Original title: "Altcoins keep falling, it's time to refocus on Defi"

Original author: Alex Xu, Lawrence Lee, Mint Ventures

Introduction

As one of the oldest tracks in the crypto field, the performance of the Defi track in this round of bull market is not satisfactory. The overall increase of the Defi sector in the past year (41.3%) is not only far behind the average level (91%), but also behind Ethereum (75.8%).

Data source: artemis

If we only look at the data in 2024, the performance of the Defi sector is also difficult to say, with an overall decline of 11.2%.

Data source: artemis

However, in my opinion, in the peculiar market background where altcoins fell together after BTC hit a new high, the Defi sector, especially the leading projects in it, may have ushered in the best layout time since its birth.

Through this article, the author hopes to clarify the view on the value of Defi at the current moment by discussing the following issues:

· The reason why altcoins have significantly underperformed BTC and Ethereum in this round

· Why now is the best time to pay attention to Defi

· Some Defi projects that deserve special attention, as well as their value sources and risks

This article is far from covering all the Defi with investment value in the market. The Defi projects mentioned in the article are only used as examples for analysis, not investment advice.

This article is the author's interim thinking at the time of publication. It may change in the future, and the views are highly subjective. There may also be errors in facts, data, and reasoning logic. Criticism and further discussion from peers and readers are welcome.

The following is the main text.

The mystery of the sharp drop in the price of altcoins

In the author's opinion, the performance of altcoin prices this time is not as expected. There are three main internal reasons in the crypto industry:

· Insufficient growth on the demand side: lack of attractive new business models, PMF (product market fit) is a long way off for most tracks

· Excessive growth on the supply side: further improvement of industry infrastructure, further lowering of the threshold for entrepreneurship, and excessive issuance of new projects

· Continuous wave of lifting of restrictions: continuous unlocking of tokens of low-circulation and high-FDV projects, bringing heavy selling pressure

Let’s look at the background of these three reasons separately.

Insufficient growth on the demand side: The first bull market lacks innovative narratives

In the article "2024 will be the main rising year of this bull market, and a more stable strategy is to increase positions" written by the author in early March, it is mentioned that this bull market lacks business innovation and narratives of the same magnitude as Defi in 21 years and ICO in 17 years. Therefore, the strategy should be to overweight BTC and ETH (benefiting from the incremental funds brought by ETFs) and control the allocation ratio of cottages.

So far, this view is very correct.

The lack of new business stories has led to a significant reduction in the inflow of entrepreneurs, industrial investment, users and funds. More importantly, this situation has suppressed investors' overall expectations for the development of the industry. When the market hasn’t seen stories like “Defi will devour traditional finance”, “ICO is a new innovation and financing paradigm” and “NFT subverts the content industry ecosystem” for a long time, investors will naturally vote with their feet and move towards places with new stories, such as AI.

Of course, the author does not support overly pessimistic arguments. Although no attractive innovations have been seen in this round, the infrastructure is constantly improving: · Block space fees have dropped significantly, from L1 to L2 · Cross-chain communication solutions are gradually becoming complete, with a rich list of options · User-friendly wallet experience upgrades, such as Coinbase’s smart wallet supports fast creation and recovery without private keys, direct call of cex balances, no need to recharge gas, etc., allowing users to get close to the web2 product experience · Solana’s Actions and Blinks functions can publish on-chain interactions with Solana to any common Internet environment, further shortening the user’s usage path

The above infrastructure is like water, electricity, coal and roads in the real world. They are not the result of innovation, but they are the soil for innovation.

Excessive growth on the supply side: excessive issuance of projects + continuous unlocking of high-market-value tokens

In fact, from another perspective, although the prices of many altcoins have hit new lows this year, the total market value of altcoins has not fallen much compared to BTC.

Data: Trading view, 2024.6.25

So far, the price of BTC has fallen by about 18.4% from its high point, while the total market value of altcoins (displayed as Total3 in the Trading View system, indicating the value of the total encrypted market value after deducting BTC and ETH) has only fallen by -25.5%.

Data: Trading view, 2024.6.25

The limited decline in the total market value of altcoins is based on the substantial expansion of the total amount of newly added altcoins and their market value. From the figure below, we can intuitively see that the growth trend of the number of tokens in this round of bull market is the fastest in history.

