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The total lock-in value is a useful indicator for the overall DeFi adoption rate, but it hardly tells the full story of the true adoption rate and product market applicability.
” DeFi Development Status Report: What stage do you think DeFi has developed? 》
Written by: Glassnode
In just 8 months, DeFi has attracted more than 100 billion U.S. dollars into smart contracts. These contracts not only realize what traditional finance can do, but also bring new financial primitives. These innovations provide individuals with new opportunities to truly own their own assets, participate in global capital coordination, trade through decentralized exchanges, and use lending markets.
In this article, we will explore the current status of Ethereum-based DeFi and study the key indicators that help us understand its explosive growth and availability.
The grassroots evolution of DeFi
DeFi is both a technology and a sport, where teams of researchers and engineers unite to reimagine financial services. Since the early days of smart contract innovation (such as raising funds through ICO), to early NFT experiments (such as CryptoKitties) and the initial DEX implementation (the earliest hint of a decentralized future in finance), the field has gone for a long time. road.
The above chart shows the explosive growth of user base and value in the DeFi ecosystem. What we see is the new spirit behind the perfect combination of innovation storms and financial incentives. The entire community is self-sufficient by incentivizing participation in the DeFi protocol. Incentives that encourage users to switch to products that effectively grow and retain users and capital.
In 2019, Synthetix became the first DeFi project to carry out a DeFi liquidity mining experiment. In this experiment, users are encouraged to provide liquidity to the sETH / ETH Uniswap pool. This later inspired a wave of income farming projects in 2020, especially after Compound Finance launched COMP token liquidity mining in its lending market.
The introduction of the COMP incentive mechanism to encourage lenders and borrowers to earn COMP tokens made the agreement popular-the total locked value of the agreement jumped from US$100 million to US$500 million within a week.
The key innovation here is actually a social innovation, because participants are rewarded with governance tokens that provide liquidity and use protocols.
How to measure the adoption of DeFi?
The growth of DeFi can be expressed in many ways, the most intuitive way is to measure active users. Since the beginning of the DeFi experiment, the growth of users has been explosive. Since the beginning of 2018, the number of unique addresses that interact with Ethereum DeFi in some way has exceeded 2.1 million.
Data source: Dune Analytics
If we consider that every Ethereum address is part of the entire addressable market (TAM), then we can say that DeFi has penetrated less than 3% of non-zero Ethereum addresses (~58 million addresses) so far. As the adoption rate of Ethereum grows, the potential TAM for DeFi applications will also increase.
The “Total Lock-in Value (TVL)” metric has been popularized to describe the total assets deployed in smart contracts. In the TVL concept, lock, deposit, store, send, lend, provide, these terms have the same meaning. In the exchange, we can treat these assets directly as liquidity, while in the loan agreement we can treat them as collateral.
Source: DeFi Llama
The relevance of TVL varies from protocol to protocol, so it should always be considered along with utilization, transaction volume, and other usage indicators. The utilization rate describes how much supply-side liquidity is being used productively by the demand side of the agreement. Take the classic environmental protection example of the lemonade stand as an example:
- Suppose I produce 100 glasses of lemonade every day. The quantity that can be used on the demand side is 100 cups.
- Now, suppose that the demand side buys and consumes on average 70 of these cups every day. That is 100-70 = 30 cups of unused lemonade. We can assume that, as a supplier, I might start to reduce the amount of cups made every day to meet demand more closely.
- But wait. What if the local government comes in and says that they will subsidize my lemonade stand by buying an additional 30 cups a day, regardless of usage (which is roughly equivalent to the liquidity mining reward provided by the agreement)? Now, we have a reasonable reason to continue supplying 100 cups a day.
Therefore, although the $124 billion TVL may fluctuate back and forth, this is a nascent market in which money will flow to wherever the best risk/return is expected. If users are scarce, but liquidity incentives are strong, then rational participants will seize these opportunities. In order to determine whether these protocols are developing a loyal user base, we must delve deeper into the metrics that describe the stickiness of end users and liquidity providers.
DeFi protocol type adopts
Loan agreements attract people’s interest because users are attracted to:
- Earn interest through tokens
- Get leverage and have the ability to go short
- Obtain the liquidity of other tokens without selling their current assets
Maker launched the first DeFi lending market, allowing users to generate DAI for ETH deposits and provide more types of collateral over time.
Compound popularized a wider range of asset lending and provided more token loans/borrowing tokens. When placing a loan position, the lender receives cToken representing its deposit. These cTokens can be used as primitives for other protocols.
