[In-Depth Research Report] Alpaca: DeFi upstart galloping on the move
By Xu Xiaopeng, Mint Ventures
1. Key points
1.1. Core investment logic
Alpaca is on a track with clear demands and continuous growth. The overall quality of the project is excellent, which is a high-potential project worthy of attention:
- The market size of market maker is basically the same as the total size of DEX. In the long run, it is in a rising period. In addition, the arrival of subsequent specialized institutions will help the business volume of high-end market-making financial products such as Alpaca continue to grow.
- The project has a very excellent and diligent team, whose innovation, product iteration speed, industry direction judgment, community operation, etc. are all reliable.
- The new developments followed may bring a huge increase to Alpaca’s overall revenue and the profits of token holders, including the convenience of more external protocol access after the development of SDK, the improvement of capital efficiency and new interest income brought by the launch of AUSD, and the business expansion.
- Alpaca currently listed on several CEX including Kucoin, MXC, and Gateio, but it has not launched on top exchanges, especially Binance.
1.2. Valuation
Regardless of comparing with similar leveraged lending projects on BSC or mature lending projects in the industry, Alpaca’s current valuation is in a reasonably underestimated range.
1.3. Main risks
For details, see “Internal Risk” and “External Risk” in the section of “Fundamental Risk”.
2. Basic information
2.1. Business scope
Alpaca is the largest leveraged lending protocol on BSC, which is essentially a derivative and money market serving decentralized market makers. Market makers (liquidity farmers) can leverage a larger amount of principal through Alpaca protocol to enhance their absolute profits of market-making. Lenders can obtain loan interests through lending funds.
For decentralized exchanges, Alpaca provides liquidity through improving its capital efficiency by connecting borrowers (market makers) and lenders.
Since leverage is used for farming through Alpaca’s lending, the farming process of users are also a process of going short or long assets at the same time. In this way, Alpaca actually provides lending + leverage services, but the main scenario at present is the liquidy farming in the AMM DEX.
2.2. History and roadmap
The official launch time of the Alpaca project is February 26, 2021. After publishing the first article (“Introducing Alpaca Finance”) introducing the project on Twitter and Medium, it has been in operation for more than 4 months so far, and its core products have been launched. The team has high efficiency, and the work objectives of the roadmap are listed in great details.
The work completed in Q1 (actually takes only one month) mainly focuses on: early token distribution, the launch of the minimum viable product and Alpaca leveraged yield farming, code audit and preliminary token empowerment.
The details are as follows:
In Q2, Alpaca team entered a full-speed working state, provided a richer kind of tokens for loan and leverage pool, and added an oracle guard to prevent and control attacks. In addition, it integrated a new DEX (Waultswap), tried NFT-style activities on the marketing side, and launched the single-asset leveraged yield farming function which has given Alpaca token a new empowerment.
The details are as follows:
Based on the situation of Q1&Q2, the Alpaca team has very good fulfilling capability, with rapid product iterations.
The key tasks that the team wants to accomplish in Q3 and Q4 include:
In the working plan of Q3 and Q4, there are many key points worth of attention, including: multi-chain expansion, improving the composability of protocols, issuing AUSD stable token and expanding use cases, further empowerment of governance tokens, enriching NFT use cases in its own ecosystem, expanding the Alpaca ecosystem through investment, expanding institutional service, and entering the field of underlying loans.
Many of the above business directions are expected to bring a large increase of business volume to Alpaca, such as multi-chain business expansion, more kinds of assets, farming pools and DEX, and the increase of protocol composability.
According to the work plan for the second half of the year, it can be seen that the Alpaca team is preparing to expand its business to a broader financial field from leveraged yield farming services.
3. Existing main products and business conditions
3.1. Leverage yield farm
a. Business logic and user roles
Leveraged yield farming is the current core business of Alpaca, through which it has obtained US $1.2 billion of TVL. leveraged yield farming is essentially a derivative of the lending business. Different from those basic lending platforms such as Aave, Compound, BSC and the current largest lending platform Venus, the users of Alpaca focus on liquidity farm on the DEX platform after lending funds. Although users can also lend currencies on Venus for farming, the loan leverage rate is low due to the limitation of the collateral ratio of most cryptocurrencies. However, based on the same collateral, farmers can use Alpaca to leverage more funds to participate in liquid farm, multiplying their returns (and risks).
In the Alpaca’s leveraged yield farming business, there are 4 roles:
- The lender Alice deposit her BNB to the Alpacas’ fund pool. Her BNB can be borrowed by DeFi farmers for farming, and Alice can obtain the loan interest as income.
- Bob, a farmer, wants to establish a leveraged yield farming position. The farming transaction pair is BTCB (BTC in BSC)/BNB. He borrows BNB from the fund pool. Then the smart contract of Alpaca Finance will automatically convert part of BNB borrowed by Bob into BTCB, intelligently adjust the optimal ratio of BTCB and BNB, and inject BTCB/BNB liquidity into PancakeSwap to enjoy PancakeSwap’s LP income.
- Erin is the liquidator. Anyone can participate in the liquidation, but it is usually done by robot. When the liquidator finds that the risk ratio of one of the leveraged positions is greater than the default ratio set by the system, Erin will call the kill method in the contract in real time to automatically clear the leverage position, so as to ensure that the lender Alice’s funds will not suffer losses. Meanwhile, Erin will earn a 5% return on this liquidation position. There is also a robot inside Alpaca Finance, and 100% of its yields are used to buy back and burn Alpaca tokens.
- Carlos who is a bounty robot monitors the accumulated rewards in each fund pool in real time, and regularly claims and reinvests these rewards as LP, so that DeFi farmers can obtain compound interest income. This is similar to the operation of a DeFi aggregator. For this service, he withdraws 3% of the reward into the developer fund to pay for operating expenses. Currently, this is played by the official robot.
