Comprehensive comparison of tokenomics, cash flow and moats of the Top 10 DeFi blue chips: Who is the king of value capture
By Xu Xiaopeng, Mint Ventures
Updated on July 23, 2021
For most investors who have had stock investment experience, they have heard of the concept of “blue-chip stocks” and are very familiar with the blue-chip stocks in the stock market. When talking about blue-chip stocks, Chinese investors will discuss Kweichow Moutai, China Merchants Bank and Gree, while American investors will refer them to major companies such as Apple, Amazon, and Microsoft.
Since the beginning of this year, the concept of “DeFi blue chips” has been frequently discussed by cryptocurrency investors. Starting from this concept, this article attempts to answer the following questions:
- What is the significance of paying close attention to and understanding DeFi blue-chip projects?
- Which projects are currently considered as “blue-chip projects” in the fast-iterative DeFi field?
- Which project is the best or the worst, based on the horizontal comparison of the current valuations of various DeFi blue-chip projects?
- How likely are these projects to remain “blue”? What is the source of their competitive advantages?
2020 is regarded as the first year of the DeFi outbreak, we are all witnesses of the birth and growth of DeFi blue-chip projects. There is no ultimate answer to the discussion of the above questions, but we believe that continuous thinking about them will bring us a lot of enlightenment.
1. Our understanding for DeFi blue-chip projects
1.1. The significance of paying attention to DeFi blue-chip projects
Before starting to discuss what a DeFi blue-chip project is, we need to think about a question: when we select certain projects from many DeFi projects and label them as “blue chips” after evaluation, what is the necessity of such behavior?
First of all, based on the research on blue chips, we can find the logic behind the rise of excellent DeFi and how they maintain their market occupancy rate and learn from it. This is helpful for the investment or entrepreneurship of crypto practitioners. Furthermore, blue-chip projects are competitive players who has won (albeit only temporarily) from the open market competition. By investing in them, investors hope to capture the long-term dividend of the future development of the DeFi track. Finally, we can invest in high-quality blue-chip projects as an asset portfolio, pursuing the performance that exceeds the average return of the DeFi track project with small fluctuations.
In fact, the way to select representative projects in the industry and compile them into index fund products has appeared in 2020, such as the DeFi Pulse Index (DPI) jointly created by DeFi Pulse and Set Protocol. This index issues tokens for investors to invest and track the performance of the DeFi asset portfolio.
1.2. What are DeFi blue chips
The concept of blue chips comes from the casino, where the blue chips are the most valuable chip. Therefore, people later call those stocks with high market cap and good business performance as “blue-chip stock”. In addition to high market cap and good business performance, the characteristics of blue-chip stocks often include: dominant positions in their industries, active trading, and generous dividends.
From this, we can give a definition of blue-chip projects in the DeFi field: DeFi blue chips are those projects with high circulating market cap, good business performance, and widely recognized by crypto investors. They should have the following characteristics:
- Top ranked market cap
- High and stable protocol revenue
- Leading position in the DeFi track
- Widely adopted by other DeFi protocols
- Active trading with good liquidity
1.3. DeFi blue chips in our eyes
Based on the above criterias, we have selected 10 blue-chip projects from the numerous DeFi protocols:
The above DeFi projects basically meet our definition of blue-chip project. We found that DEX accounts for 50% of the top 10 blue-chip projects (Synthetix can also be classified as DEX), with 49.5% of the total market cap of the top 10 blue chips. The category of lending and currency protocols accounts for 24.6%, and Link which is the leading project in the Oracle category alone accounts for 22.9%. This market cap data basically reflects the current industry landscape: DEX and lending platform are the most important infrastructures in the DeFi market at present, and they also capture most of the industry’s revenue and value. At the same time, since the Oracle serves as the infrastructure for all DeFi projects, it is also given a very high valuation by the market.
2. Business model and token value capture of DeFi blue chips
The reason why the tokens of blue-chip projects can carry such a large market cap is due to their business model, the economic value or potential economic value captured by the tokens in the business model. Next, we will analyze their business models and token value capture methods.
2.1. Business model and token’s value capture
2.1.1. DEX
The four blue-chip DEX projects all adopt the AMM (Automatic Market-Maker) mechanism. Its main business model is to provide trading services for traders by connecting market makers and traders. Most of the transaction fees will be used as market-making rewards for market makers, and a small part will be used as protocol revenue of these platforms.
a. Uniswap
Revenue model
Uniswap is the proponent of the AMM mechanism, and it is currently the platform with the largest transaction volume and number of active addresses on Ethereum. Uniswap’s revenue is mainly transaction fees. The transaction fees of the Uniswap V2 are unified at 0.3%, while the initial support rates of the Uniswap V3 are 0.05%, 0.3% and 1%, which vary according to different trading pairs.
Token value capture
Uniswap’s only token is Uni, which was announced on September 16, 2020. The initial total supply of Uni is 1 billion. The specific distribution method is as follows:
It should be noted that the total volume of UNI tokens is not constant. After 4 years of issuance, UNI will begin to inflate at 2% annually.
The main token usage scenarios of UNI currently include:
- Governance of the Uniswap protocol: include the modification of key parameters, etc.
- Distribution of UNI community vault: determine the distribution and use of the community vault which accounts for 45% of the total UNI
- Uniswap protocol fee switch and parameter settings: modify whether charge the protocol transaction fee and the transaction fee rate
From this point of view, although the UNI token has sufficient control over the Uniswap protocol, there is no design to capture profits directly in the current UNI tokenomics. This is mainly presented in: i. UNI can control and modify the main parameters of the protocol through governance, representing its control over the protocol; ii. It can draw a percentage from the transaction fee of the protocol at its will; iii. If the transaction fee sharing of the protocol is activated in the future, it is also necessary to establish an economic link between this revenue and the UNI token.
Uniwap is divided into V2 and V3 versions. Since V3 has launched for a short time, most of the AMM liquidity is still distributed on V2, while V2 and V3 have different ways of charging protocol fees.
Transaction fee of V2
The Uniswap V2 includes a 0.05% (1/6 of the total transaction fee) protocol fee, which can be turned on or off. The fee will be sent to the designated address after turning on. Before Uniswap issues UNI tokens, this fee can be used as a stable source of cash flow for the core team. After the official issuance of the UNI token in September 2020, the switching authority of the protocol fee was handed back to the community, and it is currently closed, meaning that all transaction fees of Uniswap V2 are currently given to market makers.
