An introduction to the blue chips of DeFi
As the total-value-locked in DeFi protocols reaches $65 billion, we take a brief look into the main players to understand what they do, and why they’re attracting so much retail and institutional attention
Uniswap — Decentralized Exchange
Uniswap is the most popular and most used decentralized exchange built on Ethereum, with $44bn in traded volume last month. People can use Uniswap to trade any token built on ETH at a low cost, and can additionally use their ETH based tokens to supply liquidity in return for earning fees and other rewards. Uniswap continues to dominate the DeFi space, with 67% of the DEX volume market share and $79m in monthly protocol revenue. Uniswap’s popularity has allowed it to be a key introduction for many people into DeFi concepts such as liquidity pools and yield farming. Dex’s work by using an automated-market-making model, where users provide their tokens as liquidity and the automated-market-maker sells to maintain the desired ratio of the liquidity pool. This allows users to earn attractive returns as they receive a % of the trading fees earned, as high as 30–50% APY on certain crypto pairs, and around 10–20% for stablecoin pools. The main risk for entering liquidity pools is impermanent loss, where the price of the tokens moves significantly enough to effect the ratio of the pool. It’s because of this reason that the APY of pools is higher than most other returns in crypto, as users need to have compensation for taking the risk.
Aave — Lending & Borrowing
Aave is a decentralized network of collateralized lending pools run by smart contracts, that allow people to freely lend, borrow, and earn interest on their crypto assets. Aave is the leader in DeFi lending, with over $12bn in TVL, as their strong product offering and easy to use platform continues to attract users looking for passive income. The latest updates allow users to easily transfer their collateral from one coin to another without having to repay their loan or withdraw it out of Aave. This increases user’s ability to manage liquidation risk by being able to swap their collateral if the original asset starts falling in price. The governance token, AAVE, is used by holders to determine various changes to the rules and policies of the protocol. Holding the token also provides the user various bonuses such as reduced fees/rates, higher borrowing limits, and advance access to certain pools. Aave has also innovated “flash loans”, which are uncollateralized short term loans that are issued and settled within the same block of transactions. AAVE Pro is also set to launch within the coming weeks, where the protocol will use private pools to provide institutional investors with direct access. These pools will be separate from existing liquidity pools on Aave. Aave’s investors include ParaFi Capital, Framework Ventures, Three Arrows Capital, etc.
Yearn.Finance — Asset Management & Yield optimisation
Yearn.Finance is a DeFi platform that automatically reallocates investors’ funds and finds the highest yield across various DeFi products such as Aave and Compound. The platform allows the average crypto investor access to more advanced strategies, and it’s easy-to-use interface has caused it’s popularity to consistently increase, with over $3bn in TVL. “Earn” is the main product where users deposit stablecoins such as DAI, USDC, USDT, and Yearn will optimise and rebalance across DeFi lending platforms to achieve the highest returns. “Vaults” are a similar product, but instead of optimising lending returns, these optimise deposits based on yield farming and act as a “actively managed mutual fund”. This allows users to have a simplified access to yield farming whilst still maintaining exposure to their preferred assets, as users are not limited to just stablecoins. YFI is the native governance token of Yearn, and it allows users to vote on strategies for different vaults, change the fee structure, and so on. Holders also benefit directly from the platform’s earnings, as the protocol charges 2% management fees and 20% performance fee. The entire management fees and 50% of the performance fees accrues to the treasury that is controlled by the token holders. With a limited number of YFI, growing TVL, and constant buy pressure from the treasury, the tokenomics are likely to act as a strong driver for the price.
