Interestingly, while the bitcoin price tumbled last week, it was the ETH price that fueled the broader market declines. ETH suffered from a great deal of sell-side pressure, which is not totally unexpected in light of its meteoric price appreciation in 2020, the reasons for which have two-pronged, Strix Leviathan’s Proudman explained. First, many market participants are heavily levered to the long side in ETH. Secondly, much of the buying activity over the last couple of months can be attributed to the rise of decentralized finance, or DeFi, on the Ethereum blockchain. 

“There are a lot of folks over their skis at the current price level. A pullback is not totally unexpected,” said Proudman.  
For its part, Strix Leviathan’s fund has remained on the sidelines and has not traded any DeFi assets so far, though they are watching the space extremely closely. They have several concerns, chief among which is the mania and price appreciation over the last 30-90 days feels reminiscent of the 2018 ICO bubble, where lots of capital was directed toward untested ideas, Proudman explained. While the ideas themselves may not be bad, it’s unclear how they will play out. He went on to say: 

“This DeFi movement is the first time we’ve had all these interweaving smart contracts. And nobody really understands the risk factors there, particularly when it comes to Ethereum’s price point.” 

Proudman went onto explain how many of the smart contracts in DeFi use ETH as collateral for their activities, whether it’s lending, borrowing or derivatives offerings. They rely on the ability to liquidate ETH in the event the price falls to cover user balances. But gas prices on ETH are trending extremely high right now, which means it might not be possible for a smart contract to liquidate the holdings quickly enough to offset the material decline in the ETH price. 

Proudman harkened back to the massive market drop in the second week of March, detailing that during the dramatic price decline over a couple of hours, protocols had the ability to liquidate assets, adding that the network is congested because everyone is using it on these protocols. 

“If we see a material impact in price, I think there’s a lot of unknown with what could happen with all of the billions of dollars that are locked up on these lending and derivatives platforms,” he said. 

Meanwhile, Proudman discussed the irony in the fact that most decentralized finance protocols are owned by centralized parties or individuals. He added that it is on-chain, and there are compelling and fascinating elements to it. Gas prices are one of these interesting components, and with prices where they are, you’ve got to move large sums of money to offset the costs of executing contracts. 

Ultimately the network is a work in progress, one whose capacity limitations are not lost on Vitalik Buterin or the Ethereum Foundation. Fortunately, Ethereum 2.0 is right around the corner, whenever that will be.