In this business model, the liquidity farmer Bob is the bottom source of demand. His pursuit of liquidity farming returns drives the operation of the entire leverage business. Alice meets Bob’s borrowing needs through deposits and she can earn the interest. The liquidator Erin ensures that the system will not have bad debts while receiving liquidation rewards. The reinvestment robot Carlos improves the revenue efficiency of the entire system and charges a certain handling fee. The Alpaca team that builds this multilateral lending platform collects 10% of depositors’ interest income as the main source of its income. In terms of business model, it is concise and clear.
b.Long and short position tools
It should be noted that Alpaca not only provides a leveraged yield farming tool, but also allows you short or long a certain asset while liquidity farming.
For example, if you choose to establish a BUSD-BTC 3x leveraged yield farming position through Alpaca, you have three options:
i. You are bullish on BTC, thus you want to go long on BTC while liquidity farming. Then you use BTC as the principal and borrow 2 times the value of BUSD to open a position. The contract will automatically sell part of the BUSD in exchange for BTC to complete the 1:1 ratio of LP, and then deposit the LP position (50% BTC — 50% BUSD) with 3 times the market value of the original principal into Pancake to start farming. In this case, because part of the borrowed BUSD is converted to BTC, this means that you go long on BTC at the same time. When the price of BTC rises, you can earn double yields of liquidity farming profit + the rise of BTC. The specific position opening details are as follows:
ii. You are bearish on BTC, thus you want to go short on BTC while liquidity farming. Then you use BUSD as the principal and borrow 2 times the value of BTC to open a position. The contract will automatically sell part of the BTC in exchange for BUSD to complete the 1:1 ratio of LP, and then deposit the LP position (50%BTCB-50%BUSD) with 3 times the market value of the original principal into Pancake to start farming. In this case, because part of the borrowed BTC is converted to BUSD, you are equal to shorting BTC at the same time. When BTC declines, you can earn double yields of liquidity farming profit + the decline of BTC. The specific position opening details are as follows:
iii. You want to do Market Neutral — Arbitrage. The principal can be divided into two equal parts, and the above two strategies can be executed at the same time to hedge risk. No matter whether BTC eventually rises or falls, the above two strategies can hedge the gains and losses brought by BTC price fluctuations to arbitrage. At this time, your two positions are similar to the following picture:
*The above strategies are all examples. Users will have more operation strategies based on actual needs and scenarios.
Reading here, you may find that it is not so easy for users who are novice to start leveraged yield farming to understand the above mechanisms. Indeed, due to the existence of different factors such as slippages, impermanent losses, cryptocurrency price fluctuations, transaction fees, etc., the profitability relative to the initial principal is not so easy to predict after a leverage position is opened.
In order to accurately evaluate the risk-return ratio, professional Alpaca users usually apply an emulator with a set of multiple parameters to measure the expected return of opening position for farming, as shown in the figure below:
c. Product depth
Due to the complexity of its product, Alpaca’s products have a certain depth, which provides a low-to-high product ladder to users who want to earn profits through Alpaca:
- Entry level: directly provide mainstream assets such as BNB, stablecoins, BTC, ETH, etc. for lending to obtain interest income, with the characteristics of low risk, low difficulty, and low yield;
- Intermediate level: leveraged yield farming of stablecoin pairs, such as USDT-DAI, BUSD-UST, etc., but users need to pay attention to the slippage loss of opening positions, etc., with the characteristics of medium and low risk, medium difficulty, and medium yield;
- Advanced level: leveraged yield farming of non-stable coin pairs, which requires the ability of profit trial calculation, risk balance, trend judgment, or it can be used as a hedging tool or short/long tool. It is characterized by medium to high risks, high difficulty, high yield suitable for high-level financial players.
d. Business data
Alpaca’s TVL (Total Value Locked) is composed of: leveraged yield farming positions supplied + outstanding deposit balance + staked Alpaca-BNB liquidity farming LP + staked sAlpaca value. The main income source of Alpaca protocol is the fee of loan interest income, so we mainly observe the fund utilization of the deposit side here. The official data of Alpaca at 13:00 on June 30, 2021 are used here. The indicators are as follows:
After calculation, Alpaca’s overall fund utilization rate (total borrowings/total deposits) is 42.04%, higher than Venus (33.5%) and Compound (33.9%), and slightly lower than Aave (44.6%). The overall fund utilization rate of Alpaca is relatively high, among which the BNB part has made an important contribution.
At present, the business of Alpaca is on the right track. From the perspective of the correlation between Alpaca’s TVL and its token price in the past 30 days, Alpaca’s TVL has always remained above US $1 billion (even during the period a sharp drop of more than 50% on Alpaca’s price) whose fluctuation is far less than that of its token price, although the TVL of Alpaca fluctuates with the token price. This shows that the impact of Alpaca’s token price on its product business is shrinking, and users use its products more out of actual demands.
3.2. Grazing range
Grazing range is a reward pool jointly launched by Alpaca and other projects on BSC. Users can deposit the project token Alpaca to get token rewards from partners and limited edition NFTs issued by Alpaca and its partners. At the same time, Alpaca will also reward users for their leveraging farming of partners’ tokens on Alpaca.
This type of cooperation model is similar to Pancake’s existing syrup pool + liquidity farming model, which has benefits for Alpaca, token holders and partners:
- Alpaca & token holders: the farming subsidy provided by the partners provides Alpaca with cash flow in addition to interest sharing, which improves the intrinsic value of Alpaca tokens and also helps increase the volume of locked tokens and ease the selling pressure of circulation market;
- Partners: form the promotion of precise users, with access to potential product users and token investors. Alpaca can provide liquidity from leveraged yield farming users for the project, and rapidly increase the depth of the capital pool.
