Over the past few months, investors poured billions into hundreds of so-called decentralized-finance apps, which let users lend, borrow and trade cryptocurrencies without intermediaries like banks. Then Sushi happened.
The story of Sushi, a project that’s only a few weeks old, illustrates at once the risks of DeFi’s copy-and-paste culture and the fact that the industry isn’t as decentralized as touted. Back in August, an anonymous entity that goes by Chef Nomi copied the code of another DeFi project, Uniswap, and launched an exchange dubbed SushiSwap. The only difference was that the latter offered its own token, named Sushi, which lured hundreds of millions in user funds within days.
Chef Nomi cashed out in early September, netting about $13 million, leading to a backlash from disappointed Sushi holders and sending the coin’s price down by almost 80%. That triggered a dip across the estimated $15 billion DeFi token sector.
SushiSwap “was a come-to-Jesus moment for a lot of industry participants,” said Nic Carter, co-founder of researcher Coin Metrics. It’s becoming clear that most DeFi projects and tokens, which often entitle holders to a share of revenue, are overvalued, he said.
DeFi is the latest crypto byproduct being billed as revolutionizing finance. Advocates say the software sitting on digital ledgers is supposed to run financial functions without human intervention, and to let participants govern how the services run by using tokens. Problem is, most projects aren’t fully decentralized, but managed by development teams with access to a portion of the funds, as in the case of Chef Nomi, who tweeted later that the funds were returned to the project.
Regulators are also unlikely to take kindly to many of the projects, which are not even checking their users’ identities — and a crackdown is likely coming, according to Carter.
Most DeFi projects use open-source code, which allows anyone to see and copy it. This enables other users to duplicate a product or launch one with slight modifications.
“There’s an easy access point for anyone to create a derivative of your work, and the liquidity moves very quickly,” Carter said. “It’s like being able to copy and paste Apple’s infrastructure and being able to create a competitor instantly.”
This isn’t new in the world of crypto. Many early projects copied, altered or branched off from existing software. Bitcoin Cash is a derivative of Bitcoin, for instance. In the Initial Coin Offering boom of 2017 and 2018, the practice was rampant before pressure from regulators put an end to the sales. More than 2,000 tokens and related projects eventually died, according to tracker Coinopsy, and cost investors billions. Industry observers say that many of the DeFi projects won’t survive.
“The expectation that every forked project will launch a token that is valuable similarly is not a sustainable economic engine,” said Lex Sokolin, global fintech co-head at Consensys, which analyzes DeFi projects and related risks.
What’s different this time around is that many Defi projects are interconnected: Coins from one app are often used in another, in get rich quick schemes such as yield harvesting, for example.
The amount of user money locked in DeFi apps is down nearly 20% since the beginning of the month, but still stands at $7.8 billion, according to DeFi Pulse.
“It’s an evolving situation and as more information comes out things could turn out to be fine, or this could be another scandal that undermines trust in DeFi and crypto in general,” said Aaron Brown, a crypto investor who writes for Bloomberg Opinion. “But anyone who expected crypto to become a major part of the financial system without growing pains and lessons was foolishly optimistic.”