Transaction fee of V3
The protocol fee rate of Uniswap V3 is more flexible. With UNI governance, the protocol fee rate can be set to 0, 1/4, 1/5, 1/6, 1/7, 1/8, 1/9 or 1/10. For example, if the transaction fee for a transaction pair on Uni V3 is 0.3% and the protocol fee rate is 1/5, then 0.3%*1/5=0.06% of the transaction amount will be charged by the protocol after the transaction occurs. The initial value of the V3 protocol fee rate is 0. Now the community has not formally voted to a proposal to modify this parameter. Therefore, all the transaction fees of Uniswap V3 are also going to market makers.
Summary
Uniswap is deeply loved by users as a Dex veteran. However, the value source of UNI tokens only comes from its governance rights over protocol parameters and governance rights over a large number of UNIs in the community vault. The right to tax all transaction fees on Uniswap has not been enabled. We understand that the zero-fee model of market makers is a subsidy policy, similar to the effect of providing liquidity mining rewards to market makers.
b. PancakeSwap
Revenue model
PancakeSwap is the DEX with the highest transaction volume and user activity, but it currently only runs on BSC. Similar to Uniswap, PancakeSwap generates revenue from transaction fees, with a 0.3% transaction fee on all transactions (of which 0.25% is allocated to market makers). In addition, its other revenue sources include lottery, market prediction, IDO, etc., but the proportion is small.
Token value capture
The only token of PancakeSwap is Cake, which is distributed by Fair Launch without private placement or reserve share for the team. There is no upper limit on the max supply of Cake. The current effective emission of each block is about 19 Cakes, and the effiective emission of a single day is about 501,200 Cakes. According to CoinGecko, total circulation of Cake is about 195 million (2021.7.13 12:00 SGT).
Cake’s usage scenarios mainly include:
- Stake in the Syrup Pools to obtain free tokens of cooperative projects (but there is a limit to the number of Cake deposits for a single address)
- Stake Cake LP token on the Yield Farms to obtain new Cake emission, and the current APR is about 72% (2021.7.13 12:00 SGT)
- Used to participate in proposal voting and governance
- All or part of the PancakeSwap revenue is used to buy back and burn Cake
- Used to participate in the lottery, personal files creation and NFT minting and other functions
From this point of view, as the core token of the project, Cake basically captures the complete economic value of the project. This is represented in the ability to control the main resolutions of the protocol through voting, to obtain the cash flow income of the project through buy-back and burn, and to obtain the new production of Cake and other cooperative projects through staking.
However, it should be noted that the current Cake inflation rate of the project is much faster than the burn rate.
According to the last week’s burn data published by PancakeSwap on July 6, 2021, the burn amount of transaction fees + market prediction fees is US $1.7 million, the burn amount of NFT and profiles is US $80,000, and that of the auto-compound fees is US $140,000. Based on the average price of Cake last week at US $12.6, the above major revenue portion can buy back and burn 153,000 Cakes. Compared with the net emission of more than 3.5 million cakes per week, this buy-back is a small magnitude. However, about 23% of the Cakes emission now are used as rewards for Cake staking mining and paid to the Cake holders.
Summary
Pancake’s revenue sources are more diverse. At present, its dominant status of DEX on BSC is gradually strengthened. This is due to its token model without hard cap and a large amount of Cake emission, providing sufficient incentive budget and great help to improve the overall scale of its business. In this context, the total market cap of Cake is expected to continue to expand. However, under pressure from its competitors, it is difficult for PancakeSwap to control its inflation level in a short time to reach what officials call “emission and burn equilibrium” before the DEX war on BSC is over. Therefore, its token price may continue to be under pressure.
c. SushiSwap
Revenue model
The early code of SushiSwap was forked from Uniswap. Its main business revenue model is similar to that of Uni and Pancake, which is mainly based on transaction fees of the platform. In addition, Sushi now has a lending product called Kashi Lending, which does not bring profits to token holders right now. Sushi’s cross-chain business layout is very aggressive, as in addition to Ethereum it has launched on BSC, Polygon, Fantom, Avalanche, Heco and other main networks.
Token value capture
SushiSwap’s only token is Sushi, with a hard cap of 250 million. Currently, 17.298 Sushi are produced per block, and the emission is gradually decreasing until it achieves full circulation around November 2023.
According to CoinGecko data, the total supply of Sushi now is 228 million, accounting for 91.1% of the max supply (2021.7.13 12:00 SGT).
Now Sushi has two usage scenarios: i. Governance voting; ii. Buy-back and redistribution of Sushi through transaction fees.
At present, the main income of Sushi holders is from 1/6 of total transaction fee (0.3%) of the platform, i.e., 0.05%. Sushi holders need to deposit their tokens into the Sushibar of the platform to obtain the staking certificate xSushi to earn this part of the profit. The way to distribute profits is to uniformly convert the transaction fee to Sushi and deposit them into Sushibar, so as to continuously increase the net value of xSushi relative to Sushi. After the redemption of xSushi, users later can exchange it for the staked Sushi and its additional yields.
In addition, if users want to participate in governance, they must also deposit Sushi into SushiBar to get xSushi for voting.
Summary
Compared with Uniswap, SushiSwap, as a challenger, is more aggressive in its overall strategy, represented in rapid multi-chain deployment, exploration of lending business, etc. The subsidy war between SushiSwap and Uniswap is still going on, in the form of providing token rewards for market makers.
2.1.A.4. Curve
Revenue model
Compared with the above three comprehensive DEXs, Curve mainly focuses on the niche DEX track of stable currencies exchange and wrapped token exchange. Its main business revenue comes from transaction fees, just like other DEXs. Compared with other DEXs, Curve is characterized by less transaction pairs, low slippage, and high volume per user (less active users). According to IOSG’s data in March 2021, Curve’s average daily transaction volume per user in 30 days exceeded $1.3 million, the highest among all DEXs.
In addition to stablecoin and wrapped token exchange, Curve is also entering the field of other asset trading through its partnership with Synthetix. In terms of the layout of Layer2, Curve has already depolyed on Polygon, Fantom and xDai. Compared with its TVL on Ethereum, the latter has a smaller TVL, accounting for only a single-digit proportion of Curve’s TVL.