In addition, Alpaca also distributes limited edition NFTs to users who have reached a certain amount of Alpaca deposits. Currently, NFT only has the collection and display functions. According to the official roadmap, it will explore the specific equity use cases of NFT in the ecology in the second half of the year.
So far, the grazing range has reached cooperation with 9 projects. The specific list is as follows:
We found that there are also some well-known BSC and multi-chain projects such as Belt finance, DODO, Boring DAO, etc. in addition to newer projects. This can prove the attractiveness of Alpaca in the BSC ecosystem.
3.3. Future business
According to the roadmap of the team for the second half of the year, there are three areas of business progress worthy of special attention, namely:
a. AUSD
At present, there is no too detailed information about AUSD, but it should be a stablecoin product issued with Alpaca’s interest-bearing assets (ib token) as collateral. According to the team’s AMA in April, this business was originally scheduled to launch at the end of the second quarter. However, due to the continuous outbreak of security incidents on the BSC from May to June, the team has increased the workload of security audits, resulting in delays in the release of some functions.
The collateral assets of AUSD should be mainstream crypto assets deposited by users into Alpaca, such as stablecoins, BTC, ETH, BNB, etc. The mint method may be similar to Makerdao (just guessing). However, like all stablecoin projects, AUSD also faces the same problems as other new stablecoins: in a stablecoin market with strong network effect, what new value do you provide for stablecoin users, so that they are willing to use your products?
Like any new product, a new stablecoin is difficult to be adopted by users if it has no “multiple benefits” compared with old stablecoins. The advantages and characteristics of the current mainstream stablecoints are roughly as follows:
- USDT: first issued with the largest issuance. Its first-mover advantage has built a strong currency network effect, but it is criticized for its centralization and opacity. The market has been worried about its credit risk.
- USDC: it was issued earlier, and its current issuance is second only to USDT. Although it is also a centralized stablecoin, it is under strict supervision and uses US dollars as collateral, which reduces credit risk. USDC is also the most rapidly promoted stablecoin outside of the crypto world.
- BUSD: its issuance ranked the third. Although it is mainly issued by Binance, there are also regulations that pay attention to its collateral and issuance volume, and the credit risk is small. In order to promote BUSD, Binance has provided strong operational support such as transaction fee reduction and exemption, so as to expand its applicable scenarios. It is currently the most widely circulated stablecoin in the BSC ecosystem.
- DAI: a decentralized stablecoin with the largest issuance and the longest history, issued by Makerdao using an over-collateralization mechanism. It has the largest network effect among decentralized stablecoins.
Due to the strong network effects and brand advantages, it is very difficult for new stablecoins to compete with old stablecoins, even if they have no problem in terms of security and decentralization. Because the lack of use scenarios will lead to insufficient demand for stablecoins, and then the coin price will be not pegged to US dollar for a long-term run. This phenomenon exists in Venus’s VAI now.
For the minters and users of AUSD, it may have two new values, making people willing to mint and use it:
- For the users of AUSD: Alpaca may first launch the leveraged yield farming scenario of AUSD within the ecosystem, which can make AUSD have an early usage scenario and income source and avoid the embarrassment of having no place to use. This is the main difference between AUSD and other pure stablecoin project — Alpaca itself can provide the early usage scenario for AUSD without the need of looking outside, which solves the problem of cold start.
Of course, AUSD will eventually need to expand its use cases beyond the Alpaca ecosystem, otherwise its ceiling will come soon. The expansion of the external scenario is ultimately determined by the size and product impact of Alpaca ecology.
b. Institutional business
Introducing more institutional and professional-level investor funds to the platform may be one of Alpaca’s priorities in the second half of the year. In addition to the clues on the roadmap, this can be confirmed by two other events.
First, in early June, Alpaca has set up a company; second, the team has begun to recruit ToB positions such as head of business director, head of institutional growth, and head of institutional sales, and now there are already some candidates in the negotiation.
The establishment of a company can enable the project to better meet the qualification requirements of other party in the cooperation with institutions, especially traditional financial institutions. In addition, the recruitment of institutional positions indicates that the team will shift its business focus to serving institutions.
Why does the institutional business become the focus of the project? This may be determined by industry trends and Alpaca’s own product positioning. In the view of industry trend, the rapid growth in the crypto world is far from halting, and the space for investment, arbitrage, and trading opportunities is much larger than that of the traditional financial market. As long as the compliant channels for access to DeFi gradually become smooth, institutional funds will inevitably start to earn princely sums. The stablecoin yield products with a fixed return rate of 4% recently launched by Compound and Coinbase have demonstrated this trend. They are very attractive for institutional assets in the global low interest rate environment.
In terms of Alpaca’s products, the leveraged yield farming on the platform and subsequent more complex derivative trading tools have extreme high thresholds of understanding and practice to most ordinary users. Only professional players and institutions with professional data modeling capabilities and mature arbitrage experience are the best service targets for such products. Although the absolute number of such users is far less than retail players, the overall amount of their funds is far higher than that of retail players.
So why are institutional users willing to use Alpaca instead of traditional derivatives tools? In other words, after the token rewards of liquidity farming have faded, is there still any gold worth digging in the DeFi market? This answer may also be yes.
The reason behind this is that the underlying transaction mechanism of DeFi liquidity farming such as AMM, is different from the traditional transaction matching mechanism. The gaining source of liquidity farming is also more complex and non-linear. On the one hand, the gold farming opportunities come from the rapid growth of the crypto market, on the other hand, it comes from the radical change of the rules. This is a “new gold mine” different from the traditional financial market.
