Daily Market Update - August 4, 2020 (Explore Defi)

$BTC 24 Hour High $11,453.08 $BTC 24 Hour Low $11,112.21 $BTC +1.62% 

Total Market Cap $343 BN (+0.88%)

24 Hour Volume $97 BN (+8.99%)

Notable DeFi Movers Meta (MTA) (+39.69%) Ampleforth (AMPL) (-10.88%)

BTC Dominance 60.3% (-0.66%)

$BTC climbed for a second consecutive day (from 11,000 to 11,360 levels) off 22.6B physical traded volumes, traded range around 300 with decreased volumes from overnight. 

$BTC futures seeing a drop off in volumes, dropping about half from 31B->14B overnight as volatility cools off. Open interest bouncing back from 4B to 4.8B after the massive liquidations logged yesterday. Only 30.7M liquidated overnight (22.9M Long, 7.8M Shorts)

Alt watch: All top 10 alts in the green, notably….

  • $XRP moving past 0.30 resistance with a +6% movement, currently trading at 0.315 off. overbought RSI levels. XRP cofounder Jed McCaleb owed $9B upon his exit from Ripple Labs, noted to be selling US$375K equivalent to 1.74M tokens per day, but not enough to affect the market as per Whale Alert.

  • DeFI coins regained momentum once again, market cap increasing to 9.6B, up from 7B range last week.

  • Seeing $LINK push past 9 levels with +12% movement overnight after failing to break through 8.0 for the past two weeks. Trading at upper Bollinger bands and $1.33 above its 10D SMA. 

  • $SNX up now to 4.31 with large $1 trading range volatility swings every other day for the past week. Currently at overbought RSI levels. 

DeFi’s Breakout and Why it Matters: Real Value Accretion and Governance

Written by Arca VP of Portfolio Management: Hassan Bassiri, CFA 

Decentralized Finance (DeFi) has come into its own in 2020 with a total market value of ~$4.1 billion, which still pales in comparison to Layer 1 valuations ($45 billion), and barely registers on the radar relative to the size of traditional centralized financial products (insurance, asset management and lending platforms). Nonetheless, the 600% YTD growth rate of value locked in DeFi products and subsequent token outperformance can be attributed to two primary factors:

  • Real (non-inflationary) yield in the form of exogenous cash flows

  • Community Involvement / Governance

The mechanics behind how DeFi applications work can be complex, but the basic premise is quite simple. These platforms turn non-productive assets and investments held on users’ own personal balance sheets into productive assets that can be lent or staked to earn a yield. By rewarding you for using their platform, these platforms bootstrap customer growth faster than normal startups, and once a community of customers develops, they ultimately hand the keys over to their growing communities to make key decisions.   Simple in concept, complex in operation. Let’s explore each of these primary factors further using a few examples.

1. Exogenous Flows Create Value for Token Holder

There have been many iterations of token models and monetary policy. Some are inflationary, some are deflationary, and others are flexible. Compared to a pure inflationary model (which is actually just a tax on non-stakers), DeFi protocols are generating real yield for their users (“DeFi Farmers” or “liquidity miners”) via exogenous “cash flows” coming from other protocols.

For example, Aave is a lending/borrow protocol similar to Compound. When Aave v2 launches, users that stake AAVE tokens in a Balancer pool will effectively become the “equity backstop” for the system in the event of a liquidation shortfall (similar to how MKR holders backstop the stabletoken, DAI). In exchange for assuming this risk, aave stakers will receive:

i) 90% of platform fees (paid in ETH/USDC) ii) Balancer (BAL) tokens

iii) Balancer pool trading fees (paid in ETH)

iv) AAVE inflationary rewards

With the exception of iv, all of these represent real yield to AAVE stakers. In AAVE’s model, participants can realize a return selling USDC/BAL/ETH without adding constant selling pressure to the underlying AAVE token, but they also have the option to reinvest/stake those returns in the Aave platform to effectively own a bigger part of the network (thereby entitling them to more future flows). Re-investing exogenous flows not only creates buying pressure for the native token, it acts as a velocity sink (i.e. less circulating tokens), and as more and more tokens are staked, the total value locked (TVL) of the network increases, making the protocol more secure and more visible to other DeFi users and investors). In our view, exogenous cash flows are the key to long-term value accretion for token holders because they actually reduce the selling pressure on the native token and help bootstrap positive, reflexive behavior. This is quite different from the Compound model, where liquidity miners recycle assets to mine COMP and then immediately sell COMP to offset their interest expense.