Token value capture
Curve’s only token is Crv. Crv was issued on August 13, 2020, with the max supply of 3.03 billion. The specific distribution is as follows:
- 62% distributed to liquidity providers
- 30% for shareholders, with linear unlock within 2–4 years
- 3% for team members, with linear unlock within 2 years
- 5% as a community reserve
Of the 3.03 billion, 1.3 billion (43%) of Crv has already been distributed in the initial issuance. The distribution ratio is:
- 5% distributed to the early liquidity providers of Curve, linearly unlocked within 1 year
- 30% to shareholders, linearly unlocked within 2–4 years
- 3% to team members, linearly unlocked within 2 years
- 5% as a community reserve
The specific unlock and release schedule is as follows:
According to Coingeke data, the total supply of Crv so far is 1.545 billion (2021.7.13 SGT).
The value of Crv to token holders includes:
- Obtain the transaction fee of the platform: After users stake and lock their Crv tokens, they can obtain the locked token certificate veCRV, with which they can receive the 50% fee sharing of the whole platform. Another 50% of the transaction fee is for the LP providing liquidity and is distributed through 3Crv tokens (the LP token for stablecoin exchange pool, which can be converted into stable currencies).
- Accelerated returns for liquidity market-making: Liquidity providers can speed up the Crv rewards for their liquidity market-making by locking Crv, improving their overall APR for market-making.
- Protocol governance: The governance of Curve also is also realized through veCRV. In addition to the modification of protocol parameters, the scope of governance also includes the voting of the Curve protocol, and the weight distribution of Crv’s liquidity incentives among various transaction pools.
Crv captures the value of the overall protocol quite adequately. It can not only obtain the cash flow of the protocol’s transaction fees and accelerate the market-making earnings, but the most noteworthy thing is the role of Crv in governance.
Curve is different from Pancake, Sushi, and other DEXs which can freely initiate the depth of market-making. If a token aims to launch on Curve and obtain sufficient liquidity and generate Crv’s subsidy to liquidity pool, it requires a community vote. Therefore, if a token issuer want to enter Curve and gain trading depth (such as Binance for BUSD), it will have a strong demand for Crv to lock and vote, which provides Crv with a strong source of demand and lock-up motivation.
As a result, we can see that more than 69% of supplyed Crv becomes veCRV that are locked, and the average lock period is 3.67 years (the maximum lock-up period is 4 years).
Summary
The degree of competition in the DEX segment track where Curve is located is lower than that of the comprehensive DEX. This is represented in Curve’s right of choice of listed tokens, as well as the right of determing distribution rate by Curve for incentive in each liquidity pool. Curve’s unique mechanism of lock-up, earning acceleration, and incentive weighted voting make the demand for Curve tokens more extensive and stable. Its investors and users are also mainly high-net-worth crypto groups and institutions.
2.1.2 Lending/currency protocols
The DeFi blue-chip projects in the category of lending/currency protocols plays the role of a bank and even a central bank in the crypto world. On the one hand, they attract deposits through interest and token subsidies, and on the other hand they provide liquidity to users in need. Like DEXs, lending and currency protocol projects are also the infrastructure of DeFi world today, and their main way to obtain profits is interest-rate differentials or seigniorage.
a. Aave
Revenue model
Aave is currently the lending project with the highest TVL, and it is also one of the DeFi projects with the highest TVL. Its TVL on July 13 was US $8.78 billion, second only to Curve’s US $9 billion. The current revenue sources of Aave protocol include interest margins on deposits and loans, as well as the flash loan fee of V1. At present, Aave does not impose any commission on the flash loan fees on V2 and Polygon, but all the fees are paid to the depositors. In addition to offering services on Ethereum, Aave also deployed on Polygon in May this year, and its TVL on Polygon was as high as US $1.9 billion.
Token value capture
The only token of Aave has the same name as the project. Since the predecessor of the project was ETHlend established in 2017, the project’s business model and economic model were subsequently reshaped. In addition, the original circulating 1.3 billion Lend tokens were migrated to 13 million Aave at a rate of 100:1. An additional 3 million Aave were newly distributed to the governance of AAVE protocol and subsequent community incentive budgets.
According to CoinGecko data, the current circulating supply of Aave is 12.83 million, accounting for about 80% of the total supply. The allocation of the remaining 20% Aave is determined by the community, and it is mainly used for DAO’s governance budget, donation support for ecological projects, lending minting as well as vault subsidy.
It should be noted that Aave DAO usually adopts a quarterly discussion mode for the remaining major expenditures of Aave. For example, Aave’s lending incentives started in late April this year, and after July, the community needs to vote again to decide whether to continue to use Aave from the ecological budget pool for the lending incentive plan, as well as the amount and distribution details of the plan.
Now the main usage scenario of Aave is governance, including voting for new tokens to enter the currency market, adjustment of important parameters, etc. Although the current protocol income cash flow of Aave is good, the community has not initiated the proposal of using the protocol revenue to buy back AAVE for redistribution or for burn.
According to the new Aavenomics 2.0 released last year, it encourages Aave holders to deposit tokens in the Safety Module (deposit vault) in the future and to distribute the protocol revenue to the deposit participants.
Summary
Although Aave currently do not provide direct empowerment except for governance, the accumulated funds of the protocol revenue are under the control of the token holders. So it is in the state of “the meat in the pot yet to be eaten”, and the economic value of the protocol has not been dissipated. In addition, Aave’s rapid innovation speed and extensive protocol adoption are expected to maintain its leading position as the largest DeFi lending platform.
For a full analysis of the Aave project, you can read the previous in-depth research report on Aave provided by Mint Ventures:
b. Maker
Revenue model
Maker has a long history, and the organization behind it is Makerdao founded in 2014. The Maker protocol is one of the largest decentralized applications on the Ethereum and the first DeFi application with massive adoption. Its role is to mint a decentralized stablecoin: Dai. The mechanism of Maker allows users to use crypto assets supported by the protocol as collateral to mint (lend) Dai, while charging a stability fee (borrowing interest) for the Dai lent by users. In addition to minting interest, two other revenues of Maker currently come from: 1.PSM (Peg Stability Module) business — other USD stable currencies can be exchanged for Dai on Maker, with a transaction fee during the process; 2. Liquidation penalty income.
Token value capture
Maker’s token is MKR with a max supply of 1,005,577, and it is almostly in full circulation (the team account has around 90,000 MKR uncirculated).