For example, in the communication with some senior users in the Alpaca community, they said that professional users choose leveraged yield farming as one of arbitrage tools. On the one hand, they can earn farming gains by using leveraged yield farming. This is the first type of non-loss (interest) derivative, which can make up for the loss of other derivatives combined with it. More importantly, the capital fluctuation curves of leveraged yield farming and options are different, and the intersection of different yield curves can bring low-risk arbitrage opportunities. It is worth mentioning that the game environment of DeFi products is more complicated due to its composability and openness. While amplifying uncertainty and risks, there will also be more arbitrage opportunities that can be flexibly captured.
What’s more is that even for the types of institutional clients that would use simple products like BlockFi, Celsius, Compound, and Coinbase to seek 4% interest, Alpaca can also offer at least this APY as well as doing it with no lockup and in non-custodial, decentralized fashion.
The Alpaca team may have increased its resource investment in institutional services based on the prediction of the above trends.
c. Improve the composability of protocols
At present, Alpaca’s protocol interaction mainly comes from the direct use of users and calls from the protocol are less frequent, because the function of leveraged yield farming is far more complicated than the DeFi aggregators and the basic lending protocols. Q3 Alpaca will add its SDK to facilitate the use of leveraged yield farming function by external protocols. It is a very important means to enhance the level of business by improving the composability of protocols. Stani Kulechov, founder of Aave, said in a recent AMA that currently nearly 80% of Aave’s transaction volume comes from the call of external protocols, which also makes Aave one of the most successful basic protocols on the Ethereum. In addition, innovative products such as cross-asset leveraged yield farming will be launched in the future.
4. Alpaca team
As a DeFi project that was born only 4 months ago, the Alpaca team is still mysterious and anonymous. It has not disclosed any information about its core members and has never given any relevant information on the number of team members, job position composition and geographical distribution.
When asked about their anonymity, their Head of Strategy Samsara responded by saying, “Our team is distributed all over the world, and we want to focus on building the best products rather than having to worry about changing macroeconomic climates in various jurisdictions, which often flip-flop on a quarterly basis, potentially hampering innovation and execution. The reality is that this is DeFi and we’re working with 100% open-source smart contracts. That means our code logic is deterministic, verifiable, and trustless. That’s true regardless of what the developers’ names are, just as it was true when blockchain was first invented by an anonymous figure, Satoshi.”
But such an anonymous team is impressive in the following aspects:
4.1. Fast product iteration and responsiveness
Obviously the Alpaca team is a believer and practitioner of “agile development”. The so-called agile development refers to a set of methodology which takes the evolution of user needs as the core and adopts an iterative and step-by-step approach to develop new software. Its principles include: advocating simplicity, embracing change, incremental improvement, fast feedback, and moving forward with light burdens, etc.
Alpaca has a rich document library with six versions: English, Chinese, Thai, French, Portuguese and Russian. If you browse through the documentation of the top DeFi projects, including those that have been around for much longer, you’ll find most of them lack language support beyond English. Alpaca is promoting the project with such a work and product idea, which is reflected in the perceptible external aspects such as community management, product interaction, code efficiency, and document arrangement, etc.
In terms of product iterations, Alpaca has maintained a state with steady introduction of major functions and intensive small improvements. Here the major functions mainly refer to the core functions that can be placed on the product roadmap, such as the leveraged yield farm (LFY) recently launched and dual-asset lending. Small improvements include a quick response to detailed requirements, such as “whether users can add the real-time price on the position opening page to avoid the opening loss due to price changes.”
The agility and rapid response of the team can also be seen in another emergency. After the launch of Alpaca, it quickly attracted nearly 1 billion TVL within a week due to its original open source code, refreshing interactive pages and interesting image of alpaca. However, on March 4, Alpaca’s similar project — Meerkat Finance (MKAT) vanished a day after the launch, raising questions about the safety of the Alpaca project itself. In half a day, the TVL plummeted by nearly 30% (from 1 billion to 700 million). After the incident, Alpaca team quickly responded on Twitter and the community on the same day, giving a transparency statement and reiterating that they were conducting an audit with Peckshield and another company. On March 5, it launched the bug bounty program to encourage bug catching with high bonus. On March 6, the team announced the result of bug bounty and made amendments. As a new project that had launched for only one week, the professionalism and participation of its community users and the team’s response speed are impressive.
The diligence of the project on the product side can also be proved by the update frequency on Github. Alpaca’s code update volume and frequency are almost the highest on BSC now.
4.2. Innovation capability
Alpaca is not the pioneer of leveraged yield farming, whose original practitioner was Alpha (later expanded to BSC) deployed on Ethereum. However, Alpaca did not completely fork Alpha’s code, but made a lot of innovations based on its code framework, and this laid the foundation for more innovative functions as well as risk prevention in the future. So far, Alpaca’s innovations compared with Alpha include two-way asset lending (Alpha’s recent V2 version has also begun to support it), leveraged yield farm, AUSD stablecoins, and cross-asset lending. In addition, there are more user-DeFined options when opening positions.
4.3. Deep understanding of Meme culture
With the popularity of DeFi trend and the outbreak of Dogecoin and Shiba this year, the word “Meme” has been repeatedly mentioned in the community as well as the communication and operation of DeFi projects.
Meme refers to a popular Internet culture gene copied and spread in derivative way. It is a bit similar to the “gag culture” in Chinese.
The most successful representative of meme culture in the coin circle is the Dogecoin with dog head as the token symbol. The spiritual core of meme culture in the crypto world is to reduce seriousness, with anti-authority and geek spirit.
