DEFI MARKET OVERVIEW

Crypto Briefing Research Department

January 10, 2020

Contents

Introduction: Decentralized Finance (DeFi)

Decentralized Finance (DeFi) has been a growing trend over the last two years. Although the market is relatively young, the capital locked up in DeFi smart contracts has grown from $0 to nearly $700M in just over 24 months. The market is growing at an exponential rate, and the trend is expected to compound over the next decade.

Despite all the criticism surrounding Ethereum, it remains the primary choice for DeFi applications (dApps). Given its flexibility, decentralization, and the amount of development, Ethereum fits current market needs. However, it is expected that other platforms will start eating Ethereum’s market share as the DeFi sector evolves.

Currently, DeFi dApps give access to a full range of features and financial services. Users can issue stable coins, borrow, lend, and trade cryptocurrencies without having to deal with centralized third parties.

Long term HODLers can finally put their assets to work by lending to borrowers that prefer to use decentralized services to leverage their positions.

Users can also trade synthetic instruments (commodities or stocks) that were not available to crypto traders before.

Still, one has to remember that these are all early-stage projects and they bear a decent level of risk. As an example, most of these dApps are still highly dependent on centralized teams and are sourcing the data (usually the price feeds) from centralized data providers (oracles). So, as with the rest of the market, the DeFi space shares similar centralization concerns.

Furthermore, DeFi dapps carry additional systemic risks since they rely on the collateralization of existing crypto assets, which themselves are highly volatile.

Nevertheless, as the market evolves, most of the issues will likely get resolved and the trend which started two years ago will likely continue. This makes the DeFi sector very attractive and it will likely present even more investment and saving opportunities going forward.

DeFi Ecosystem

Maker Dao ⁠— the Leading DeFi dApp

Maker DAO holds half of the funds in the DeFi ecosystem — over $340M worth of value in Ethereum staked on its smart contracts, which makes it the current leader in the DeFi sector.

Generally speaking, Maker DAO is a stable coin system based on Ethereum. Its native coin Dai is a collateral-backed cryptocurrency, whose value is stable relative to the US Dollar. By far this is the largest decentralized price-stable currency in the space and, unlike most other stablecoins, is not backed by a central reserve of fiat currency. Decentralized Dai is growing in popularity as more concerns arise over the Bitfinex and widely used centralized stable coin Tether.

Users can buy and trade Dai on cryptocurrency exchanges.

They can also mint their own Dai by locking up the collateral in a blockchain smart contract through a Collateralized Debt Position (CDP). Every CDP has a Liquidation Ratio of 150%, which means that if your collateral value drops below 150% of your outstanding Dai, the contract will liquidate your position. In fact, the current average collateralization ratio across the platform is around 260%.

Prior to November of this year, users could only deposit Ethereum as the collateral to issue Dai tokens. Since November however, Maker DAO is migrating to multi-collateral Dai and is already supporting other tokens as collateral, such as BAT. The project’s community is also evaluating whether or not to add more collateral options to the platform.

What also differentiates Dai from other stablecoins, is that Maker Dao offers a Dai Savings Rate (DSR). This gives you the option to earn interest (about 2%) by simply holding the stable coin in a special smart contract.

Maker also has its own governance token MKR. MKR token holders govern the Maker Protocol and the smart contracts that power Dai by voting for the protocol upgrades and other important governance decisions.

Still, despite the success of Maker DAO as a project, it is being criticized for its inefficiencies. The governance of the protocol is still largely centralized, and one whale can basically rule major protocol decisions.

Also, according to some reports, there is a loophole for stealing all the ETH ($340M) from the protocol requiring only $20M. If a number of minor whales decide to collude to conduct such an attack, it would shake up the entire Ethereum ecosystem. However, according to the team, this is highly unlikely given MKR liquidity.

All things considered, and given its size and popularity, Maker DAO will likely remain the flagship dApp in the Ethereum ecosystem and will continue to shape the future of the sector going forward.

Synthetix Among the Top Crypto Winners of 2019

Synthetix is currently the second-largest DeFi platform on the market. Currently, over $150M is staked on its smart contracts.

The platform allows for synthetic asset issuance on Ethereum. Using Synthetix, investors can trade synthetic fiat currencies, cryptocurrencies, and commodities issued on the Ethereum blockchain which are all pegged to real assets.

Users do not need to hold SNX tokens to trade on the Synthetix Exchange. Instead, they can use ETH, or any other synthetic asset (synth) that is already available on the platform.

Nevertheless, the SNX token plays a vital role in the Synthetix ecosystem. In fact, all the synthetic assets traded on the Synthetix Exchange are backed by the SNX token. Users mint new Synths only by buying and staking SNX tokens.

Synths are currently backed by a 750% collateralization ratio.

Synthetix tokenomics has helped it attract a lot of stakers to the protocol and grow its capitalization. Currently, around 84.65% of tokens are staked with a staking reward of 54.36%.

Users are incentivized to stake SNX tokens in two different ways. Firstly, stakers receive exchange fees, which are sent to the fee pool (the average exchange fee is around 0.3%). In order to claim this reward, you need to stake SNX as collateral and mint sUSD (Synthetix stablecoin).