MKR’s token usage scenarios include:
i. The core governance token of the protocol allows its holders to vote to modify the risk parameters of the Maker protocol, introduce new collateral, modify Dai’s deposit interest rate, and select Oracle node groups, etc.
ii. The revenue of the Maker protocol will enter into the Maker Buffer address. After the Maker buffer reaches a certain amount of surplus, part of the surplus will be entered into the surplus auction to buy back and burn the MKR to improve the intrinsic value of MKR tokens.
However, it should be noted that if the Maker system has a bad debt which the buffer fund is insufficient to cover, additional MKR will be issued for auction and the sold Dai will be used to cover the bad debts of the system. This also curbs MKR holders to govern the protocol with a prudent attitude. In addition, according to the monthly report disclosed by MakerDAO, the Maker protocol has substantially increased cost expenses since May this year. The expense was US $594,000 in May, and it was as high as US $1.261 million in June. The net income of Maker protocol can only be generated after deducting these expenses.
Summary
Maker’s business volume has soared with the outbreak of DeFi in the past year. It mainly benefits from the widespread adoption of Dai, but its loan flexibility and composability are not as good as Aave and Compound. In our opinion, the key battlefield for Maker is not lending, but the market share of stable currencies. In this year, both BUSD with rapid development of Binance ecology and USDC backed by major US institutions Coinbase and Circle, will be the major competitors of Dai in the future.
c. Compound
Revenue model
The Compound project was established in 2018. It is one of the most successful lending protocols so far, and the first DeFi project to introduce the lending fund pool model. Later this innovation becomes a mock object for Aave and other lending protocols. The revenue of Compound entirely comes from the interest margin between depositors and borrowers. Although Compound has the plan to deploy on Layer2, it is currently only available on Ethereum.
Token value capture
Compound did not issue tokens at first, and instead it carried out equity financing through traditional financing channels. Compound didn’t issue the governance token COMP of the protocol until April 2020, when the project started lending mining (which is also the starting point of the DeFi mining trend in 2020). The total supply of COMP is 10 million and the specific distribution plan is as follows:
According to CoinGecko data, the current circulating supply of COMP is 5.377 million, with the circulation rate of 53.7%.
The only function of COMP now is governance, without explicit value capture means. However, at present, the protocol revenue of Compound from the interest margin is kept in the reserve form. Specifically, the reserve amount for USDC alone is US $6.55 million, which is mainly used for bad debt losses under extreme protocol conditions instead of distributing to the team. Will the future COMP reserve be brought under the governance authority of the community, like Aave, or even used to buy back or burn Comp? There is some uncertainty here.
Summary
Compound looks less attractive for investors than another lending giant Aave, due to slower innovation speed and fuzzy model of token value capture. However, its head position in the lending market is expected to remain.
2.1.3 Oracle
The operating logic of the crypto world is different from the real world. It operates based on consensus mechanisms, cryptography, smart contracts, and distributed and transparent properties. In the smart contract, when we input the X variable, it will produce the expected Y result. The source of the X variable can be divided into two types. One is from the on-chain data of the blockchain itself, which can be directly obtained. The other is from off-chain data, such as the results of the 2021 European Cup final, which would need to be fed to a smart contract via Oracle.
In the current crypto market, there are three kinds of Oracles: centralized, decentralized, and federated. Among them, the most widely used on DeFi is decentralized Oracles, such as Chainlink, Nest, Trellor, etc.
a. Chainlink
Revenue model
Chainlink mainnet launched May 30, 2019 and began to provide price feed service. It consists of a two-layer structure. In the bottom layer, multiple data sources provide data to the Oracle node network, and in the upper layer, multiple Oracle node networks provide data to the blockchain.
The Chainlink ecosystem contains three main roles: data demander, Oracle node, and data source. The cooperative relationship of these three roles operates under a two-layer structure. The general process is: the data demander initiates a data request, the Oracle node obtains the data from the data source and pays the fee, the data is provided to the data demander after processing, and the data demander pays the fee to the Oracle node on a per-time basis.
Chainlink’s two-layer structure has three characteristics. First, the data demander can customize the composition of the data source, including the reputation and number of nodes. Second, the underlying structure ensures the decentralized nature of data, while multiple Oracles at the upper layer ensure that the system can continue to operate when a single point of failure occurs to any one of the Oracles. Third, Chainlink uses the method of chain-aggregated data to send data to the data demander. The advantage of chain-aggregated data is that the data content can be reviewed multiple times, and the data provided by the data source is recorded on the blockchain to increase reliability.
Let us take an example to explain the above process. In order to ensure the security of the collateral, a DeFi lending application needs to obtain the price information of its collateral and lent assets on a regular basis. Therefore, it initiates a request for the price data of the asset to Chainlink. After receiving the request, multiple Oracle nodes in Chainlink Oracle network request the real-time price of the asset from the data sources of asset price (e.g. Biance, Huobi, Kraken and other exchanges) and pay the fee. Then the Oracles send the data to an on-chain smart contract, which delivers a reasonable data to the data demander after removing the outliers.
In addition to the price feed service of Oracle, Chainlink also provides services such as VRF (verifiable random function，encrypted proof mechanism to generate verifiable random numbers), project reserve certification and other services.
Token value capture
Chainlink’s token Link was issued in September 2017, with a total supply of 1 billion. Currently, there are 436 million in circulation, with a circulation rate of 43.6%. The specific token distribution methods are as follows:
Unlike most of the projects mentioned above, Chainlink’s project tokens do not have governance rights over the project and are used for two main purposes:
i. Used to pay the cost of node operators to obtain data for smart contracts;
ii. Used for the mortgage made by node operators at the request of the contract creator.
From this point of view, Link is a typical functional token, which plays the role of the settlement medium of ChainLink ecology and credit collateral (the more Link staked by nodes, the more data demander will believe in the data reliability of nodes). It is an important resource in the ecosystem, but it cannot capture the full economic value of the ecology. This is different from the positioning of most DeFi tokens as “equity tokens”. Taking Aave as an example, the Aave holders can initiate proposals and vote through tokens to determine the direction of project development and the distribution of the protocol ecological fund. The cash flow income of the protocol will also be fully distributed to token holders, basically capturing the full rights of the project.
Summary
Launched in 2017, Chainlink is more like a centralized company offering services through blockchain technology, rather than a DeFi project. Its token design model prevents its investors from enjoying the dividends of Chainlink’s rapidly growth. However, it is not easy for the latecomers to challenge the position of Chainlink due to the stable moat of the Oracle product. For details, please see the analysis of the moat in this article.