Alpaca chose alpaca as the mascot of the project and said formally in the beginning of the official document: Alpaca — what a majestic animal! We can’t think of a better mascot to represent our ethos.
- Alpacas love to live in the mountains at high altitudes… They will make your farming yields sky-high once you become their friend.
- Alpacas come in 22 gorgeous colors… We will offer many farming pools for you to choose from.
- Alpacas are green animals; they have a very light carbon footprint, and 95% of their wool is usable… Sending transactions on BSC is incredibly efficient and will cost you much less gas than on other chains, maximizing your yields.
- Alpacas do not bite, and lack sharp teeth… Everything about our project is transparent and verifiable; there will be no rug pull!
- Alpacas are a great investment; they’re inexpensive to raise, require small acreage, and provide a regular supply of wool… Our protocol’s leveraged positions will allow you to amplify your profit potential, providing higher yields on less capital.
Within a few days after the launch, the developers changed the image of Alpaca for many times, and the combined IP images include Harry Potter, Laser Eye, etc. Most surprisingly to Chinese users, Alpaca even grayed out the page and created an image of alpaca honoring Yuan Longping on the death day of Yuan Longping, the father of hybrid rice in China.
The community inherited the alpaca meme culture from the core team. Community users continuously redeveloped the image of alpaca and created a large number of theme emoticons, which became a unique cultural language in the community, as shown in the below figure:
4.4. Emphasis and investment on safety
The team attaches great importance to the security of funds and contracts. It arranged security audits by Peckshield and Certik before the official functions were launched. Alpaca is one of the few profitable projects that had not been affected during the period of May to June when BSC security incidents occurred frequently.
Oracle and lightning loan attacks are the most frequent attack methods on BSC. In order to prevent and control this risk, Alpaca has launched a set of exclusive risk control mechanisms, which is called as “Oracle Guard”. To be specific, when the price of an assets in a user’s farming pair from the DEX (PancakeSwap) differ more than 10% from the median of a batch of off-chain oracles verified by Alpaca, the Oracle Guard will enter the protection mode. This consists of disabling liquidations, opening and closing positions, and adding collateral, all of which aim to protect users from trading at bad prices and taking an unjust loss.
In the interviews with community users, many users mentioned the team’s focus on code security and transparency. They said that the team would cooperate with community volunteers with code audit ability to conduct multiple audits before submitting the official audit, while maintaining open source code. This practice of community participation in audits not only improves the community’s trust in the project, but also enhances code security and work efficiency.
In the evaluation of BSC by DeFi Safety on June 12 of this year, Alpaca’s safety score ranked the first. Considering the update speed of Alpaca products and the complexity of its business, this result is really incredible.
4.5. Summary
Alpaca team’s hard work in agile development, innovation ability, grasp of meme culture and strong guarantee on security are all impressive and highly recognized by the community. Moreover, Alpaca has not received external venture capital, nor has it issued coins for financing through IDO or IEO. This team has always maintained a high development morale and rapid product iteration, showing the maturity of senior practitioners in the product direction. Where does their motivation come from?
I think this closely related to the economic incentive mechanism of Alpaca which is different from other projects, which will be analyzed in the following section of “Token model analysis”.
5. Business analysis
5.1. Industry prospect and potential
Alpaca’s business started from leveraged yield farming. This year, it is expected to start the stablecoin, cross-asset leverage and other businesses. It can be seen as a derivatives and currency market providing services for decentralized market makers. Different from centralized exchanges, the liquidity of DEX is almost entirely provided by market makers. In addition, compared with the high threshold of market markers in the centralized exchanges, DEX allows every ordinary user to come and provide liquidity through the AMM model so they can harvest transaction fee yields. Therefore, the total liquidity of DEX in the AMM model can be regarded as the total scale of market-making capital.
According to the data of Debank on July 1, 2021, the top ten DEXs with AMM mechanism have locked US $33.77 billion of market-making liquidity (almost half of the total locked value of DeFi). This can be regarded as the upper limit of the market scale for professional market makers, and this amount is still growing.
As mentioned in the chapter “Basic information”, Alpaca’s leveraged market-making products are relatively complex, more suitable for professional market makers or institutions with arbitrage modeling capabilities (or the ability to use arbitrage models). So, in the current US $33.77 billion DEX market-making world, how much does the professional market-making capital account for?
We don’t know the specific figures for the time being. However, according to The Block research analyst Igor erdiev’s capital calculation for Wintermute, the current largest market maker in the crypto field, its total market-making capital on CEX and DEX are at least US $55 million. Wintermute is an algorithmic market maker specifically designed for cryptocurrencies, providing market-making services on almost all mainstream CEXs. Its weekly trading volume on Bitfinex is approximately US $2 billion, twice that of the second place. It is also one of the largest market makers on DEX platforms such as Synthetix, Tokenlon, and dydx.
Even so, the market-making capital of US $55 million does not account for a large proportion in the whole crypto world, and even in the DEX world. I believe that with the development of DEX and the popularity of compliant channels, more and more market-making institutions will enter the market-making field of DEX and increase the proportion of their market-making capital. Such kind of professional clients are the target users of Alpaca.
Given that decentralized trading platforms are the most important infrastructure in the crypto world, as well as the long-term trend of professional market-making capital to increase the share of DEX liquidity, the potential market size of Alpaca is also large and expected to expand rapidly.
5.2. Token model analysis
Alpaca adopts a single token model. Alpaca is not only the governance token of the project, but also realizes deflation through profit repurchase and burn to enhance the intrinsic value of Alpaca tokens.
At present, the sources of Alpaca’s repurchase funds currently mainly come from three parts:
- Loan interest: Alpaca will charge 10% of the loan interest as protocol fee, of which 5% will be used to buy back Alpaca and 5% will be controlled by the team as the operating capital of the project.