New Tokens by Blockchain, data source: https://dune.com/queries/3729319/6272382

It should be noted that the above data only counts the token issuance data of the EVM chain. More than 90% of them are issued on the Base chain. In fact, more new tokens are contributed by Solana. Whether it is Solana or Base, most of the newly issued tokens are memes.

Among them, the representative memes with higher market capitalization that emerged in this round of bull market are:

· dogwifhat: 2.04 billion

· Brett: 1.66 billion

· Notcoin: 1.61 billion

· DOG•GO•TO•THE•MOON: 630 million

· Mog Coin: 560 million

· Popcat: 470 million

· Maga: 410 million

In addition to meme, a large number of infrastructure tokens are also being issued or will be issued this year, such as:

The second-layer networks are:

· Starknet: market value of 930 million, FDV7.17 billion

· ZKsync: market value of 610 million, FDV3.51 billion

· Manta network: market value of 330 million, FDV1.02 billion

· Taiko: market value of 120 million, FDV1.9 billion

· Blast: market value of 480 million, FDV2.81

Cross-chain communication services include:

· Wormhole: 630 million in circulation, FDV3.48 billion

· Layer0: 680 million in circulation, FDV2.73 billion

· Zetachain: 230 million in circulation, FDV1.78 billion

· Omni network: 147 million in circulation, FDV1.42 billion

Chain building services include:

· Altlayer: 290 million in circulation, FDV1.87 billion

· Dymension: 300 million in circulation, FDV1.59 billion

· Saga: 140 million in circulation, FDV15 100 million

*The above market value data comes from Coingecko, and the time is 2024.6.28

In addition, there are a large number of tokens that have been listed and are facing massive unlocking. Their common characteristics are low circulation ratio, high FDV, and early institutional rounds of financing. The cost of institutional rounds of tokens is very low.

The weakness of demand and narrative in this round, coupled with the over-issuance of asset supply, is the first time in the crypto cycle. Although the project party tried to maintain the valuation by further reducing the circulation ratio of tokens at the time of listing (from 41.2% in 2022 to 12.3%), and gradually sold them to secondary investors, the resonance of the two finally led to the overall downward shift of the valuation center of these crypto projects. In 2024, only a few sectors such as Meme, Cex, and Depin maintained positive returns among the major sectors.

The ratio of MC to FDV of new coins, image source: "Low Float & High FDV: How Did We Get Here?", Binance research

However, in my opinion, the collapse of the valuation center of high-market-value VC coins is the market’s normal response to various crypto anomalies:

· Batch creation of ghost town Rollups, with only TVL and robots but no users

· Financing through refurbished terms, but actually providing similar solutions, such as a large number of cross-chain communication services

· Starting businesses based on hot spots rather than actual user needs, such as a large number of AI+Web3 projects

· The profit model has not been found or simply not found, and the token has no value capture

The decline in the valuation center of these altcoins is the result of the market's self-repair, a benign process of bubble bursting, and a self-rescue behavior of funds voting with their feet and clearing the market.

The actual situation is that most VC coins are not completely worthless, they are just too expensive, and the market eventually puts them back to where they should be.

It's time to pay attention to Defi: PMF products, get out of the bubble period

Since 2020, Defi has officially become a category in the altcoin cluster. In the first half of 2021, the most popular project in the Top 100 crypto market capitalization list was Defi. At that time, there were so many categories that it was dazzling, and they vowed to redo all the existing business models in traditional finance on the chain.

In that year, Defi was the infrastructure of the public chain. DEX, lending, stablecoins, and derivatives were the four must-haves after the new public chain went online.

However, with the over-issuance of homogeneous projects and a large number of hacker attacks (embezzlement), the TVL obtained by the Ponzi model of stepping on the left foot and the right foot quickly collapsed, and the price of the spiraling tokens spiraled back to zero.

Entering this round of bull market cycle, the price performance of most Defi projects that have survived to this day is not satisfactory, and there are fewer and fewer primary investments in the Defi field. As at the beginning of any bull market, investors like the new stories that have emerged in this cycle the most, and Defi does not belong to this category.

