who in light of market conditions, concluded to end inflationary rebases via migration to a non-rebasing v2 contract for the better and preserve the value of their token.
Step 6: Focus more on Blue-Chip Cryptocurrencies (BTC, ETH, etc)
As pointed out previously, popular DeFi cryptocurrencies are likely to tank more in bear. However, if you still desire to retain exposure to the market, focusing more on Blue-Chip cryptocurrencies would be recommended. Within the same period of time, Bitcoin, albeit volatile itself, is less volatile than most DeFi tokens.
For those that strongly believe in the future of cryptocurrencies, buying in times of bear isn’t a bad option too (as long as you maintain an appropriate Dollar-Cost-Average). Hence, buying into more established, higher-market capitalization crypto results in a “better store of wealth” as opposed to most DeFi tokens.
Step 7: Maintain a stablecoin portfolio
When Crypto Winter pops up, you should be well-prepared and there’s no better way of doing so than maintaining a stablecoin portfolio. You can deploy your assets when you feel that the market outlook is positive and that markets are looking stronger again.
You can further grow your stablecoin portfolio by farming on stable-to-stable pools or simply using Overnight’s USD+ to avoid the leg-work involved in Yield-Farming. There’s no better feeling than watching your stablecoin portfolio grow while you wait for the markets to do their thing.
It’s important to come up with a minimum allocation of stablecoins in your portfolio and stick to your plan — most people recommend at least 50% being in stables in times of DeFi winter.
Step 8: What stablecoins to avoid
It is equally important to avoid certain types of stablecoins owing to doubts about their collateralization aspects. The infamous UST crash serves as a precedent for which stablecoins you should hold & avoid. To be more precise, stablecoins not fully collateralized should be on your list to avoid while those appropriately collateralized are relatively safer. There are numerous types of stablecoins in the Crypto market and avid DeFi users should do their due diligence when making this decision to avoid the same fate as UST.
An Algorithmic Stablecoin is one such stablecoin that is collateralized via its native token (in UST’s case, LUNA). This works fine in times of market strength; however, the inverse is also applicable in times of weakness. Both tokens portraying signs of extreme sell-off adds to the cascading decline in market capitalization. If a depeg situation ever arises, the only mechanism to support the price of the said stablecoin is selling the native token for it (in Terra Luna’s case, the UST bought back via this mechanism was burned). What initially started off as a mild depeg led to billions in capitalization being drained within a matter of days.
On the other hand, the most prominent fiat-collateralized stablecoins are USDC & USDT (hypothetically they are always redeemable for 1$ in fiat). Nevertheless, there have been rumors about Tether’s fallacious claims and a lack of transparency regarding its collateralization aspect. Though unverified and merely rumors, they are also factors to consider.
The matter at hand, algorithmic stablecoins should be avoided at all costs. We’d recommend reading up on the project’s Whitepaper and docs or simply engaging in conversations with fellow DeFi enthusiasts to improve your understanding of them.
Step 9: Focus on Liquidity Mining with less Impermanent Losses
We all get attracted to chasing ridiculously high APYs — it’s human nature to follow where the gains are. However, emissions also result in equivalent sell pressures. Hence, for this purpose, we’d recommend farming with stablecoins to avoid Impermanent Losses (the net difference between the value of cryptocurrencies you provided Liquidity at versus the current value of the same set of assets).
If you’re looking for something more Yield-worthy, then farming via USD+ is also more lucrative than with other stablecoins owing to the APYs that the stablecoin generates via its collateral (deployed on a set of stable-to-stable pools).
Chasing mind-blowing APYs via stablecoins is equally questionable. Anchor, Terra Luna’s blue-chip and a key player within the Terra ecosystem, provided its users with a meticulous 20% APY. However, with UST in shambles, so is the protocol. Hence, yields with more than 10–12% APY should immediately raise red flags. However, there are circumstances where this is exempted. To be more precise here, if APYs are financed by internal rewards (native inflation for the said stablecoin) then they should be avoided. However, if the inverse persists (i.e, external rewards, e.g, in BOO, QUICK, DYST, etc) then they’re acceptable.