2.1.4 Derivatives
Derivatives may be one of the most promising tracks for rapid growth after the DEX and currency lending markets. According to the data of centralized exchanges, the transaction volume of derivatives is already close to that of the spot, growing much faster than the spot trading.
At present, compared with the trading volume of Uniswap and Pancakeswap which was less than 10 times that of the centralized exchange at the peak, the trading volume of decentralized derivatives is still several orders of magnitude lower than that of centralized derivatives. For example, the daily trading volume of derivatives on Binance has exceeded US $50 billion, however, the sum of daily trading volume of all decentralized derivatives exchanges is still around US $100 million. The potential of the decentralized derivatives market is significant. The revenue model of derivatives services is also very clear: transaction fees.
a. Synthetix
Revenue model
Synthetix defines itself as a “derivatives liquidity protocol” and its main business is synthetic asset/derivatives trading. In brief, the main business process of Synthetix currently has the following steps:
i. Minting: The user stakes the project token SNX to generate sUSD at a mortgage rate of 400%. sUSD is always anchored at 1 USD.
ii. Trading: In the kwenta exchange (and the previous Synthetix.exchange), users can use sUSD to trade and exchange for any kind of synthetic assets (“synths” is substituted below) supported by the system, including:
- Cryptocurrency assets, including sToken (long asset) and iToken (reverse synthetic asset for short), such as sETH, iETH, sDefi, etc.;
- Foreign exchange assets sEUR, sJPY;
- Equity assets such as sTSLA and sFTSE (FTSE 100);
- Commodity assets sXAU, sXAG.
The transaction process will actually burn sUSD and mint synths.
iii. Burn: After the completion of the transaction, users can exchange synths into sUSD (actually it is to burn synths and re-mint sUSD) and return sUSD to get SNX back.
The transaction fee generated in the above transaction process is the business income of the Synthetix platform.
Token value capture
Currently SNX is the only token of the project. There were 100 million tokens in the initial ICO, of which:
- 60 million for ICO
- 20 million for the team and advisors
- 12 million for the Foundation
- 5 million reserved for the cooperation
- 3 million reserved for the market
In March 2019, in order to motivate the stake behavior of SNX holders, the token model of the project has undergone a major change. By 2024, the total number of tokens will expand to 245 million.
At the end of 2019, the above new emission of tokens began to release in a smoother way. At present, the total supply of SNX tokens is about 229 million, and the current circulation is 159 million with the circulation rate of 69.4%.
Like most other DeFi tokens, the value of SNX tokens comes from governance rights and protocol cash flow:
- Governance rights: Synthetix adopts the DAO model of decentralized governance and divides the proposal into SIP and SCCP. SIP is a problem improvement proposal, which all SNX holders can vote. On the other hand, SSCP is a proposal for important issues of the protocol, which needs to be voted by an 8-member “Spartan Parliament” (similar to the representative members elected by currency holders). In addition, the ProtocolDAO, composed of core developers, is responsible for its final review and implementation.
- Transcation fee dividends: token holders who stake their SNX can receive Synthetix’s weekly transaction fee dividends.
- SNX staking mining: earn token rewards from project mining
On the whole, SNX has a complete capture of the economic value of the protocol.
But it should be noted that: Staking SNX is essentially a process of mintng Synthetix’s stablecoin sUSD, which is equivalent to lending a stablecoin with SNX as collateral (without interest). The current ratio of SNX to minting sUSD is 400%. Pledging coins also means that you begin to participate in Synthetix’s “dynamic debt pool”. Even if you don’t do anything about minting, your debt level will fluctuate with Synthetix’s system debt level, thus you may earn or lose.
For a detailed analysis of the Synthetix project and its dynamic debt pool, you can read previous in-depth research report on this project from Mint Ventures:
Summary
With the arrival of Layer2, derivatives may be the next breakout of the DeFi track. We think it is worth looking forward to their follow-up performance of both the business of Synthetix products or its SNX tokens.
2.1.5 Yield protocol
The yield protocol is a new species after the DeFi wave in 2020. The service it provides is somewhat similar to the fund service in traditional finance. Investors deposit crypto assets on the platform of yield protocol. The protocol will also achieve asset growth for investors under the balance of returns and risks according to various strategies. Since the yield protocol will adjust the position to pursue high returns according to the changes of the yield situation of each platform. This behavior is similar to the smart pool that switches computing power between different POW currencies in order to pursue the highest return, so the yield protocol is also called “Defi aggregator”. The revenue model of yield protocols is similar to that of traditional private equity funds, which mainly charge performance fees or fund management fees.
a. Yearn
Revenue model
Yearn’s core product is the DeFi aggregator. Users can gain passive income by depositing assets in Yearn’s various vaults without having to be familiar with the knowledge of the underlying protocol of DeFi. Compared with obtaining DeFi yields by operating on your own, the advantages of using Yearn are reflected in: 1. The expensive gas is shared by the funds in the entire strategy pool; 2. The guardian of the strategy and strategist will continuously monitor and optimize the strategy to ensure that the funds can obtain the best returns in the market; 3. It uses the Keep3r network to sell the yield tokens and reinvest in basic assets to maximize compound interest.
Through the above series of services, Year’s V1 version charges 5% performance fee and 0.5% withdrawal fee, and V2 version charges 20% performance fee and 2% annual management fee.
Token value capture
YFI is the only token of Yearn. It adopts a method of no pre-mining and no fundraising. A total of 30,000 YFI were issued in the early stage, all of which were distributed to early users of the Yearn platform, as well as liquidity providers on Curve and Balancer. A further 6,666 YFIs were issued through the community’s YIP-57 proposal, of which 1/3 were used to reward project contributors, and 2/3 entered the project’s financial coffer for follow-up project operations.
The value of Yearn mainly comes from governance right + cash flow buy-back. Governance right is easier to understand, that is, users put up proposals and vote through YFI. The capture of project cash flow by YFI tokens has undergone several changes: starting from the YIP-36 proposal in August 2020, the portion of the project’s accumulated income funds exceeding the cumulative US $500,000 or more will be allocated to the users who stake YFI in governance contract. In the YIP-58 proposal in January 2021, the dividend plan was changed to buy back YFI to inject into the operating fund of the project, which is a way of buy-back without burn, but also not distributing it to the holders. The basic logic is: continuous use of the project cash flow to buy back YFI can improve the intrinsic value of YFI. However, compared to directly distributing the repurchased YFI to the existing investors of YFI, it is better to keep YFI in the operating fund as the operating capital of the project, which can better promote the long-term development of the project.