In other words, when using Aave, you generate yield by holding AAVE tokens, whereas when you use Compound, you generate yield by selling COMP. It’s no surprise then that Aave’s native token (LEND, which is becoming AAVE) has gone straight up, while Compound’s token (COMP) has gone straight down. Token accretion models matter.

Further, when comparing Aave’s token accretion model to that of most Centralized Exchanges (BNB, FTT, LEO, HT, etc.), it’s easy to understand why investors are flocking towards DeFi. When an exchange conducts a buyback and burn of its native token, it’s symbolic, but there is no real value accretion for holders because no actual cash is received. A token holder can still be rewarded, but only if the token accretes value due to scarcity, without really having any control / voice on the decisions made by the exchange. Again, token accretion models matter.

2. Community Governance ~ Equity Voting Rights

We’ve established that cash flows matter, but arguably the biggest driver of DeFi’s recent success is in its Community / Governance. There is an old adage in the digital asset space that “community is everything” -- with the success of Synthetix (SNX) and ChainLink (LINK) serving as prime examples. The latest emerging trend in DeFi is putting control of the platform into the hands of the community - e.g., SNX is winding down its Foundation and turning control over to 3 DAOs and Aave’s proposal to migrate to a governance token will allow the community to decide how inflationary rewards are split between stakers and liquidity miners, which assets get listed on the protocol, collateralization ratios, interest rates, and more.

Giving users the right to vote as though they were equity holders not only decentralizes the network, but also forces engagement because it ties the future value of protocol to decisions the community makes today. It’s pretty apparent that governance matters to DeFi users, but what are those voting rights worth?

Enter YFI - The DeFi Aggregator

We can put the value of governance in perspective by studying Yearn.Finance (“YFI”), an automated Decentralized Finance (DeFi) yield aggregator built on Ethereum. Yearn works by automatically depositing stablecoins into the highest yielding lending/borrowing protocols (AAVE, Compound, Curve, and DyDx).   As DeFi has exploded, finding the most beneficial rates across all platforms has become a much harder and more time intensive task - even for the most experienced user. Yearn aims to reduce the barriers to entry, increasing the capital pool by attracting new users and making other DeFi protocols more valuable. In other words, it’s as if you had a computer that automatically took your idle cash and deposited it into the highest yielding savings account across all global banks, all day, every day, without you needing an account with any of the individual banks.

Created by Andre Cronje on 7/17/20, the YFI token has no VC backing, no pre-mine, no ICO and no founders reward. The original 30,000 tokens created had to be “earned” via liquidity mining and Andre has explicitly stated that the token has no value at all. Nonetheless, YFI is currently trading at ~$4,000/token and has a $120 million market cap. Why? Our past write-ups have touched on this, but it’s worth repeating… successful projects typically have three key similarities, and YFI is no exception:

  1. Product market fit (PMF)

  2. Well-designed “tokenomics”

  3. Community / governance

1. PMF - YFI as the DeFi Aggregator

Given that DeFi has proven product market fit in the digital assets space, YFI as an aggregator of these protocols should also have value. Ben Thompson’s Aggregation Theory requires that three things be true for an aggregator to capture value (with a hat tip to Messari):

  • Direct relationship with users? Yes, users can go to Yearn to lend their assets

  • Zero-marginal cost for serving users? Yes, it’s free to optimize another user’s deposit

  • Demand-driven multi-sided networks with decreasing acquisition costs? Yes, in our opinion

The last requirement is such that when users come to the YFI platform it becomes more attractive for suppliers (other DeFi protocols) to join too because it makes each protocol more valuable and draws in more users, which in turn reduces customer acquisition costs for the platform (in this case, YFI). There is an established symbiotic relationship between other DeFi protocols and YFI where both can accrete value to users. A real-world example would be Expedia or Travelocity and its airline/hotel counterparts -- while each airline/hotel may prefer to draw customers directly to their own websites (and have tried), the aggregators make the user-experience easier, and after achieving critical mass, the hotels/airlines no longer have a choice but to participate.