But it is precisely because of this that Defi projects that have emerged from the bubble have begun to appear more attractive than other altcoin projects. Specifically:

Business: With a mature business model and profit model, the top projects have a moat

DEX and derivatives earn transaction fees, lending collects interest spread income, stablecoin projects collect stability fees (interest), and Staking services collect pledge service fees. The profit model is clear. The user demand of the top projects in each track is organic, and they have basically passed the user subsidy stage. Some projects still achieve positive cash flow after deducting token emissions.

Ranking of crypto project profits, source: Tokenterminal

According to Tokentermial’s statistics, 12 of the top 20 most profitable protocols so far in 2024 are Defi projects, which can be classified as follows:

· Stablecoins: MakerDAO, Ethena

· Lending: Aave, Venus

· Staking services: Lido

· DEX: Uniswap labs, Pancakeswap, Thena (income comes from front-end fees)

· Derivatives: dYdX, Synthetix, MUX

· Income aggregation: Convex Finance

The moats of these projects are varied, some of which come from the multilateral or bilateral network effects of services, some from user habits and brands, and some from special ecological resources. However, from the results, the top Defi projects all show some commonalities in their respective tracks: market share tends to be stable, the number of later competitors decreases, and they have certain service pricing power.

As for the moats of specific Defi projects, we will elaborate on them in the project section of the third subsection.

Supply side: low emission, high circulation ratio, and small scale of tokens to be released

In the previous subsection, we mentioned that one of the main reasons for the continued collapse of the valuation of altcoins in this round is the high emission of a large number of projects based on high valuations, as well as the negative expectations brought about by the current huge amount of released tokens entering the market.

And most of the top Defi projects have passed the peak period of token emission due to their early launch time, and the tokens of institutions have basically been released, so the selling pressure in the future will be extremely low. For example, Aave's current token circulation ratio is 91%, Lido's token circulation ratio is 89%, Uniswap's token circulation ratio is 75.3%, MakerDAO's circulation ratio is 95%, and Convex's circulation ratio is 81.9%.

On the one hand, this shows that there will be little selling pressure in the future, and it also means that no matter who wants to gain control of these projects, they can basically only buy tokens from the market.

Valuation: Market attention and business data diverge, and valuation levels fall into historical lows

Compared with new concepts such as Meme, AI, Depin, Restaking, and Rollup services, Defi has always received very little attention in this round of bull market, and its price performance has been mediocre. On the other hand, the core business data of each head Defi, such as trading volume, lending scale, and profit level, have continued to grow, forming a divergence between price and business, which is specifically reflected in the fact that the valuation level of some head Defi has reached a historical low.

Take the lending protocol Aave as an example. While its quarterly revenue (referring to net income, not overall protocol fees) has surpassed the high point of the previous cycle and set a record high, its PS (circulating market value/annualized revenue) has hit a record low, currently only 17.4 times.

Data source: Tokenterminal

Policy: FIT21 Act is conducive to the compliance of the Defi industry and may trigger potential mergers and acquisitions

FIT21, the Financial Innovation and Technology for the 21st Century Act, is the main goal of the bill to provide a clear federal regulatory framework for the digital asset market, strengthen consumer protection, and promote the United States' leadership in the global digital asset market. The bill was proposed in May 23 and passed by the House of Representatives with a high vote on May 22 this year. Since the bill clarifies the regulatory framework and the rules for market participants, after the bill is officially passed, it will become more convenient for both entrepreneurs and traditional finance to invest in Defi projects. Considering the attitude of traditional financial institutions represented by BlackRock towards crypto assets in recent years (promoting the listing of ETFs and issuing treasury bonds on Ethereum), Defi is likely to be their key layout area in the next few years. For the fate of traditional financial giants, mergers and acquisitions may be one of the most convenient options, and any related signs, even if it is just the intention of mergers and acquisitions, will trigger a revaluation of the value of Defi leading projects.

Next, I will take some Defi projects as examples to analyze their business conditions, moats, and valuations.

Considering the large number of Defi projects, I will give priority to projects with good business development, wide moats, and more attractive valuations for analysis.

Defi projects worth paying attention to

1. Lending: Aave

Aave is one of the oldest Defi projects. After completing its financing in 2017, it completed the transformation from peer-to-peer lending (the project was still called Lend at the time) to a peer-to-pool lending model, and surpassed Compound, the head project in the same track, in the last bull market cycle. Currently, it ranks first in the lending track in terms of market share and market value.

