Market Update: Increased appetite for risk as DeFi TVL surges and NFTs see record monthly volume of +$1.2bn

Over the past month we have seen signs of genuine demand returning, with sentiment also shifting positive as capital inflows to DeFi and NFTs provide a boost for network activity. Layer 1 blockchains like Terra and Solana are gaining serious traction as adoption increases across smaller protocols that offer cheaper and faster alternatives with attractive yields. Prices reflect the user demand, with Solana breaking it’s ATH and up 210% from July lows, and Terra up 438% over the same period.

The strong demand in DeFi and NFTs is continuing to support the bullish case for Ethereum, but most importantly it’s reducing the circulating supply even further, with the percent of total supply on exchanges now at a record low of 13%. The amount being locked up in ETH 2.0 deposits also continues to climb to now total over 5% of supply, with protocols like Lido allowing users to capture returns whilst still having liquidity to use their staked ETH.

The latest EIP-1559 hard fork on ETH proved to be another bullish catalyst after successfully being activated at the start of August, with it being one of the largest upgrades the network has seen and an important milestone before the significant move to PoS with ETH 2.0. Although the effects will likely materialise over the longer term, the upgrade has already seen over $200m of ETH burned, spurring further price appreciation which in turn encourages more speculation.

We take a deeper look into the current state of the market below:

Strong growth in DeFi TVL, layer 1s like Solana and Terra gain momentum

With the recovery in price, we’ve also seen a recovery in DeFi activity with TVL across the board increasing as users gain confidence and an improved appetite for risk and yield-bearing opportunities. Total DeFi TVL bottomed out at $96bn less than a month ago, and has now rallied back to $143bn, just shy of the all-time-high of $155bn seen when ETH was trading at +$4,000. AAVE continues to lead the pack with 9% dominance over the DeFi market and currently $13bn in TVL. Demand for lending and borrowing is rising with AAVE, Compound, and Maker now representing $43bn in total deposits, a level not seen since the May highs.

Interest rates have seen some increased movement from the higher demand, but overall borrowing rates at the top 3 markets remain stable around 3–5% on USDC, with smaller protocols gaining traction as they offer more attractive returns and the ability to increase the productivity of assets, through mechanisms such as liquid ETH staking on Lido.

This week Solana traded at a new all-time-high and is currently now trading at a market cap of $20bn, managing to disconnect as BTC remains stuck in its new range. TVL on Solana has seen a strong increase as it doubles to $2.4bn over the past month, with adoption increasing as new DeFi and NFT protocols launch on the network. Solana is heavily backed by VCs and FTX CEO Sam Bankman-Fried, with strong branding and marketing ensuring it is seen as a cheaper and faster alternative to ETH, competing alongside the likes of BSC. One of the drivers for Solana’s recent gains is the launch of Wormhole 2.0, which is an interoperability protocol that enables communication between Solana and other blockchains like ETH, Terra, and BSC. Raydium, Serum, and Mango are the main Solana protocols that are boosting DeFi demand, offering cheap and easy to use DEXs and AMMs. The all-time-high price for Solana also coincided with the first large scale NFT collection released on the network, with 10,000 “Degenerate Apes” selling out in less than 10 minutes, causing a surge in the demand for buying Solana.

Terra has also been one of the best performers recently as TVL jumps +100% over the past month to total $6.1bn, as the network has caught the attention of DeFi users from the attractive 20% yield on the native UST stablecoin. This has seen strong demand for minting UST, which can only be done through ‘burning’ Terra as the reserve asset. This creates a process of constant bid pressure for the network token, as loans can only be collateralised by Terra, and UST can only be minted with Terra. The high stablecoin returns are made possible because Terra is a PoS network, and therefore when users take out loans, they’re overcollateralizing a productive asset which the protocol then stakes itself to earn further yield. Not only is Terra used as the main token to maintain the peg for the UST stablecoin, but token holders also receive 100% of the transaction fees. Lido is another protocol on the Terra network that has boosted demand, as it lets users stake their ETH and get liquid stETH in return, allowing the possibility to then earn further yield that would not be possible with normal staked ETH that is locked into the network and therefore illiquid.

NFTs are booming, with the main marketplace hitting record volume of $1.2bn over the past month

OpenSea is the most popular NFT marketplace on ETH and has seen an explosion in users and traded volume this year, with the past 30 days proving to be another significant step up. Current volume is 900% higher over the previous 30 days as demand for collections such as CryptoPunks, Artblocks, and Parallel Alpha are seeing price gains as much as 200%. The excitement started when celebrity entrepreneur Gary Vaynerchuk announced he spent $4m to buy a single CryptoPunk. On the same day, an unknown buyer came out to lift over 100 punks, spending over $10m in ETH. Initially it was rumoured that it was the large crypto hedge fund Three Arrows Capital that were behind the move, with co-founder Su Zhu tweeting “We bought punks and other NFTs because they’re undeniably part of the broader story of digital scarcity, meme economy, collective capitalism, and metaverse.”

The Ethereum based game Axie Infinity has also been leading the exponential growth for NFTs and blockchain based gaming, adding another bullish catalyst for ETH. The game was slowly accumulating a loyal player-base over the past year, before seeing a surge to now have almost 1,000,000 active users. The price has seen a significant rally too, and is up 2000% in less than 3 months. Despite the lofty valuation, the game has the numbers to back it up, with protocol revenue that dwarfs most other blockchains or dapps. Over the past 30 days AXS has generated $344m in fees, compared to $404m for ETH, and significantly higher than protocols like Uniswap and Aave which brought in $91m and $28m respectively.

Options continue to show strong upside for ETH over the longer term, futures remain healthy

As we mentioned in our previous market update, a combination of the market being positioned heavily bearish and a strong increase in front dated calls caused a squeeze to push us higher from range lows.

Since then we have seen the 3-month futures basis consistently hold around 7–8% and perp futures funding remain at 10% annualised. This is one sign of genuine demand returning for derivatives, but when compared to the levels we saw earlier in the year of 40% futures funding rates, we can infer that the main driving factor of the recent market move has been from spot buying. This is further backed up by derivative OI as a percent of total market cap being significantly lower than earlier in the year too, with leverage ratios across exchanges also staying relatively low. This is a sign of a much healthier market, and therefore potential moves higher are more likely to be sustainable now that there’s plenty of cash on the side-lines, and still room for derivatives to add fuel to the fire before looking overheated.

Options have seen consistently bullish moves, with the top 3 changes in BTC instrument OI over the past month coming from 88k Sept-21 calls, 100k Oct-21 calls, and 140k Dec-21 calls. ETH continues to show the same bullish bias, benefiting from the strong activity in DeFi and NFTs, with a significant amount of demand for 5k-10k Dec-21 and 40k-50k Mar-22 call spreads. Over 30% of total ETH option open interest is for Dec-21 expiry, with over 60% of this being for 5,000 strikes or higher.

Despite the move higher over the past 30 days, volatility remains compressed and similar to levels seen during the sideways period, with BTC 7 day realized and implied vol now at 54 and 78 respectively, compared to levels of 150 in May. Longer dated contracts have priced in slightly more volatility, with ATM Dec-21 expiry trading at 95 IV from 84 a month ago. BTC has the largest open interest for Sept-21 contracts, with 64k being the most held strike.

Crypto Market Insights and Thought Leadership by Covario AG.