In just eight months, DeFi has attracted more than $100 billion to smart contracts. These contracts both enable what traditional finance can do and bring a whole new original language of finance. These innovations offer new opportunities for individuals to truly own their assets, participate in global capital coordination, trade through decentralized exchanges, use lending markets, and more.
In this article, we will explore the current state of ethereum-based DeFi and examine the key metrics that will help us understand its explosive growth and availability.
The Grassroots Evolution of DeFi
DeFi is both a technology and a movement, with teams of researchers and engineers coming together to reimagine financial services. The field has come a long way since the early days of smart contract innovation (e.g., raising capital through ICOs), then early NFT experiments (e.g., CryptoKitties) and the original DEX implementation (which first hinted at a decentralized future for finance).
The chart above shows the explosive growth of the user base and value in the DeFi ecosystem. What we see is the new spirit behind the perfect storm of innovation and combination of financial incentives. The entire community lifts itself up by incentivizing participation in the DeFi protocol. Incentives that drive users to products that grow effectively and retain users and capital.
In 2019, Synthetix became one of the first DeFi projects to conduct a DeFi liquidity mining experiment, in which users were incentivized to provide liquidity to the sETH / ETH Uniswap pool. This later inspired a wave of revenue farming projects in 2020, especially after Compound Finance launched COMP token liquidity mining in its lending marketplace.
The introduction of COMP incentives to encourage lenders and borrowers to earn COMP tokens popularized the protocol – the total locked-in value of the protocol jumped from $100 million to $500 million in one week.
The key innovation here was actually a social innovation, as participants were rewarded with governance tokens that provided liquidity and access to the protocol.
How do you measure DeFi adoption?
DeFi’s growth can be expressed in a number of ways, the most intuitive being to measure active users. Since the DeFi experiment began, user growth has been explosive, with the number of unique addresses interacting with Ether DeFi in some way exceeding 2.1 million since the beginning of 2018.
Data source: Dune Analytics
If we consider every Ether address to be part of the overall addressable market (TAM), then we can say that DeFi has penetrated less than 3% of non-zero Ether addresses to date (~58 million addresses). As Ethernet adoption grows, the potential TAM for DeFi applications will also increase.
The metric “total locked-in value (TVL)” has been popularized to describe the total assets deployed in smart contracts. In the TVL concept, the terms lock, deposit, store, send, lend, and offer, all have the same meaning. In an exchange, we can consider these assets directly as liquidity, while in a loan agreement they are considered as collateral.
Source: DeFi Llama
The relevance of TVL varies by protocol, so it should always be considered along with utilization, trading volume and other usage metrics. Utilization describes how much supply-side liquidity is being used productively by the demand side of the protocol. Take the classic environmental example of a lemonade stand.
Suppose I produce 100 cups of lemonade per day. The amount available on the demand side is 100 cups.
Now, suppose the demand side buys and consumes an average of 70 of these cups per day. That’s 100 – 70 = 30 cups of unused lemonade. We can assume that, as the supply side, I might start making fewer cups per day to more closely meet demand.
But wait. What if the local government comes in and says they will subsidize my lemonade stand by buying an additional 30 cups per day regardless of usage (which is roughly equivalent to the liquidity mining incentive provided by the deal)? Now, we would have a valid reason to continue to supply 100 cups per day.
So while the $124 billion TVL may fluctuate back and forth, this is a nascent market in which money will flow wherever the best risk/reward is expected. If users are scarce, but liquidity incentives are strong, then rational participants will take advantage of these opportunities. To determine if these protocols are developing a loyal user base, we must look more deeply at the metrics that describe the stickiness of end users and liquidity providers.
The DeFi protocol type uses
Lending protocols attract interest because users are attracted to
Earning interest through tokens
Gaining leverage and the ability to short
Gaining liquidity in other tokens without having to sell their current holdings
Maker launched the first DeFi lending marketplace, allowing users to generate DAIs against deposits of ETH and offer additional types of collateral over time.
Compound popularized broader asset lending, offering more token lending/borrowing tokens. When a loan position is placed, the lender receives a cToken representing its deposit. These cTokens can be used as proxies for other protocols.
Aave started competing with Compound by offering different token economics, up to 75% user collateral borrowing rate, and a wider variety of token lending/borrowing.