- The team’s liquidation robot will receive 5% of the liquidation reward through liquidation works, 100% of which will be used to buy back and burn Alpaca. It should be noted that the liquidation of Alpaca is open to all users, so its liquidation robot may not be able to scramble for the liquidation right, so the income is uncertain.
- Handling fee for leveraged yield farm yield: Alpaca will charge a 19% handling fee for the yield of leveraged yield farm (CAKE farming is currently launched), of which 10% is used to buy back Alpaca and distribute it to its deposit users, and 9% will be used as operating capital of the project and controlled by the team.
In addition to the above three sources of repurchase funds, Alpaca can obtain more sources of repurchase funds with the development of more new businesses. For example, in the recent communication with the Chinese community, Samsara who is the core member of the team, said that in the future a certain proportion of 5% of the third-party robot revenue will be used to repurchase Alpaca, and the overall liquidation revenue in the highly volatile market will also become a value source for Alpaca.
In addition, in the communication with Samsara who is the core member of Alpaca, he mentioned that in the future Alpaca will increase the proportion of the above protocol revenue that would be used to buy back and burn Alpaca, ensuring that more than 50% of the protocol revenue would go to the holders of Alpaca.
New attempt of team motivation
Readers familiar with the token economy model of DeFi projects may be surprised to see this: shouldn’t Alpaca’s protocol revenue be captured by the project token holders? Why does the team now take away more than 50% of Alpaca protocol revenue?
Alpaca’s core team did share a large percentage of the protocol revenue. In fact, in addition to the above revenue, the team also collects a 3% handling fee from the token reward reinvestment of DEX liquidity farming and 8.7% of the output from the Alpaca token from liquidity farming. This process will last for two years until all tokens are distributed.
I think this is also one of the core reasons why the Alpaca team is so effective. Although it sounds a little unusual for more than 50% of protocol revenue to be attributed to the team rather than to the holders, this may be a more reasonable team incentive model.
If we think that blockchain\DeFi entrepreneurship is similar to traditional Internet entrepreneurship, we will find that the existing incentive model of blockchain team is a bit weird: The entire DeFi cash flow income belongs to the token holders. The core team (mainly the founding team) does not receive wages, and their incentives either come from the continuous unlocking of free team shares in the early stages of the project, or from a certain percentage of token distribution generated by fair farming. It’s as if the startup team doesn’t get paid, lives on unlocking and realizing cash from the initial offerings and options in the early stage of the startup and pays the company’s daily fixed expenses.
This model may cause two negative effects:
- At the later stage of the project development, as the actual professional manager of the project, the startup team will lose their economic motivation to keep striving.
- Due to the lack of sufficient daily economic income, the team is unable to carry out measures such as team expansion in the important development periods, limiting its development speed.
The above statement is not scaremongering. Stani Kulechov, the founder of the well-known DeFi protocol Aave, said in a recent AMA that the core team may gradually drift away from the development and operation of the project after completing the development of Aave2.5, and it is planning to start a new WEB3 venture project.
The model adopted by Alpaca is more like the business model of traditional startup companies: the protocol obtains operating income through the provision of financial services. Part of the income is used for costs and expenses (the core team uses it to pay for operating costs, including wages and office space, etc.), and the remaining part is retained as net profit for shareholders (token holders).
On the one hand, this profit distribution model ensures that the core team has a stable cash flow income to maintain expenses, on the other hand, the team’s income is also consistent with the growth of the project, because the team’s income will increase with the growth of the overall protocol revenue. This model avoids the problem of team incentives and project decoupling in the later stage of project development.
In this model, the principal-agent problem between professional managers (founding team) and shareholders (token holders) with option incentives (continuous token distribution) seems to be alleviated to a certain extent.
In the end, it will take time to observe and test whether this model is better than the existing model of “governance tokens to capture all protocol revenue”, which is a long-term road to explore.
The author argues that in this process, Alpaca holders need to observe the following:
i. Under the condition of getting more protocol revenue, does the core team have higher work efficiency than other teams and make the pie bigger more efficiently?
ii. Is the team willing to gradually transfer the distribution proportion of protocol revenue and increase the revenue capture ratio of token holders after the protocol revenue pie becomes bigger? Because as the total protocol revenue grows, the proportion of the team’s fixed expenses and labour costs in total revenue should decline.
5.3. Competition landscape
Project moat and source of competitive advantage
As a platform providing financial services to market makers, Alpaca’s moat mainly comes from the following points:
- Core team with excellent comprehensive quality. This is reflected in agile development and product iteration capabilities, skilled application of Meme culture, accurate grasp of industry trends, and a good balance between project capital utilization rate and risks.
- Good community atmosphere. Due to the complexity and professionalism of the products, the average level of users in the Alpaca community is high, with good trading and financial knowledge as well as code talents. The community has given the team great help in the development of third-party tools, document compilation, production of communication materials, production of opening model tools, code audit, product strategy, community operation management and many other aspects of the project. In addition, the internal community is very united.
- First-mover advantage of the project in product\model\risk management\TVL. The design of DeFi leveraged yield farming products is complicated. As an early project in this field, Alpaca has a certain first-mover advantage over the latecomers in terms of product and model experience accumulation.
In the traditional value investment concept, the moat of an enterprise mainly comes from intangible assets (brands, patents, franchise rights), network effect, switching cost (after users use it, the cost to replace the product is very high) and cost advantage (from the scale, geographic location, resources, etc., that are hard to imitate). These competitive advantages that are difficult to shake and hard to imitate prevent new competitors from entering the market to compete with existing players.
