The return of (I)DeFiX

TL;DR

This paper introduces DeFiX, a new index for DeFi tokens, and finds that cryptocurrency market exposure significantly influences DeFi returns more than other factors like network effects or investor attention.

Contribution

The paper designs a dedicated DeFi market index and empirically analyzes the drivers of DeFi returns, highlighting the dominant role of cryptocurrency market exposure.

Findings

DeFi tokens returns are driven by investor attention and network variables.

Cryptocurrency market exposure has the strongest impact on DeFi returns.

The TVL/MC ratio does not predict DeFi market movements.

Abstract

Decentralized Finance (DeFi) is a nascent set of financial services, using tokens, smart contracts, and blockchain technology as financial instruments. We investigate four possible drivers of DeFi returns: exposure to cryptocurrency market, the network effect, the investor's attention, and the valuation ratio. As DeFi tokens are distinct from classical cryptocurrencies, we design a new dedicated market index, denoted DeFiX. First, we show that DeFi tokens returns are driven by the investor's attention on technical terms such as "decentralized finance" or "DeFi", and are exposed to their own network variables and cryptocurrency market. We construct a valuation ratio for the DeFi market by dividing the Total Value Locked (TVL) by the Market Capitalization (MC). Our findings do not support the TVL/MC predictive power assumption. Overall, our empirical study shows that the impact of the cryptocurrency market on DeFi returns is stronger than any other considered driver and provides superior explanatory power.