Aave started to compete with Compound by providing different token economics, up to 75% of user collateral borrowing rate, and more types of token loans/borrowing.
Data source: The Graph
In each agreement, there is its own currency market, and their interest rates and utilization rates are different. Examples of Compound and Aave are listed below. Utilization rate = 1-(free liquidity / market size). If you deposit 1 billion US dollars and lend 100 million US dollars at the same time, the utilization rate is about 10%.
Prices in these markets follow the utilization curve. As the overall market utilization rate increases, interest rates will also increase to encourage more lenders to enter the market and borrowers to withdraw. Conversely, as the utilization rate drops, the interest rate also drops to encourage more borrowers to join. In the chart below, we notice how the current utilization rate affects the interest rate of the DAI market on Compound Finance.
As you can see, a market with a higher utilization rate will reward lenders with a higher yield to attract more liquidity. For borrowers, this has also become more expensive.
Since going online, these markets have been growing steadily, with stablecoin markets having the most activity and utilization. As we can see in the table below, stablecoins maintain a good balance in borrowing and lending. In most cases, the average utilization rate exceeds 75%. Volatile assets such as ETH and wBTC are usually rich in collateral, but there are fewer borrowers.
Arbitrageurs will transfer their deposits and borrowed funds to places where they can find higher interest rates/risks and returns. There is a risk premium for participating in a less liquid market. Interest rates have stabilized and normalized, as shown by the USDC interest rate between Compound and Aave over time. New liquidity mining plans and other governance impacts may cause new interest rate fluctuations.
Liquidity incentives and lenders that attract attractive returns lead to liquidity, followed by borrowers’ adoption. This continued liquidity and utilization rate has led to attractive borrower and lender interest rates and continued adoption.
Decentralized Exchange (DEX)
Last year, the use of DEX increased significantly. Although loan control has the highest liquidity, DEX greatly controls the most users. Of the 2.1 million users who have interacted with DeFi, 1.53 million used Uniswap at some point (~73%). In comparison, there are 316k (approximately 15%) users who have interacted with Compound at a certain point in time.
Data source: Dune Analytics
Liquidity providers (LP) use capital to earn a portion of transaction fees and liquidity rewards. Attract users to the platform through market depth and the availability of tokens they are interested in. A positive feedback loop is established, with more users generating more expenses, and more expenses attracting more liquidity. When the liquidity reward expires, sufficiently high users and fee income can continue to maintain the liquidity in the agreement.
In terms of actual demand for these products, the transaction volume has been very strong. Among all Ethereum DEX, the transaction volume in the past 12 months is 420 billion U.S. dollars, the 30-day transaction volume is 67 billion U.S. dollars, and the daily transaction volume is 4 It reached its peak in the month, above US$3 billion. In addition, to date, 1.98 million unique addresses have interacted with DEX.
Data source: Dune Analytics
Measuring the relationship between liquidity and users, we have an interesting view on transactions that satisfy the stickiness of both supply and demand. The holy grail of adoption is when a DEX can attract strong continuous liquidity and trading volume for a long time.
Data source: Uniswap Analytic, Sushiswap Analytic, DeFi Llama
Keep in mind that although in the case of Curve, its liquidity seems to be inflated relative to transaction volume and fees, Curve focuses on stablecoin pairs with much less volatility. In addition, Curve invests assets in the liquidity pool into Compound and Year Finance to obtain additional income in addition to transaction costs. They are an example of DeFi projects benefiting from composability. Projects such as Yearn use their platforms as the basis for stable currency swaps and liquidity mining.
We can also measure the operating status of an exchange through user maintenance. Some exchanges continue to maintain strong liquidity through incentive programs, but there are still some shortcomings in retaining users.
In the following breakdown, we see that Uniswap lost 240,000 addresses in April, while retaining, returning and creating 615,000 new users. We saw that Sushiswap lost 18,000 addresses while retaining, returning and creating 31,000 users. This brings Uniswap’s net user retention to +375,000 users, while Sushiswap’s net user retention is +13,000 users.
Data source: Dune Analytics
The use of stablecoins has become a core part of DeFi, and the reserve-backed tokens USDT and USDC issued by centralized institutions occupy most of the market share. In most DEX pairs and lending markets, stablecoins have become the base currency.
The biggest attempt to design a decentralized stablecoin is DAI, which maintains a soft peg to the US dollar through market arbitrage without the need for central reserves. DAI is the currency of MakerDAO, backed by the collateralized debt position of ETH and other tokens. MKR tokens are used as a last resort asset and can be used to repay the lender in the event of any bankruptcy. In order to incentivize holders of MKR tokens, when debt holders repay a stability fee similar to the interest rate that keeps the system stable, MKR tokens will be burned.