Aave's main business model is to earn interest spread income from lending. In addition, Aave launched its own stablecoin GHO last year, which will generate interest income for Aave. Of course, operating GHO also means additional cost items, such as promotion costs, liquidity incentive fees, etc.

1.1 Business situation

For lending protocols, the most critical indicator is the active loan scale, which is the main source of income for lending projects.

The figure below shows the market share of Aave's active loan scale in the past year. In the past six months, Aave's active loan share has continued to rise and has now reached 61.1%. In fact, the ratio is even higher because the chart repeatedly counts the loan volume of Morpho's yield optimization module built on Aave and Compound.

Data source: Tokenterminal

Another key indicator is the profitability of the protocol, that is, the profit level. Profit in this article = protocol revenue - token incentives. As can be seen from the figure below, Aave's protocol profit has opened up a large gap with other lending protocols, and it has long gotten rid of the Ponzi model of stimulating business through token subsidies (represented by Radiant, the purple part in the figure below).

Data source: Tokenterminal

1.2 Moat

Aave's moat mainly includes the following 4 points:

1. Continuous accumulation of security credit: Most new lending protocols will have security incidents within one year of going online. Aave has not had a security incident at the smart contract level since its operation. The security credit accumulated by the risk-free and stable operation of a platform is often the top priority for Defi users when choosing a lending platform, especially whale users with large capital volume, such as Justin Sun, who is a long-term user of Aave.

2. Bilateral network effect: Like many Internet platforms, Defi lending is a typical bilateral market, where depositors and borrowers are both supply and demand. The unilateral scale growth of deposits and loans will stimulate the growth of business volume on the other side, making it more difficult for later competitors to catch up. In addition, the more abundant the overall liquidity of the platform, the smoother the liquidity in and out of both depositors and borrowers, and the more likely it is to be favored by large capital users, which in turn stimulates the growth of the platform's business.

3. Excellent DAO management level: The Aave protocol has fully implemented DAO-based management. Compared with the team-centric management model, DAO-based management has more comprehensive information disclosure and more comprehensive community discussions on important decisions. In addition, a number of professional institutions with high governance levels are active in the Aave DAO community, including top VCs, university blockchain clubs, market makers, risk management service providers, third-party development teams, financial consulting teams, etc. The sources are rich and diverse, and governance participation is relatively active. Judging from the project's operating results, Aave, as a latecomer in peer-to-pool lending services, has better balanced growth and security in product development and asset expansion, and has surpassed its big brother Compound. In this process, DAO governance played a key role.

4. Multi-chain ecological position: Aave is deployed on almost all EVM L1\L2, and TVL is basically at the top of each chain. In the V4 version that Aave is developing, multi-chain liquidity will be connected in series, and the advantages of cross-chain liquidity will be more obvious. See the figure below for details:

In addition to the EVM public chain, Aave is also evaluating Solana and Aptos, and there is a possibility of deployment on the network in the future.

1.3 Valuation Level

According to Tokenterminal data, Aave’s PS (ratio of circulating market value to protocol revenue) and PF (ratio of circulating market value to protocol fees) have hit record lows, with PS at 17.44 times and PF at 3.1 times, due to the continued recovery of protocol fees and revenue, and the fact that the coin price is still hovering at a low level.

Data source: Tokenterminal

1.4 Risks and Challenges

Although Aave's share in the lending market continues to rise, a new competitor is worth noting, which is Morpho Blue's modular lending platform. Morpho Blue provides a set of modular protocols for third parties who are interested in building lending markets. You can freely choose different collateral, borrowing assets, oracles and risk parameters to build a customized lending market.

This modular approach allows more market participants to enter the lending field and start providing lending services. For example, Gaunlet, Aave's former risk service provider, would rather interrupt its service relationship with Aave and launch its own lending market on Morpho blue.

Image source: https://app.morpho.org/?network=mainnet

Data source: https://morpho.blockanalitica.com/

Morpho blue has grown rapidly since its launch more than half a year ago, and has become the fourth largest lending platform in terms of TVL after Aave, Spark (Aave v3 fork lending platform launched by MakerDAO) and Compound.