Before YFI, Curve Finance (CRV) had $100 million in Total Value Locked (TVL). When YFI farming began, CRV TVL jumped to $400 million within a week and even after liquidity mining incentives ended, CRV continues its upward trajectory.

As a result, YFI is now more valuable because DeFi protocols compete to be a part of the ecosystem (value by association), and YFI holders can vote on which projects to integrate and which yield farming strategies to implement so that ultimately those underlying cash flows accrete value to the governance token.

YFI is also not just a yield aggregator for stablecoins. The second iteration of the network (YFI v2) will have a more user friendly dashboard and will introduce a whole new set of yield tools previously only accessible to the most experienced DeFi coders, such as: ytrade (finding arbitrage opportunities), yliquidate (the ability to bid for liquidated assets), yleverage (taking advantage of funding rates), ypool and smart contract credit delegation lending. Token holders may be able to control how capital is allocated to various strategies and how creators are compensated for publishing those strategies.

2. Well Designed Tokenomics

Originally, there were only 30,000 YFI tokens which could be “earned” via liquidity mining and by participating in the governance process. The first pools distributed 10,000 each via the CRV and BAL pools of 98%/2% DAI/YFI and 98%/2% yCRV /YFI.

Scarcity value (30k initial supply), imbalanced pool ratios (when a user contributes DAI to a 98%/2% YFI Balancer pool they’re essentially market buying YFI) and staking YFI to earn more YFI within a 10 day distribution period all combined to drive up the token price. Whether YFI will retain/enhance its value will be up to its community, which will vote on future supply and inflation. Voters have to balance the need for future inflation to incentivize the Founder (who owns very little of his own token) and attract liquidity providers versus over-inflation / dilution.

3. Community / Governance

YFI is truly decentralized in the sense that any change to the ecosystem goes through on-chain voting and proposals. YFI is only two weeks old (compared to AAVE and SNX which have been established in this space for over two years), and there are already 31 YIPs (YFI Improvement Proposals), an extremely active Discord, and a Telegram group with over 1700 active users.

However, the decentralization process happened so quickly that there will be, and have been, bumps in the road. YFI has already been forked numerous times (YFII,YFIII, etc.), Quorum had to be reduced to 20% in order for proposals to pass, and only YFI holders can vote rather than Balancer pool token (BPT) holders as a BPT represents 2% YFI. More importantly, to date the only concrete decision that the community has agreed upon is that there will be future inflation; however, the emission schedule and its allocation (between LPs, founders, etc.) has not been finalized.

What Does the Future Hold?

It’s fair to say YFI is in the early stages of a governance experiment. Price action will be extremely volatile, fluctuating daily as the market attempts to find equilibrium with the odds of each proposal passing. While no one knows what the future holds, it’s evident that the YFI community is willing to risk a lot of capital to voice their opinion on the protocol’s future because they see a massive total addressable market (TAM) both for DeFi and for YFI as the primary DeFi aggregator.

Whether YFI token holders are able to come together and pass proposals in the best interest of the protocol (and whether the market agrees) remains to be seen, but it will be fascinating to watch it all unfold. Regardless, YFI perfectly exemplifies why DeFi matters, and how value accrues in the form of governance and tokenomics.

As Jack Purdy of Messari wrote recently:

“Since crypto operates in this regulatory gray area, even US-based projects (albeit somewhat decentralized) have been able to pursue this equity-like giveaway in the form of tokens. These early projects are pioneering a growth hack that will lay the groundwork for many similar models in the future. While the yield-farming craze may seem like the next get-rich-quick scheme on the surface, it represents a novel means of incentivizing a large number of people to perform valuable services for an early-stage network addressing the critical chicken and egg problem of any financial marketplace.
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