Data source: The Graph
In each protocol, there are respective money markets with different rates and utilization rates, examples for Compound and Aave are listed below. Utilization rate = 1 – (free liquidity / market size). If $1 billion is deposited while $100 million is lent, the utilization rate is approximately 10%.
Prices in these markets vary with the utilization rate curve. As total market utilization increases, interest rates will also increase to encourage more lenders to enter the market and borrowers to exit. Conversely, as the utilization rate decreases, the interest rate will also decrease to encourage more borrowers to enter. In the chart below, we note how current utilization rates affect interest rates in the DAI market on Compound Finance.
You can see that markets with higher utilization rates reward lenders with higher yields to attract more liquidity. It also becomes more expensive for borrowers.
These markets have been growing steadily since launch, with the stablecoin market having the most activity and utilization. We see in the table below that stablecoins have maintained a good balance in terms of lending and borrowing, with an average utilization rate of over 75% in most cases. Volatile assets such as ETH and wBTC are typically rich in collateral, but have even fewer borrowers.
Arbitrageurs will move their deposits and borrowed funds to where they can find higher rates/risks and rewards. There is a risk premium for participating in less liquid markets. Interest rates level off and normalize as shown by the USDC rates over time between Compound and Aave. New liquidity mining programs and other governance implications may lead to new interest rate volatility.
Liquidity incentives and lenders that attract attractive returns steer liquidity, while borrower adoption follows closely behind. This continued liquidity and utilization leads to attractive rates and continued adoption by borrowers and lenders.
Decentralized Exchanges (DEX)
The use of DEX has grown significantly over the last year. While loan control has the highest liquidity, DEX greatly controls the largest number of users. Of the 2.1 million users who have interacted with DeFi, 1.53 million have used Uniswap at some point in time (~73%). This compares to 316k users who have interacted with Compound at some point in time (~15%).
Data source: Dune Analytics
Liquidity providers (LPs) use capital to earn a portion of their transaction fees and liquidity rewards. Users are attracted to the platform by the depth of the market and the availability of tokens they are interested in. A positive feedback loop is established where more users generate more fees, and more fees attract more liquidity. When liquidity rewards expire, high enough user and fee revenue can continue to keep liquidity in the agreement.
In terms of actual demand for these products, trading volumes have been very strong, with $420 billion in the past 12 months and $67 billion in 30-day trading volume across all Ether DEXs, and daily volumes peaking above $3 billion in April. In addition, 1.98 million unique addresses have interacted with DEX to date.
Data source: Dune Analytics
Measuring the relationship between liquidity and users, we have an interesting take on exchanges that meet the stickiness of both supply and demand respectively. The holy grail regarding adoption is when a DEX can attract strong and consistent liquidity and trading volume over a long period of time.
Data sources: Uniswap Analytic, Sushiswap Analytic, DeFi Llama
Keep in mind that while in Curve’s case its liquidity appears to be inflated relative to trading volume and fees, Curve focuses on stablecoin pairs with much less volatility. In addition, Curve invests assets from its liquidity pool into Compound and Yearn Finance for additional returns beyond transaction fees. They are an example of how DeFi projects benefit from composability. Projects such as Yearn use their platform as the basis for stablecoin swaps and liquidity mining.
We can also measure how well an exchange is run by user maintenance. Some exchanges continue to maintain strong liquidity through incentive programs, but there are 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 see that Sushiswap lost 18,000 addresses while retaining, returning and creating 31,000 subscribers. This gives Uniswap a net retention of +375,000 users and Sushiswap a net retention of +13,000 users.
Data source: Dune Analytics
The use of stablecoins has become a core part of DeFi, with reserve-backed tokens issued by centralized institutions, USDT and USDC, capturing the majority of market share. Stablecoins have become the base currency in most DEX pairs and lending markets.
The biggest attempt at decentralized stablecoin design is the DAI, which maintains a soft peg to the US dollar through market arbitrage without the need for a central reserve. DAI is the currency of MakerDAO and is backed by collateralized debt positions in ETH and other tokens. MKR tokens are used as an asset of last resort and can be used to repay lenders in the event of any bankruptcy event. As an incentive for MKR token holders, MKR tokens are burned when debt holders repay a stabilization fee similar to the rate that keeps the system stable.
Despite the clear dominance of USDT and USDC, DAI’s growth as a stablecoin remains impressive, having reached over $3.6 billion in circulation since its inception.