Its growth rate on Base is even faster. Less than two months after its launch, its TVL has reached 27 million US dollars, while Aave's TVL on Base is about 59 million.

Data source: https://morpho.blockanalitica.com/

2.Dexs: Uniswap & Raydium

Uniswap and Raydium belong to the Evm ecosystem and Solana ecosystem of the Ethereum camp respectively. Uniswap launched the V1 version deployed on the Ethereum mainnet as early as 2018, but what really made Uniswap popular was the V2 version launched in May 2020. Raydium was launched on Solana in 2021.

The reason why we recommend paying attention to two different targets in the Dexs track is that they belong to the two ecosystems with the largest number of Web3 users, namely the Evm ecosystem built around the king of public chains, Ethereum, and the Solana ecosystem with the fastest user growth, and the two projects have their own advantages and problems. Next, we will interpret these two projects separately.

2.1 Uniswap

2.1.1 Business Situation

Since the launch of V2, Uniswap has almost always been the Dex with the largest share of transaction volume on the Ethereum mainnet and most EVM chains. In terms of business, we mainly focus on two indicators, namely transaction volume and handling fees.

The figure below shows the share of Dex's monthly trading volume since the launch of Uniswap V2 (excluding DEX trading volume of non-EVM chains):

Data source: Tokenterminal

Since the launch of V2 in May 2020, Uniswap's market share has risen from a peak of 78.4% in August 2020 to 36.8% at the peak of the Dexs war in November 2021, and has rebounded to the current 56.7%. It can be said that it has experienced the brutal test of competition and has established a firm foothold.

Data source: Tokenterminal

Uniswap's market share in transaction fees also shows this trend. Its market share bottomed out in November 2021 (36.7%), and then rebounded all the way to 57.6% at present.

What is even more commendable is that, except for a few short months in 2020 (Ethereum mainnet) and the end of 2022 (OP mainnet), Uniswap has not incentivized liquidity for the rest of the time, while most Dexs have not stopped subsidizing liquidity so far.

The following figure shows the proportion of the month-end incentive amounts of major Dexs. It can be seen that Sushiswap, Curve, Pancakeswap, and the ve (3,3) project Aerodrome on Base were once the projects with the largest subsidy amounts in the same period, but none of them have won a higher market share than Uniswap.

Data source: Tokenterminal

However, the most criticized point of Uniswap is that although there is no token incentive expenditure, the token also has no value capture, and the protocol has not yet turned on the fee switch.

However, at the end of February 2024, Erin Koen, a Uniswap developer and head of foundation governance, published a proposal in the community to upgrade the Uniswap protocol so that its charging mechanism can reward UNI token holders who have authorized and custody their tokens. The proposal has sparked a lot of discussion at the community level. The subsequent formal vote was originally scheduled for May 31, but it is still delayed and has not yet been formally voted. Despite this, the Uniswap protocol has taken the first step in starting to charge and empower Uni tokens. The contracts to be upgraded have completed development and auditing. In the foreseeable future, Uniswap will have separate protocol revenue.

In addition, Uniswap labs actually started charging users who use the Uniswap official web front-end and Uniswap wallet for transactions as early as October 2023, with a rate of 0.15% of the transaction amount. The currencies involved in the charges are ETH, USDC, WETH, USDT, DAI, WBTC, agEUR, GUSD, LUSD, EUROC, XSGD, but stablecoin transactions and WETH\ETH swaps are free of charge.

And just the fees charged by the Uniswap front-end have made Uniswap labs one of the highest-earning teams in the entire Web3 field.

It can be imagined that when Uniswap protocol layer fees are enabled, based on the annualized fee calculation for the first half of 2024, Uniswap's annualized fees will be approximately US$1.13 billion. Assuming the protocol fee rate is 10%, the annualized revenue of the protocol layer will be approximately US$110 million.

After Uniswap X and V4 are launched in the second half of this year, they are expected to further expand their market share of transaction volume and transaction fees.

2.1.2 Moat

Uniswap's moat mainly comes from the following three aspects:

1. User habits: When Uniswap started charging front-end fees last year, many people thought it was not a good idea. Soon, users' trading behavior would switch from Uniswap's front-end to trading aggregators such as 1inch to avoid paying additional transaction fees. However, since the front-end started charging, the revenue from the front-end has always been on the rise, and its growth rate has even exceeded the growth rate of the fees of the entire Uniswap protocol.