Synthetix — Derivatives & Synthetic assets
Synthetix is a non-custodial derivates exchange, where overcollateralized borrowers deposit funds into SNX and create on-chain synthetic versions of real world assets such as precious metals, foreign currencies, and oil. Synthetix provides crypto users the ability to have non-blockchain exposure, where users can go long or short assets such as Tesla or Gold. Sythentix’s strategy of bridging traditional legacy assets and new digital assets through these innovative products has seen it gain popularity fast, with now over $1.4bn in TVL. The collateral system is similar to that of MakerDAO, where SNX is locked up to create sUSD, and then sUSD acts as debt while SNX acts as collateral. The key difference being that staked SNX can be used to mint various synthetic assets and not just the sUSD stablecoin. The native token, SNX, has value because it is needed to generate new synthetic assets. Holders also receive a portion of the trading fees from the entire platform, and can also earn rewards by staking their SNX. Currently over 80% of circulating SNX is locked in on the platform. One of the downsides to Synthetix is its high collateralization ratio, requiring 750% of staked SNX to the value of the Synth asset. Additionally SNX is more volatile than other assets such as ETH which can lead to higher risk when it comes to keeping your ratio intact. Synthetix’s investors include Paradigm, Framework Ventures, Coinbase Ventures, etc.
MakerDAO — Lending & Borrowing
MakerDAO is a decentralized system for collateralized loans where users can lock up their ETH to receive DAI, the platform’s stablecoin. When a user locks up ETH, they are able to take out a loan of a smaller amount in DAI, which is pegged to the US dollar. The native token of MarkerDAO is called MKR, which allows tokenholders to own and govern the protocol. Holders of MKR currently receive all of the interest paid by borrowers and trading fees paid by traders, as well as a cut of liquidations paid by borrowers. MKR primarily acts as a form of support for the loan system, as whenever the price of ETH drops significantly or when too many loans are liquidated at once, MKR is created and sold to pay off the loans. MKR is also bought back using the proceeds from liquidation fees. This means MKR holders are the last line of protection in case of a blackswan event where collateral falls too fast. It also serves an additional role as a governance token, allowing holders to vote on how high fees should be and which types of collateral should be accepted by the system’s smart contracts. MakerDAO’s investors include a16z, Polychain, IOSG Ventures, etc.
Compound — Lending & Borrowing
Compound is a decentralized crypto lending and borrowing protocol run by algorithms and smart contracts. Anyone with an internet connection and a crypto wallet such as MetaMask can supply their crypto or borrow assets at interest rates set by real time supply and demand, which allows people to lend and borrow without having to negotiate terms through a middle man such as a bank. When people deposit their crypto assets into Compound, they are provided c-tokens (cETH, cDAI etc) which represent a claim to their portion of the asset pool. Similar to other DeFi protocols, loans are overcollateralized and therefore you must provide more value in crypto as collateral than you can borrow. Compound was initially started by Robert Leshner and funded by VC, but since the release of the COMP token control and governance has been gradually handed over to the community. Votes have been held to add coins, adjust interest rates, and various other improvement proposals. Compound is fairly simple to use and understand, which allows it to be a major player as retail looks for passive income. Compound’s investors include a16z, Paradigm, Polychain, etc.
Balancer — Decentralized Exchange
Balancer is an automated market maker similar to Uniswap where users can provide their crypto to liquidity pools to earn rewards and a percentage of the trading fees. The key difference is that Balancer allows people to create their own Liquidity Pools with up to eight assets pooled instead of just two. The creator of the pool arbitrarily sets the weights of the underlying assets which are automatically rebalanced by smart contracts as the prices fluctuate, in order to maintain the ratio’s of the pool. This allows anyone to create their own self balancing index fund or invest in someone else’s, a key upside being that liquidity providers still earn fees while their index funds are rebalanced. A downside to this is increased divergence loss as the prices of the various assets can fluctuate more broadly than is possible with just two assets provided at 1:1. BAL is the governance token for this protocol and users that deposit assets are rewarded in BAL. Balancer specifically names some goals such as deploying the protocol on blockchains other than Ethereum, implementing layer two solutions, introducing fees at the protocol level to generate revenue and more, with these being examples of actions BAL holders can make. Balancer’s investors include DeFiance Capital, Three Arrows Capital, Alameda Research, etc.