So, is the moat theory of traditional value investment still applicable in the blockchain field?
First, let’s look at the patent licensing of intangible assets. In the DeFi field, patents and franchises are rare due to the open source code as well as the transparency and openness of blockchain. However, Uniswap has applied for BUSL1.1(The Business Source License) for their V3 code, prohibiting other projects from forking its codes for commercial purpose without permission. It is said that Alpaca will also begin to apply for code protection for its original function codes (single-asset leverage, cross-asset lending), prohibiting other projects from forking without permission for a period of time.
However, due to the anonymity of a large number of DeFi projects, the protective effect of the license still needs to be observed. There have already been instances of anonymous projects forking Uniswap V3 code before.Still, such projects that make blatantly “illegal forks” are much less likely to receive support from investors, the ecosystem(blockchain and exchanges) or potential partners, both for liability reasons and negative PR.
The brand effect of intangible assets in the DeFi field primarily comes from the safety and longevity of the project, rather than from emotional factors. The longer a DeFi runs without risk, the more users believe in its reliability and tend to use it. For example, many users dare to use Compound and Aave even though they do not have the ability to audit the codes, just because these products have experienced a long time test and multiple rounds of extreme market stress tests.
Network effect has outstanding effects in the fields of public chains and stablecoins, but not in DeFi projects so far.
In terms of cost advantage, since the development cost of DeFi projects comes more from the intellectual capital of team members, i.e., staff salaries, it is almost impossible to build cost barriers and thus the moat of cost advantages is also very rare.
Switching costs exist for some basic DeFi platforms that are widely adopted by external protocols, because other DeFi projects may require adjustments to their overall models and new security audits if they want to replace a piece of their own DeFi Lego. Secondly, institutional users may also have a high switching cost for their arbitrage tools. They need to conduct a complete preliminary investigation on their cooperation platforms, including the understanding of platform security, stress resistance under extreme conditions, team ability, service stability, future product roadmaps and ways to deal with competition. This evaluation process often takes 3–6 months. Due to the high cost of evaluation and decision-making, organizations do not easily change their DeFi partners if there are no safety accidents. On the contrary, individual users easily quit a DAPP to use a newer or better one because their switching costs on specific products are very low.
In general, due to the openness and transparency of blockchain and the autonomy of user account rights, it is more difficult to charge high “monopoly rents” than traditional industries to form a monopoly advantage in the DeFi field. This also means that the core team of DeFi projects must continue to update its knowledge, iterate products, improve its own protocol composability and always prioritize user needs, so that it may not be caught up by later innovators.
In other words, the core team itself is the most critical “moat” for most DeFi projects.
5.4. Basic risks
a. Main internal risks
- The team’s product development progress or market expansion is not as good as expected, especially in the institutional market. Risk level: Medium
- Bad debts caused by black swan events such as extreme market conditions and smart contract vulnerabilities. Risk level: low
b. Main external risks
- Track competition is intensified: more professional and excellent teams will enter the market-maker service track with the support of capital, lowering the overall operating profit of the industry. Risk level: Medium
- Cryptocurrency enters a bear market: the crypto world has a distinct cycle. When a bear market cycle comes, the transaction volume of the entire trading market will decline significantly, and so will the profits of market markers. This will also have a direct impact on Alpaca’s project revenue. Risk level: Medium
6. Token circulation and distribution
6.1. Total supply and total circulation
The total supply of Alpaca tokens is capped at 188 million. Now the total supply, total circulation and market capitalization of the tokens are as follows (unit: 1,000):
Alpaca’s farming bonous lasts for 2 years and will end in February 2023. The output declines monthly, as shown in the following figure:
The monthly inflation ratio of project tokens will drop below 5% after July, and the subsequent inflation selling pressure will gradually decrease.
It should be noted that the project launched the Stronk fund pool in March due to the large output of token mining in the early days. Users can put the locked Alpaca tokens into the Stronk fund pool and obtain the lock-up certificate sAlpaca. In return, they will be rewarded with additional sAlpaca tokens (s means Stronk). On July 12, four months later, users can exchange sAlpaca tokens for Alpaca by 1:1. It is estimated that the total amount of principal and interest to be unlocked will reach about 30 million Alpaca, which will directly increase Alpaca’s market circulation by nearly 30%, causing short-term pressure on the token price. However, it should be noted that, in fact sAlpaca is a freely circulating certificate of deposit that can be exchanged with Alpaca in the secondary market, and the current exchange rate is close to 1:1
Therefore, the circulation pressure of 30 million locked Alpaca has conducted disguised transmission to the market through sAlpaca in advance. When 30 million sAlpaca can be exchanged for Alpaca, its impact may be relatively limited.
6.2. Token distribution
Among the 131 million tokens supplied by Alpaca, the main wallets distributed are as follows:
7. Preliminary valuation
7.1. Five core questions
What business cycle is the project in? Maturity stage or the early and middle stage of development?
The project is in the early stage of operation, the core functions of its products have been launched, and PMF (Product market fit) has been verified.
Does the project have a solid competitive advantage? Where does it come from?
The project has a certain competitive advantage, which mainly comes from the excellent team, the experience accumulation when the project was established early as well as the first-mover advantage in capital.
Is the medium and long-term investment logic of the project clear? Is it in line with the industry trend?
The project has a clear investment logic, and the main scenario is precise. It aims to provide financial services for market makers and it will expand to the its market share with the focus on the institutional market. In the future, DEX will still be the foundation of the industry development, and the professionalization and institutionalization trend of market makers will continue. So the development direction of the project is aligned well with the industry trend.
What are the main variables in the operation of the project? Are these variables easy to quantify and measure?