Summary
The yield protocol may be the DeFi track with the least barrier. If Yearn wants to survive, it must keep evolving in its business model, and develop services with more long-term value for customers before the funds leave.
2.2. Comparison of cash flow capture methods for DeFi blue-chip projects
We found that the DeFi blue-chip projects that continuously generate cash flow have very different methods of using cash flow, including:
i. The direct distribution of cash flow to token holders, which is similar to the direct cash dividend of listed companies. The projects using this scheme are: Synthetix, Curve, Aave (only for planning, without actual implementation).
ii. Use cash flow to buy back tokens and distribute tokens to token holders, which is similar to the way that a listed company buys back stocks and gives them to shareholders based on their shareholding ratio. The project adopting this scheme is: SushiSwap.
iii. Use cash flow to buy back and burn tokens, which is similar to the way that listed companies buy back stocks and write off them to reduce circulating shares. The project adopting this scheme is: PancakeSwap.
iv. Use the cash flow to buy back tokens and use the tokens as project operating funds, which is similar to the way that listed companies buy back stocks and use them for follow-up employee equity incentives. The project adopting this scheme is: Yearn.
Other three projects:
Uniswap: it has not yet collect the protocol fee, and there is no protocol cash flow;
Compoud: Cash flow is retained as a reserve fund, but the ownership of the reserve fund is uncertain;
Chainlink: Cash flow is not directly related to token holders.
No cash flow, cash flow irrelevant to token holders, and the unclear ownership of cash flow reserve, all of them are naturally not the ideal state of token cash flow capture, which will not be discussed here.
Method i is similar to Method ii, both of which guide users to stake tokens to obtain the cash flow distribution of the protocol. Compared with direct buy-back and burn of tokens, the staking dividend model increases the token stake rate, expels short-term speculation, and is conducive to price stability.
However, the direct buy-back and burn mode of Method iii also has the advantages of simple operation and reducing dividend loss (users no longer need to claim dividends by themselves or sell transactions, etc.).
Method iv is the least adopted, and we believe that the controversy is also the most. Whether it is reasonable to adopt this scheme should depend on the project. We argue that it is reasonable to use this scheme only in one case: the buyback funds of the project are reinvested in the project (to be used by the operating fund), when the project is in an important window period of development, and the core members of the project are sure to use the buyback returns to create a very high project growth rate for token holders. Eventually token holders can obtain token value expansion from the growth of the project, which will far exceed the dividend income. This is similar to Amazon. As a fast-growing Internet ecosystem, Amazon has almost never paid dividends in the 20 years after its listing, but instead it has used all the profits that could have been converted into cash dividends for new business expansion or investment in other sectors. Amazon’s shareholders also believe that Amazon’s overall yield from doing so is far higher than directly giving them cash every year. But does the Yearn project meet the above criteria? Given that the yield protocol is a track without competitive barriers, we are not optimistic about the ultimate efficiency of the Yearn team in utilizing the funds originally owned by token holders.
On the whole, in terms of the scheme of tokens capturing cash flow, we think:
Synthetix=Curve=Aave=SushiSwap≥PancakeSwap＞Yearn＞Compound＞Chainlink＞Uniswap。
2.3. Valuation comparison of blue-chip projects
Since most of the above blue-chip projects have income and protocol profits, we try to compare the valuation levels of these projects horizontally through two indicators of price-to-sales ratio (PS) and price-to-earnings ratio (PE), to see if we can draw a preliminary conclusion that the projects are overvalued or undervalued.
Before the formal comparison of indicators, let’s briefly explain the two indicators of PS and PE. PS and PE come from the stock market and are used for horizontal and vertical comparison to preliminarily assess the investment value of stock assets. Among them, PS = total stock market cap/main business income, which is an indicator to measure whether a stock price is overvalued or undervalued from the perspective of income. PE = total stock market cap/net profit, which is a indictor to measure whether a stock price is overvalued or undervalued from the perspective of profit.
The above two indicators are understood separately in DeFi as:
Total stock market cap = total market cap of DeFi tokens
Main business income = gross income of the DeFi protocol
Net profit = Net profit of DeFi’s gross income after deducting various expenses (such as the interest paid by Aave to depositors), also known as protocol profit. In most DeFi projects, this is also the economic value that token holders can obtain.
In general, the lower the PS, the more undervalued the token value is relative to the main income of the DeFi protocol, and the more investment value it has; the lower the PE, the more undervalued the token value is relative to the net profit of the DeFi protocol, and the more investment value it has.
Then, we use Token Terminal to compare the PS and PE of the above Defi blue-chip projects. Among them, the business data of Chainlink and Yearn are temporarily unavailable, so we only compare the other 8 projects. Let’s first look at the comparison of the PS indicators of each project:
Let’s look at the comparison of the PE indicators of each project:
Before we officially start to compare the valuation levels of various projects based on the PS and PE indicators, there are three situations that need to be noted:
i. Because some projects are multi-chain deployment services, such as Aave, Curve, SushiSwap, their income and profit outside Ethereum (mainly Polygon) are not counted by Token Terminal, resulting in inaccurate data;
ii. For the above PE and PS values, Token Terminal uses the market cap of the max supply of tokens to calculate, rather than the market cap of the total supply in the market.
PS: Three concepts about the supply of tokens: 1. max supply: the total amount of all tokens released; 2. total supply: the total amount of tokens released so far, including tokens in free circulation and various lock-up mechanisms; 3. circulating supply: the number of tokens circulating freely on the market at present.
For Curve project, 1 in the figure below refers to the max supply, 2 refers to the total supply through mining and various outputs, and 3 refers to the part of total supply that does not participate in position lock-up but free circulation.
iii. Many of these projects provide subsidies to users through their own tokens, such as liquidity mining subsidies for market makers by Pancake and Sushi, and Compound and Aave’s lending subsidies, etc.