Although USDT and USDC are clearly dominant, the growth of DAI as a stable currency is still impressive, having reached more than 3.6 billion U.S. dollars in circulation since its inception.
Historically, DAI and the US dollar have maintained a relatively stable anchor exchange rate. Although the issuance is managed by MakerDAO, traders will usually try to take advantage of arbitrage opportunities to make a profit. The essence of this behavior is to withdraw collateral by depositing ETH to mint DAI, or repaying CDP in reverse.
To illustrate this point, we can see which DEX liquidity providers have established the deepest liquidity pool centered around DAI pegged to approximately $1. If the price of DAI differs too much in either direction, this has the opportunity to capture any spreads and transaction costs.
We also noticed the use of DAI in various DeFi protocols. Maintaining the link is good, but the actual use in top DeFi projects is more important.
In the loan market, DAI is a stable currency, and DAI collateral ranks second in Compound and third in Aave. Considering that the total outstanding supply of DAI is less than 10% of the total supply of USDC, USDT and DAI, this is very healthy.
In decentralized exchanges, observations of DAI suppliers show good liquidity, and DAI accounts for approximately 19% of the stablecoin liquidity on Uniswap.
On the demand side, DAI’s trading volume (including DAI) accounts for approximately 15% of Uniswap’s trading volume every day. USDC and USDT each accounted for about 43%.
Stablecoins are one of the most widely adopted assets in DeFi. The strength and stickiness of stablecoins in DeFi have some key characteristics:
- USDC, USDT and DAI represent the main DEX trading pairs
- Stablecoins provide sufficient liquidity and powerful utilization capabilities in the lending market
- DAI maintains a pegged exchange rate and growing adoption rate without the need for reserves backed by US dollars
Aggregator is a competitive application of DeFi. So far, Yearn Finance has won a clear victory.
Yearn Finance is a revenue aggregator that manages users’ funds through various strategies aimed at maximizing revenue. It works by transferring collective funds around various DeFi protocols, which has advantages of scale and ease of use for users.
Their pace of providing competitive strategies and ease of use for project integration and individual users has driven their TVL to US$4.5 billion (as of May).
Users lock their assets in the Year’s machine gun pool, which automatically allocates funds across various strategies. The basis of these strategies described in the Yearn document is this:
- Use any asset as liquidity.
- Use liquidity as collateral and manage the collateral through algorithms to avoid defaults.
- Borrow stablecoins.
- Use stablecoins for liquidity mining and/or earn fee income.
- Reinvest earnings to create compound growth.
For example, the DAI machine gun pool utilizes a complex network of strategies and interoperable protocols to generate depositor revenue. This level of complexity and strategy is too complicated for ordinary users, so Year provides users with a one-click solution without having to fully understand the complexity of their capital investment methods. They charge a 2% management fee and a 20% income commission for their efforts, which is different from a typical hedge fund.
Due to the relatively small use of smart contracts, the skills of developers and strategists, and the consistent competitive rate of return provided by automatically finding deposits and transferring them to the highest revenue source, users’ trust in the Year system has increased.
Data source: Dune Analytics
The revenue aggregator has been adopted by various DeFi users and projects as a key infrastructure. Users go to Year to find a simple way to participate in DeFi opportunities, while minimizing gas fees, complexity and liquidation risks. The project integrates Year into the key infrastructure of its project-Badger DAO and Alchemix each have deposited $300 million in the Year’s machine gun pool, and more projects continue to be added to Year.
So far, with strong growth, capital has continued to accumulate in Year and other aggregators, with little sign of slowing down.
In less than 12 months, Decentralized Finance (DeFi) has evolved from a niche industry of cryptocurrency to a leading industry. Although the total value lock-in ($124 billion) is a useful indicator for the overall DeFi adoption rate, it hardly tells the full story of the true adoption rate and product market applicability. Instead, more useful indicators can be used to fully understand the supply side (liquidity) and demand side (number, users, utilization, user retention, etc.).
In just 12 months, DeFi has achieved:
- 2 million+ users (unique address)
- All DeFi-related smart contracts have locked in a value of 120 billion+ U.S. dollars
- The daily trading volume of DEX usually exceeds 2 billion U.S. dollars
- The utilization rate of stablecoins on lending platforms with a liquidity of 10 billion + USD is usually> 80%
- Decentralized stablecoin (DAI) has a circulation and stability of 3 billion + USD
- The most exciting part is that this is just the beginning of the future of finance.