Historically, DAI has maintained a relatively stable anchor exchange rate to the US dollar. Although issuance is managed by MakerDAO, traders typically try to take advantage of arbitrage opportunities to profit, going short when the DAI reaches above $1 and going long when the DAI reaches below $1. The essence of this behavior is to withdraw collateral by depositing ETH to cast DAI, or to reverse repay CDP.
To illustrate this, we can see which DEX liquidity providers have created the deepest liquidity pools centered around a DAI peg of about $1. This has the opportunity to capture any spreads and transaction fees if the price of the DAI differs too much in either direction.
We also note the use of DAI in various DeFi protocols. While it is nice to maintain the peg, the actual use in the top DeFi programs is more important.
DAI is a stable coin in the loan market, with DAI collateral ranking second in Compound and third in Aave. This is very healthy considering that the total outstanding supply of DAI is less than 10% of the total supply of USDC, USDT and DAI.
A look at the supply side of DAI on decentralized exchanges shows good liquidity, with DAI accounting for about 19% of stablecoin liquidity on Uniswap.
On the demand side, DAI trading volume (including DAI) accounts for about 15% of Uniswap trading volume per day. USDC and USDT each account for about 43%.
Stablecoin is one of the most widely adopted assets in DeFi. The strength and stickiness of stablecoins in DeFi has a number of key characteristics.
USDC, USDT and DAI represent the major DEX trading pairs
Stablecoins provide ample liquidity and strong utilization in the lending market
DAI maintains anchored exchange rates and growing adoption rates without the need for US dollar-backed reserves
Aggregators are a competing application for DeFi, and Yearn Finance has won a clear victory so far.
Yearn Finance is a revenue aggregator that manages users’ money through a variety of strategies designed to maximize returns. It works by shifting pooled funds around various DeFi protocols, which gives it the advantage of scale and ease of use for users.
Their pace of providing competitive strategies and ease of use for project integrations and individual users has driven their TVL to $4.5 billion (as of May).
Users lock their assets in Yearn machine-gun pools that automatically allocate funds across various strategies. The basis for these strategies, as described in the Yearn documentation, is this.
Use any asset as liquidity.
Use liquidity as collateral and manage the collateral algorithmically to avoid default.
Use stablecoins for liquidity mining and/or to earn fee income.
Reinvest the proceeds to create compound growth.
For example, DAI machine gun pools utilize a complex network of strategies and interoperable protocols to generate depositor revenue. This level of complexity and strategy is simply too complicated for the average user, so Yearn offers users a one-click solution without having to fully understand the complexity of how their money is invested. They receive a 2% management fee and a 20% commission on earnings for their efforts, unlike a typical hedge fund.
User trust in the Yearn system is enhanced by the relatively low utilization of smart contracts, developer and strategist skills, and the consistently competitive rate of return provided by automatically finding deposits and moving them to the highest yielding sources.
Data source: Dune Analytics
Revenue aggregators have been adopted by various DeFi users and programs as key infrastructure. Users go to Yearn to find simple ways they can participate in DeFi opportunities while minimizing gas fees, complexity and liquidation risk. Projects have made the Yearn set the key infrastructure for their projects – Badger DAO and Alchemix have each deposited $300 million in the Yearn machine gun pool, and more projects continue to be added to Yearn.
With strong growth to date, capital continues to accumulate in Yearn and other aggregators with little sign of slowing down.
In less than 12 months, Decentralized Finance (DeFi) has evolved from a niche industry in cryptocurrencies to a leading one. While total value lock-in ($124 billion) is a useful metric for overall DeFi adoption, it tells little of the true adoption rate and the full story of product market applicability. Instead, more useful metrics can be used to get a full picture of both the supply side (liquidity) and the demand side (volume, users, utilization, user retention, etc.).
In just 12 months, DeFi has achieved.
2 million+ users (unique addresses)
120 billion+ dollars of value locked in all DeFi-related smart contracts
Daily trading volume of DEX typically exceeds $2 billion
Stablecoin utilization on liquid $10B+ lending platforms typically > 80%
Decentralized stablecoin (DAI) has $3B+ liquidity and stability
The most exciting part is that this is just the beginning of the future of finance.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/defi-development-status-report-at-what-stage-of-development-do-you-think-defi-has-reached/
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