Therefore, we need to review the data by using the market cap of total supply, including the income and profit of the Polygon business, and then adjust the PS and PE of the 8 projects. The results are as follows (market cap units: 100 million US dollars):
It should be noted that there are still some factors above that have not been taken into consideration in the calculation of PS and PE in the table. For example: Maker’s protocol revenue needs to deduct a part of MakerDAO’s expenses to be the real protocol profit (the amount was small in the past months, but it begins to increase significantly in May and June this year). The income and profits of Sushi and Curve on Polygen are only rough estimates, which do not include the income and protocol profits of these two projects on Fantom and xDAI. It is believed that the accuracy of the above data can be further improved, with the enrichment and improvement of DeFi data tools.
We have considered a number of factors as comprehensively as possible and tried to calculate the PS and PE corresponding to the market cap of total supply in addition to the market cap of max supply of each project. However, we will find that it is still difficult to directly compare the PE level of each project, because: The current income and cash flow of most projects are affected by the token subsidy. It is difficult for us to predict the actual changes in the PS and PE of the above projects if the token subsidy ceases. However, it is certain that the amount of token subsidies for most projects is on a downward trend as a whole, as the token subsidies for many projects will stop within 2–4 years. Then we will make similar comparisons and we may be able to draw a more accurate conclusion.
However, if the two DeFi projects to be compared are on the same track, and the ratio and type of subsidies are similar, such as Aave and Compound, the comparison of PE will have a greater reference value.
Based on the above data, we found an interesting situation: Why is the PE of Curve so much higher than SushiSwap and PancakeSwap under the same token subsidy?
Does the huge differences in PEs of each project mean that low-PE projects have more investment opportunities than other high-PE projects? Or is there a reasonable explanation for Mr. Market’s higher valuation of certain projects?
We argue that both views may be correct. To determine which DeFi blue-chip project has more investment value, in addition to quantitative comparison we need to combine the business model of the project, the tokenomics and the moat, to conduct a qualitative analysis to get a more objective conclusion.
3. DeFi blue-chip moat
3.1. What is a moat?
The moat is one of the key concepts in the value investment theory. It was first proposed by Warren Buffett in the 1993 shareholder letter in which he wrote: “Both Coke and Gillette have actually increased their worldwide shares of market in recent years. The might of their brand names, the attributes of their products, and the strength of their distribution systems give them an enormous competitive advantage, setting up a protective moat around their economic castles. The average company, in contrast, does battle daily without any such means of protection. ”
In subsequent writing and speeches, Buffett explained more about the concept of ‘moat’. For example, at the shareholders meeting in 2000, he said: “So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And to our managers, we say we want the moat widened every year. You know, that does not necessarily mean that the profit is more this year than last year, because it won’t be sometimes. But if the moat is widened every year, the business will do very well.”
Although Buffett himself did not systematically summarize what a ‘moat’ is, later researchers have summarized the elements of a company’s moat into the following four categories:
- Intangible assets: such as brands, patents, franchise rights.
- Customer switching costs: The cost incurred when a customer switches from one product\service to another product\service. Here the cost includes time, finance, emotion, etc.
- Network effect: A network effect occurs when the value of a product or service increases as more people use it.
- Cost advantage: The ability to deliver services or produce goods at low cost, weakening its competitors in price. The cost advantage may come from enterprise size, resource endowment, geographic location, etc.
Therefore, a moat can be understood as: a source of solid and lasting competitive advantage.
However, high-quality products, leading market shares and excellent management teams are not strictly a moat because these factors are difficult to maintain for a long time with great uncertainty, and they are easily imitated or destroyed by competitors.
It should be noted that companies with a strong moat are not the only ones to grow and be worthy of investment. Companies with a shallow moat can also achieve phased success through product innovation, excellent teams and execution capabilities, just like many fast-growing DeFi projects.
3.2. The moat of DeFi blue-chip projects
Like the real world, DeFi projects are now facing increasingly severe competition. They are also seeking and constructing their own moats, since the moat theory of value investment is still valid in the crypto world.
At present, for most projects in the DeFi field, the influence of the moat’s four elements is as follows: customer switching cost > network effect > intangible assets > cost advantage.
3.2.1. Let’s talk about customer switching costs first.
We can divide the users of a DeFi product into individual users and external protocols. The switching costs exist for both, while having a greater impact on the latter.
Taking the lending protocol Aave as an example, it has become a source of yields and liquidity for a large number of other DeFi protocols, and it is the base of DeFi Lego. If one of DeFi protocols connected with Aave wants to switch to another lending protocol to replace Aave, it means the need of new protocol research, code changes and re-audit of the overall protocol security. This not only requires high time cost and financial cost, but also faces the uncertainty of the new Defi LEGO combination.
For individual users, the switching costs will be much lower than that of protocol users, and many users even enjoy the fun of exploring new products. Nevertheless, excellent DeFi products will retain individual users through well-designed mechanisms, thus increasing their swiching costs.
In this regard, Curve provides us with a classic case. When users purchase its project token Crv, only by staking Crv they can obtain core rights such as platform fee dividends, liquidity market-making yield acceleration, etc. The longer the stake duration, the higher their yields and rights. Thus, more than 69% of circulating Crvs have been staked on the platform, with an average stake length of incredible 3.67 years (the maximum stake duration is 4 years).
We have reason to believe that these users will find it difficult to leave Curve in the next three years. They will always be loyal users of Curve and enthusiastic followers of community governance.
Among the 10 DeFi projects mentioned in this article, most of them have a moat in terms of customer switching costs, especially:
- Curve: It is accessed by a large number of external protocols, and it binds users for a long tie through token locking.
- Aave: It is accessed by a large number of external protocols, and it is also their basic liquidity layer.
- Synthetix: Users will be forced to mint sUSD after staking SNX, which is conducive to the transformation from investors to trading users. After becoming a trading user, investors’ willingness to terminate staking will be significantly reduced, circulating to form an engaging staking+ product system.
- PancakeSwap: It is the largest DEX on BSC, and it is trusted and accessed by most BSC protocols that require transactions.
- Compound: Similar to Aave.
- Chainlink: Most of its customers are DeFi protocols, and the overall cost of replacing the Oracle partners is high.
3.2.2. Second, the network effect of DeFi products.
The role of network effects in public chain competition is very obvious. It is represented in the ecological flywheel that enhances the number of users, the number of developers, and capital size reinforce each other. Numerous “Ethereum killer” public chains were all falling under this powerful rule.