Data source: Tokenterminal

This data strongly illustrates the power of Uniswap's user habits. A large number of users do not care about the expenditure of 0.15% transaction fees, but choose to maintain their own trading habits.

2. Bilateral network effect: Uniswap, as a trading platform, is a typical bilateral market. One perspective of the "bilateral" understanding of its business model is that the two sides of this market are buyers (traders) and market makers (LPs). The more and more active the transactions are, the more LPs tend to provide liquidity there, reinforcing each other. Another bilateral perspective is: one side of the market is traders, and the other side is the project party that deploys the initial liquidity of tokens. In order to make their tokens easier for the public to find and trade, project parties tend to deploy initial liquidity in Dex, which has more users and is more familiar to the public, rather than choosing relatively unpopular second- and third-tier Dex. This behavior of the project party further strengthens the habitual behavior of users when trading-new tokens are traded on Uniswap first, which forms a mutual reinforcement of the bilateral market of "project parties" and "trading users".

3. Multi-chain deployment: Similar to Aave, Uniswap is quite active in the expansion of multi-chain. Uniswap can be seen in EVM chains with large trading volumes, and its trading volume is basically ranked in the top few of the Dex of the chain.

Subsequently, with the support of multi-chain transactions after the launch of Uniswap X, Uniswap's comprehensive advantages in multi-chain liquidity will be further magnified.

2.1.3 Valuation

We use the ratio of Uniswap's circulating market value and its annualized fee, that is, PF, as the main valuation standard, and find that the current valuation of UNI tokens is in a historically high percentile range. This may be due to its upcoming fee switch upgrade, which has been reflected in the market value level in advance.

Data source: Tokenterminal

In terms of market value, Uniswap's current circulating market value is nearly 6 billion, and its fully diluted market value is as high as 9.3 billion, which is also not low.

2.1.4 Risks and Challenges

Policy risks: In April this year, Uniswap received a Wells Notice from the SEC, which means that the SEC will take enforcement action against Uniswap in the future. Of course, with the gradual advancement of the FIT21 bill, subsequent Defi projects such as Uniswap are expected to obtain a more transparent and predictable regulatory framework, but considering that the voting and implementation of the bill still take a long time, the lawsuit from the SEC will put pressure on the project's business and token prices in the medium term.

Ecological position: Dexs are the basic layer of liquidity. Previously, its upstream was a trading aggregator. Trading aggregators such as 1inch, Cowswap, and Paraswap can provide users with price comparisons of full-chain liquidity and find the optimal trading path. This model has inhibited the downstream Dex's ability to charge and price user trading behaviors to a certain extent. With the development of the industry, wallets with built-in trading functions have become a more upstream infrastructure. In the future, with the introduction of the intent model, Dexs, as the source of underlying liquidity, will become a layer that users cannot perceive at all, which may further eliminate the user's habit of using Uniswap directly and enter a complete "price comparison mode". It is precisely because of this that Uniswap is working hard to move upstream in the ecology, such as vigorously promoting the Uniswap wallet and releasing Uniswap X to enter the aggregation layer of transactions to improve its ecological position.

2.2 Raydium

2.2.1 Business Situation

We will also focus on analyzing Raydium’s trading volume and handling fees. Raydium is better than Uniswap in that it started charging for protocols very early and has a good protocol cash flow. Therefore, we also focus on Raydium’s protocol revenue.

Let’s first look at Raydium’s trading volume. Thanks to the prosperity of the current Solana ecosystem, its trading volume has taken off since October last year. Its trading volume in March once reached 47.5 billion US dollars, which is about 52.7% of Uniswap’s trading volume that month.

Data source: flipside

In terms of market share, Raydium’s share of trading volume on the Solana chain has been rising since September last year, and currently accounts for 62.8% of Solana’s ecological trading volume. Its dominance in the Solana ecosystem even exceeds Uniswap’s position in the Ethereum ecosystem.