Secondly, there is a protocol inflationary policy. From March 2019 to August 2023, the SNX supply will increase from 100,000,000 to 260,263,816, with a weekly decay rate of 1.25%. After August 2023, there will be constant yearly inflation of 2.5%.

The newly issued tokens are distributed between SNX stakers on a weekly basis, given that their collateralization ratio does not fall below the 750% threshold.

However, if the exchange fee rewards are available immediately, the inflationary reward will be escrowed for 12 months. Users must claim their rewards every week, or the rewards will expire.

Since the launch, Synthetix has shown good overall progress in terms of development and user acquisition. However, it is not without problems. In June of this year, the platform suffered an oracle attack which resulted in a $37M loss. Although all the funds were recovered after negotiation with the arbitrage bot-owner that unintentionally hacked the system, oracles still remain a major weak point for the DeFi sector.

There are also concerns that the staking ratio may start falling due to the large token inflation, falling staking rewards, and plans to add ETH as another collateral option on the platform (currently SNX is the only collateral option). The concerns are valid since they would increase the supply pressure and can potentially provoke a sell-off, given that the trading volumes on the platform will not increase.

Nevertheless, Synthetix has chosen a promising market to play on, and has the chance to excel as the DeFi space evolves. In traditional financial markets, the derivatives market is by far one of the largest markets in existence, with an estimated valuation of over $1.2 quadrillion on the high end. It is highly likely that, going forward, derivatives will become as popular in the DeFi space.

DeFi Lending Has Great Potential

DeFi lending dApps are in the perfect position to capture the growing P2P lending market. In 2018, this market was valued at $34.16B, and it is expected to reach $589.05B by 2025, with a CAGR of 50.2%. Crypto-backed loans remove third parties and intermediaries, which helps reduce costs and simplify the whole process of borrowing and lending.

Currently, the leading lending DeFi platform is Compound. This is the third platform by USD value on its smart contracts, with more than $86M staked.

Users of the Compound protocol are placed into two groups: lenders and borrowers. Lenders lend funds to the protocol and are rewarded with the interest paid by borrowers.

The mechanism used by the Compound protocol differs from other P2P lending platforms, where lender’s funds are matched and lent to another user, making face value and interest available only once the loan is repaid.

Compound aggregates the lent funds into the liquidity pool and allows anyone to supply assets and earn interest after the deposit. The assets can also be withdrawn at any time, and lenders do not have to wait before a specific loan will mature.

There are also many other lending platforms in the market, such as dYdX, Nuo Network, and bZx. The table below summarizes current interest rates on some of the largest lending platforms.

DeFi lending has quickly become popular since it lets users borrow and lend cryptocurrencies in a relatively safe and easy way. As the space expands, this market has all the opportunities to surpass traditional P2P lending in size, as well as expand its reach across the world.

DEXes Are the Future

Many experts in the cryptocurrency sphere agree that decentralized trading is the future of cryptocurrency exchanges. It provides many fundamental benefits in comparison to the centralized ancestors ⁠— control over your own funds, transparency, smaller risk of price manipulation and falsification of trade volumes, less exit scams, and counterparty risks.

However, the overall cryptocurrency trading volumes on DEXes still remains small, compared to centralized trading. There are many reasons for this, among them poor user experience, limited liquidity, and lack of functionality.

Nevertheless, current market players have been evolving along with the overall industry, and now decentralized exchanges provide a much better experience than 2 years ago.

Most of the large general-purpose blockchains have their own DEXes. However, as with other DeFi dApps, Ethereum DEXes are the most popular on the market.

Currently, one of the most interesting and dynamically developing projects in this sector is Uniswap. This is a protocol for automated token exchange on Ethereum.

While most other decentralized exchanges utilize an order book to match buyers and sellers, Uniswap utilizes liquidity pools, allowing anyone to take part in them and to be rewarded for supplying the liquidity.

Currently, around $27M is staked on Uniswap liquidity pools. Liquidity providers are free to deposit and withdraw their tokens from the liquidity pool at any time. However, while the funds remain in the pool, each liquidity provider receives a portion of the 0.3% fee charged for every swap on the platform.

Uniswap is very efficient in comparison to other decentralized exchanges on Ethereum. For ETH to ERC20 trades, it uses more than 3x less gas than IDEX.

Additionally, Uniswap is 100% on-chain and does not require KYC, which makes it a truly decentralized solution in comparison to players like IDEX, which, despite being decentralized, enforce KYC.

The Ethereum blockchain currently hosts many other DEXes on its blockchain, making great progress in decentralized trading over the last several years. As DeFi continues to evolve, decentralized trading will be the necessary piece that will govern the health of this growing industry.

Conclusion

The DeFi sector has shown strong gains over the course of the year. The dollar value on DeFi contracts has doubled, the number of users of DeFi dApps has increased by more than five fold, and the number of dApps and their functionality has increased significantly.

It is also likely that this is just the start; 2019 was a good year for building the foundation of this decentralized economy, and in 2020 we will likely see substantially greater adoption of DeFi applications.

Furthermore, 2020 is a year heavy with anticipation. As the overall market may start a new bullish cycle, the DeFi sector will likely present many interesting opportunities for all of its stakeholders ⁠— including users, investors, and developers.