Network effects also exist in multilateral user markets such as trading and lending platforms. On Uniswap, the larger the trading volume, the more market makers will be attracted to make the market to provide liquidity. On the other hand, the improvement in market-making depth will in turn increase the user stickiness of traders, so as to achieve mutual reinforcement.
However, due to the open source nature of blockchain projects and the rise of liquidity mining, new projects can use Fork project code + mining subsidies to attract users and market makers of existing projects. SushiSwap uses this approach to catch up with Uniswap, which was previously considered to have strong network effect. A large number of new Dex on BSC also challenge PancakeSwap in a similar way. However, it turns out that the success rate of this approach is getting lower and lower. Uniswap and Pancake are still the Dex with the highest number of active users on Ethereum and BSC respectively. The moat built by network effects helps them resist a certain degree of attack.
Another classic case of network effects in DeFi is the stablecoin Dai issued by Maker. The wider the circulation of Dai, the more protocols and users that accept it, and the higher the value of its currency network. Other newcomers to decentralized mortgage stablecoins, such as LUSD issued by Liquity, are still difficult to catch up with the ever-expanding Dai in a short time, even though they have superior economic mechanisms.
For in-depth research reports on Liquity, please read: “Mint Ventures In-depth research reports: Liquity, a rising star in stabilizing the currency market”.
Among the 10 DeFi projects mentioned in this article, the ones with significant network effects are:
- Currency protocol composed by Maker+Dai
- 4 DEX projects
- Aave and Compound’s bilateral lending market
3.2.3. DeFi’s intangible assets may also be one of their moats.
In the DeFi world, we will observe a phenomenon: Although other lending protocols have higher deposit yields and have passed the audit of well-known security companies, many users are still only willing to deposit in old projects such as Compound and Aave. Their reason is that these two projects have been in safe operation for longer, have gone through multiple rounds of tests, and are more trustworthy.
Thus, as an intangible asset, the brand is extremely valuable to the DeFi protocol. Different from the emotional attribute of real-world brand power, the brand of DeFi protocol is often derived from the reputation for long periods of risk-free operation, the decentralized community spirit and even the community influence of leaders, etc.
Another type of DeFi intangible asset that has quietly emerged may be the original code protected by BUSL (Commercial Source License). Uniswap used this method to prevent its code from being forked before the release of V3 code. Although there have also been incidents that anonymous projects forked their code, at least this hinders the fork of projects that value their own reputation and real-name projects. However, if the product itself is not a solid moat, the competitive advantage from original code is not strong, because other projects may be carrying out completely different model innovations from the old projects.
Since the 10 projects mentioned in this article are all well-known and widely recognized, they all have certain advantages in terms of brands in intangible assets. Of course, this advantage is not strong compared to switching costs and network effects.
Cost advantage is probably the least common moat factor in the DeFi business, due to the composability of blockchain business, the flexibility brought about by anti-regulation, the extremely active crypto venture capital support, and the fact that the full online operation of DeFi projects does not require a large amount of fixed costs.
We found that excellent DeFi blue-chip projects have at least one, or even two or three, of these above moats, which make it more difficult for them to be caught up with by later competitors. This may be one of reasons Curve has a higher PE valuation than PancakeSwap and SushiSwap.
4. Summary
There are many reasons why a DeFi project can become a blue-chip player. For example, it is on a good track (such as DEX and lending), or it may catch up with the dividends of the industry’s outbreak period, such as opportunities brought by DeFi mining wave to Yearn, or it has an excellent team.
However, if blue-chip projects aim to stay ahead in the market, they need to have a healthy revenue and token value capture model, and more importantly: a sufficiently wide moat to obtain the long-term follow and favor of users, investors, and partners.
After analyzing 10 current blue-chip projects, we believe that Curve, Aave, and Syntheix have a better overall performance in the above aspects, and they are expected to maintain the current blue-chip position and even go further.
Curve: A clear revenue model and excellent tokenomics have greatly improved the overall demand of project participants for Crv and position lock-up, which also increased the switching cost of users and investors of the project. Because Curve is also a typical bilateral market, network effects can also have a curbing effect on latecomers trying to enter this field.
Aave: It has a clear income model and reasonable method of capturing the economic value of token. Aave’s competitive advantage is stable, due to the basic position of lending protocols in DeFi and the high switching cost of external protocol users to replace the protocol combination. In addition, the long history of development and zero major safety incidents during the operation period also make many ordinary users and institutional users willing to give up the high returns of other lending protocols and prefer to Aave.
Synthetix: The revenue model is clear, the method of capturing the economic value of tokens is reasonable, and the derivatives track is long and wide. Its unique token staking mechanism also makes it easier for Synthetix investors to stake tokens and convert themselves into trading users of products, who are not easy to leave.
However, it needs to be emphasized that in a free, open, and transparent crypto world, the moat of the existing DeFi leaders is much more fragile than that of traditional world companies. The moat of the former can be easily crossed by the latecomers through economic mechanism innovation, product iteration and even huge subsidies. Those DeFi users who are more exploratory and rational are far less obsessed with a product than ordinary users who are enthusiastic about traditional brands.
Therefore, although we do not think that the core team of DeFi is the moat of a project, they are the offensive party of the project development and expansion. Only if the team continues to be diligent, enterprising and innovative, the existing project barriers will not be gradually eroded by newcomers.
From this point of view, the decision to invest a relatively mature leading project of DeFi is still a complex decision that pays equal attention to both value investment and risk investment. This is exactly the fun and challenge of investing for high returns in this ever-changing crypto world.
5. Data & reference
Defi Pulse Index：https://www.tokensets.com/portfolio/dpi
CoinGecko：https://www.CoinGecko.com/
Messari：https://messari.io/
Token Terminal：https://www.tokenterminal.com/
IOSG: IOSG Weekly Brief | Will Curve become the top of the DEX world?
Aave Research Report：https://mint-ventures.medium.com/in-depth-research-aave-the-making-of-a-defi-lending-king-db2310dbe93f
Synthetix Research Report：https://mint-ventures.medium.com/synthetixs-ambitions-a-derivatives-trading-market-with-unlimited-liquidity-a2b79279687b
Liquity Research Report：https://mint-ventures.medium.com/in-depth-research-report-liquity-rising-star-in-the-stablecoin-market-647181716bbd
Other: various Defi project products\documents\weekly reports, etc.
*If there are obvious factual, understanding or data errors in the above content, please give me feedback and I will revise it.
Author TG: Alex_xu_block
