Is the DeFi craze overvalued by $2.8 billion?

Whether you think it’s a bubble or not, decentralized finance certainly has all the markings of the ICO craze. The industry has seemingly come out of nowhere since 2020 began. According to DeFi Pulse, the total value locked in protocols has surged nearly 900% to hit $6.75 billion Aug. 20, with much of that growth concentrated in July and August.

You’d imagine that champagne corks would be flying as the founders of Maker, Aave, Curve Finance and Synthetix toast their success. But Damir Bandalo, the founder of the blockchain development community Encode.club, has performed research that could bring the DeFi sector crashing back down to Earth. He tweeted:

“A lot of talk these days around the total value locked in DeFI. However all of them count the same $ many times. So I did my own calc to find out how much is actually locked in top 15 DeFi protocols. Answer: $3.5bil compared to $6.7bil on @defipulse).”

At the time of Bandalo’s analysis, however, the DeFi Pulse figure was just $6.3 billion, which is why Bandalo put the discrepancy at $2.8 billion.

Bandalo’s revelation has the potential to be acutely embarrassing for DeFi Pulse, which has fashioned itself as an authority on the movers and shakers in this complicated and often misunderstood industry. If a finance tracker in the old-fashioned world of stocks and bonds was to make such a miscalculation to the tune of billions of dollars, the company in question probably wouldn’t recover from the damage done to its reputation.

Explaining how he figured out there was a $2.8 billion shortfall, Bandalo said that the way the DeFi industry is built “makes it hard to accurately count how much money is truly locked in the system. Ether can be deposited into MakerDAO to mint DAI—and in turn, that DAI can be deposited into Curve Finance, before making its way to other protocols. “Your $ can actually be counted five times,” he wrote.

Overall, he found that just 3.85% of Ether and 0.18% of BTC is actually locked in DeFi—statistics that Bandalo says shows that DeFi “has a lot of room to grow.”

Perhaps feeling guilty that he had rained on DeFi’s parade, Bandalo later wrote:

“This sounded a little too negative. Not my intention. Let me clarify. DeFi growth is still incredibly impressive & @defipulse are amazing. This is just my attempt at calculating real new value outside of DeFi locked in. That’s all.”

What say you, DeFi Pulse?

As you’d expect, given the circumstances, Modern Consensus wanted to talk to Damir Bandalo about his research. We also reached out to a DeFi Pulse representative with three questions. Does it agree with his analysis? Had the website accounted for the fact that the same dollar could be counted twice? Does it plan to change its calculations?

Sadly, we didn’t get a response from Bandalo—and instead of answering our questions, DeFi Pulse directed us to a Twitter thread written by co-founder Scott Lewis. (A representative later told Modern Consensus through the Discord messaging app that the site is planning to change its calculations in the next iteration of its indexer, but it is unclear what effect this would have on the aggregate total value locked figure.)

Back to Lewis’s Twitter thread. Four days ago, on Aug. 16, he wrote:

“We work really hard to remove double counted assets from @defipulse exactly to avoid this problem. The TVL only passed $6B today, for the first time ever, and has never sniffed $6.7B. If you find one we missed, please let us know. Error 1: TVL has never hit $6.7B. Full stop.”

Elsewhere, Lewis said it is right to treat DAI as a new asset, as failing to do so means “you’d also have to strike every other world currency whose value is backed by a reserve of dollars and gold.” He concluded:

“DeFi is changing very fast, and clarifying the TVL edge cases is something that we take very seriously at @defipulse. We will continue to maintain the best definition of TVL we can as DeFi grows, and eventually fully ossify when that is appropriate.”

Bandalo didn’t appear to fully buy Lewis’s explanation, replying: “Didn’t mean to be critical or call you out. I used DeFi Pulse as an example because it’s the one I use day to day. That said, definitely some double counting going on I think.”

The confusion all points to an industry that’s in a frenzy—and for less experienced crypto investors who are tempted by the astronomical gains in the value of some DeFi coins, there’s a real chance of danger. Yearn Finance recently released a token that was meant to be “completely worthless”—but in the space of a month, it’s skyrocketed from $871 to $15,073.78.

Even though the Ethereum network is the home for many DeFi protocols, the blockchain’s co-founder Vitalik Buterin has warned the public to tread with care. On Aug. 14, he tweeted:

“Reminder: you do NOT have to participate in ‘the latest hot DeFi thing’ to be in Ethereum. In fact, unless you *really* understand what’s going on, it’s likely best to sit out or participate only with very small amounts. There are many other kinds of ETH DApps, explore them!”