Are DeFi Tokens a Separate Asset Class from Conventional Cryptocurrencies?

We test for the existence of bubbles in DeFi-focused cryptocurrencies, seeking to identify key driving forces that distinguish DeFi tokens from conventional cryptocurrencies. Conducting Supremum Augmented Dickey-Fuller, and Hacker-Hatemi-J modified Wald tests, as well as Diebold-Yilmaz return and volatility spillover analysis, results evidence the presence of bubbles in key DeFi assets during the third quarter of 2020. Additional causality analysis suggests that, while Bitcoin has a causal nexus with most conventional tokens, amongst DeFi it only causes Link and Mkr. According to Diebold-Yilmaz test results, while spillovers of returns and volatilities between the conventional and DeFi markets are predominantly between Bitcoin and Mkr, contra general views about Bitcoin’s dominance, Ethereum is found to be the leading cryptocurrency influencer of conventional tokens. However, we do not observe Ethereum or Bitcoin causing bubbles in the DeFi market. Rather we find Link and Mkr are primary contributors, in terms of returns and volatilities, to DeFi bubbles. Results of our analysis suggest that the DeFi market should be viewed as a separate asset class from conventional cryptocurrencies. However, this view is slightly nuanced, with strong correlations between certain DeFi tokens and Bitcoin. DeFi tokens that are particularly prominent (Mkr and Link) are closest to acting like conventional tokens. Our findings suggest that groupings of cryptocurrencies manifest as separate asset classes; therefore the operational process of portfolio construction needs to consider inclusion of DeFi cryptocurrencies in order to optimize diversification