Step 10: Hedging your assets
Yield-Farming entails Impermanent Losses. However, if hedged accordingly, can resolve the flaws that it poses and better manage your risks. When sentiments are negative, it may be better to “borrow” an asset rather than simply “buying” it to Yield-Farm with it.
An example of this strategy can be user A wanting to farm MATIC/USDC but the said user is hesitant about acquiring non-stable assets and hence, borrows it on AAVE by providing their USDC as collateral. The user maintains an LTV (Loan-To-Value or how much you’ve borrowed against your collateral) of no greater than 50% to avoid the risk of liquidation and constantly re-evaluates their position. Yield-Farming via MATIC/USDC earns User A 60% APY and the user pays roughly 5% as borrowing interest on their USDC — the difference is profited by the user.
However, this strategy is nowhere near perfect and requires constant monitoring; it’s only recommended if you feel that you have an appropriate risk tolerance and the ability to monitor your position on a regular basis.
If the phenomenon of hedging interests you then you can start with lending your USDC (keep a reserve on-hand to LP with the corresponding MATIC borrowed) on AAVE and borrowing MATIC against it; we’d recommend an LTV of 50% if you’re starting out and then regularly checking up on the position. You can then provide liquidity via your MATIC against more of your USDC and then stake on DEXes like Dystopia or Quickswap to earn DYST or QUICK respectively. You can then harvest your rewards at regular intervals and liquidate that for more MATIC to repay your debt. Keep repeating this cycle until you’re satisfied with your earnings or until your debt is extinguished (this may take at least 1-2 years but the effort is well worth it). If your LTV crosses a certain threshold (e.g, 75% owing to MATIC surging) then make sure to liquidate a portion of your LP tokens for more MATIC and repay that debt to avoid a liquidation (the liquidation threshold for most lending protocols is above 95% and a liquidation results in you losing a portion — usually 10% — of your holdings).
If a more simplified version of hedging is something that you’re interested in, then you might want to take a look at Overnight’s upcoming product: hedged wMATIC/USD+. You can find more info about it here.
Step 11: Avoid Keeping your Crypto on Exchanges
Lastly, as they say, “not your keys, not your coins.” This is applicable in pretty much any scenario involving a centralized, custodial crypto exchange. However, the risks of you losing your funds stored on such exchanges is even greater in times of a bear market. With Celcius and other prominent centralized platforms being on the edge of bankruptcy, the phenomenon of self-custodianship is even more important.
Consider what might happen if the said exchange crashed with billions of dollars on the exchange ending up insolvent.
Hence, for this purpose, we’d advise opting for a non-custodial wallet or better still, a hardware wallet (Ledger, Tezos, etc) to avoid being stressed out about such conditions if/when they occur.
Concluding Note: The Crypto Winter isn’t the end of DeFi
We’d like to end things on a high note: this crash does not mean that DeFi is dead. Cycles have come and gone in countless times in history, bitcoin has been dubbed “dead” several times while invalidating such statements at every step of the way. Markets will evolve and battle-testing them will result in innovation resolving their flaws.
Decentralized Finance has paved the way to a decentralized economy where no centralized entity holds the ability to “pull the plug” and market forces themselves act when needed. The ability to trade permissionlessly and lend on decentralized lending/borrowing protocols without undergoing a KYC is truly invaluable — a phenomenon that no centralized entity can match.
We hope that the above serves of value to you and let us know your thoughts on how you plan to survive in times of DeFi winter.
Note: This Content is for informational purposes only; you should not construe any such information or other material as legal, tax, investment, financial, or other advice from it. All Content above is information of a general nature and does not address the circumstances of any particular individual or entity. Make sure to consult with your local jurisdiction on the necessary frame work before investing in Crypto. In addition, always make sure to DYOR before investing in anything, be it in DeFi or TradFi. The author has mentioned above practices that they are actively partaking in and are sharing them for spreading knowledge among those that are new to the space.