The main operation variables of the project are the business development progress and industry competition. They can be intuitively measured by the key function development and implementation speed of the project, TVL, capital utilization rate and other data, as well as the focus on the expansion of institutional customers.
What is the management and governance of the project? What is the level of DAO?
At present, directions of product development and protocol are primarily led by the core team. The community gives feedback on product experience and other aspects and promotes the core team to solve them. Alpaca has not yet launched the voting function. In the future, users need to stake their Alpaca tokens to get the voting rights and then attend commubity governance. The DAO is currently in the early preparation stage.
7.2. Summary of core investment logic
Alpaca is on a track with clear demands and continuous growth. The overall quality of the project is excellent, which is a high-potential project worthy of attention:
- The market size of market maker is basically the same as the total size of DEX. In the long run, it is in a rising period. In addition, the arrival of subsequent specialized institutions will help the business volume of high-end market-making financial products such as Alpaca continue to grow.
- The project has a very excellent and diligent team, whose innovation, product iteration speed, industry direction judgment, community operation, etc. are all reliable.
- The new developments followed may bring a huge marginal increase to overall revenue and the profits of token holders, including the convenience of more external protocol access after the development of SDK, the improvement of capital efficiency and new interest income brought by the launch of AUSD, and the business expansion.
- Alpaca currently lists on seceral CEXs includes Kucoin, MXC, and Gateio, but they have not launched on top exchanges, especially Binance.
7.3. Valuation assessment
Although Alpaca project has a clear cash flow, in theory we can apply the Discounted Cash Flow (DCF) model to value it. Given that DeFi is still an early market and the industry is developing rapidly with too many variables, it is likely to get a “accurate but wrong” answer if using the DCF model for valuation.
This research report mainly uses the relative valuation method to compare and Evalate Alpaca. It primarily compares the valuations of Alpaca and similar projects horizontally with the preliminary conclusion that the current market value is slightly undervalued.
a. Comparison between Alpaca and leading lending projects
Since Alpaca actually is a niche segment of the lending track, how does its valuation compare with that of Aave, Compoud, and Maker? The comparison indicator we use here is PE, i.e., the project market cap\project earnings attributed to token holders.
Based on the above data, we found that the PE of Aave and Compound is similar, while that of Makerdao is significantly lower and that of Alpaca is also lower. However, given the inconsistency of the token circulation ratios across projects, projects with low circulation ratios will face greater inflationary pressure in the future. After the author calculated the PE comparison after the circulation ratio adjustment, we found that Makerdao’s PE valuation advantage is more obvious, followed by Alpaca and Aave, while Compoud’s PE valuation is relatively high.
Of course, although the four projects are all lending projects, their business models are quite different, thus PE valuation can only be used as a reference indicator. Given that the Alpaca’s project development is in its early stage with many growth points of follow-up business, its adjusted PE of 69.8 is more attractive than the leading loan projects already in the mature period.
Of course, the reasons why Alpaca has a lower PE valuation may come from various sources, such as the project has not yet been launched in major exchanges, or it only provides services on the BSC now, or the project duration is shorter with higher uncertainty.
In summary, Alpaca’s current valuation is quite attractive.
b. The current valuation range of the market
At present, the market as a whole is in a correction stage after the bull market (there are also opinions that it has entered a bear market), where the valuation center has been clearly adjusted with obvious market bubbles. In terms of BTC growth, the highest point of this bull market is US $64,510, which is only 222% higher than the last round’s top of US $20,000. In addition, after the correction, the current growth rate is about 65% (US $33,000), significantly lower than the overall growth rate of previous bull markets. From the perspective of time length, the time duration that the current bull market has risen from the bottom is far shorter from the length for the last bull market (see the figure below).
However, the recent policy environment of global liquidity easing has fallen into a delicate situation. Although the Biden administration is eager to launch its 6 trillion fiscal expenditure budget, some federal officials have suggested that reducing the scale of debt purchases should be put on the agenda. The market’s divergence on whether the turning point of liquidity will come early is widening.
Recently, China government has strengthened its supervision on mining and speculation, and many policies are pending, causing greater pressure on the market in the short term. The inflation effect of massive money printing on US stocks is further evident. The CPI of the United States rose by 5% year-on-year in May, the largest increase in 13 years. Rising prices will put pressure on the current loose monetary policy of the Federal Reserve, which may accelerate the pace of reducing debt purchases. Furthermore, the Federal Reserve may raise interest rates in the first half of 2022, bringing a downward pressure on valuations of global risk asset market.
The increasing divergence of market trends will also have a direct impact on the valuation of a single project, which needs to be taken into consideration in asset allocation.
7.4. Summary of preliminary valuation
Alpaca serves the market of market makers with clear market demands. It is expected to maintain the current growth rate with the increase of the overall DEX market size and the proportion of institutional capital. Alpaca’s core competitive advantage is its excellent team, and also comes from scientific income distribution mechanism which ensures that the team has sufficient operating budget. In the future development, we need to focus on the expansion speed of Alpaca’s institutional market and its adoption by external protocols. Based on the comparison with the valuations of competitors and leading projects in the lending industry, the author believes that the current project valuation of Alpaca is in a reasonable low position.
*The above statement is not regarded as investment advice.
8. Reference and acknowledgments
In this report, I would like to thank Guo Hui and Daniel Xu from the Alpaca community for their help in sharing information and opinions, as well as Ariel, manager of Alpaca community, and Samsara, director of marketing strategy, for providing project information and answering questions.
Other reference information:
Project market cap
Business data
https://www.tokenterminal.com/
Products & documents
https://docs.Alpacafinance.org/
*If there are obvious factual, understanding or data errors in the above content, please give me feedback and I will revise it.