Data source: Dune

The reason why Raydium’s market share has risen from less than 10% at the low point to more than 60% at present is mainly due to the Meme trend that has continued to this day in this round of bull market cycle. Raydium uses two types of liquidity pools, standard AMM and CPMM. The former is similar to Uni V2, with evenly distributed liquidity, suitable for highly volatile assets. The latter is similar to V3's centralized liquidity pool, where liquidity providers can customize the liquidity range, which is more flexible but also more complex.

Raydium's competitor Orca chose to fully embrace the centralized liquidity pool model of Uni V3. For Meme project parties that need to mass produce and configure liquidity in large quantities every day, Raydium's standard AMM model is more suitable, so Raydium has become the preferred liquidity venue for Meme tokens.

As the largest Meme incubator in this round of bull market, Solana has seen hundreds or even tens of thousands of new Memes born every day since November this year. Meme is also the core driving factor for the prosperity of the Solana ecosystem in this round, and has become the fuel for Raydium's business takeoff.

Data source: Dune

From the above figure, we can see that in December 23, the number of new tokens added by Raydium in one week was 19,664, while Orca only had 89 in the same period. Although in theory, Orca's centralized liquidity mechanism can also choose to "fully configure" liquidity to achieve similar effects as traditional AMM, it is still not as simple and direct as Raydium's standard pool.

In fact, Raydium's transaction volume data also proves this point. Its transaction amount from the standard pool accounts for 94.3%, and the vast majority of these transactions are contributed by Meme-type tokens.

In addition, Raydium, as a bilateral market, serves the bilateral market of project parties and users, just like Uniswap. The more retail investors there are on Raydium, the more Meme project parties tend to arrange initial liquidity on Raydium, which in turn allows users and tools that serve users (such as various TG bots) to choose Raydium for trading. This self-reinforcing cycle further widens the gap between Raydium and Orca.

In terms of transaction fees, Raydium generated approximately US$300 million in transaction fees in the first half of 2024, which is 9.3 times the transaction fees of Raydium for the whole year of 2023.

Data source: flipside

The standard AMM pool fee rate of Raydium is 0.25% of the transaction volume, of which 0.22% belongs to LP and 0.03% is used to repurchase the protocol token Ray. The CPMM rate can be freely set to 1%, 0.25%, 0.05% and 0.01%. LP will receive 84% of the transaction fee, and 12% of the remaining 16% will be used to repurchase Ray, and 4% will be deposited in the treasury.

Data source: flipside

Raydium's protocol revenue for repurchasing Ray in the first half of 2024 was approximately US$20.98 million, which is 10.5 times the amount of Ray protocol repurchases in 2023.

In addition to the revenue from the handling fee, Raydium will also charge for newly created pools. Currently, the creation fee for AMM standard pools is 0.4 Sol, and the creation fee for CPMM pools is 0.15 Sol. Currently, Raydium receives an average of 775 Sol per day for pool creation (calculated at a price of 6.30 Sol, which is approximately US$108,000. However, this part of the fee is neither included in the treasury nor used for Ray repurchases, but is used for the development and maintenance of the protocol, which can be understood as team income.

Data source: flipside

Like most Dex, Raydium still has incentives for Dex liquidity. Although the author has not found data that continuously tracks the amount of its incentives, we can roughly count the incentive value of the liquidity pool currently being incentivized from the official liquidity interface.

According to Raydium's current incentives for liquidity, there are approximately $48,000 worth of incentive expenditures per week, mainly in Ray tokens. This amount is far less than the current protocol's weekly revenue of nearly $800,000 (excluding revenue from creating pools), and the protocol is in a state of positive cash flow.

2.2.2 Moat

Raydium is the Dex with the largest market transaction volume on Solana. Compared with its competitors, its main advantages come from the bilateral network effect at this stage. Similar to Uniswap, it benefits from the mutual reinforcement of the business of traders and LPs, as well as the mutual reinforcement of the project parties and trading users. This network effect is particularly prominent in the Meme asset class.

2.2.3 Valuation

Due to the lack of historical data before 23 years ago, the author only compares Raydium's valuation data in the first half of this year with the valuation data in 2023.

With the surge in trading volume this year, although Ray's coin price has risen, its valuation has still dropped significantly compared to last year, and its PF is also at a lower level compared to Dex such as Uniswap.

2.2.4 Risks and Challenges

Although Raydium's trading volume and revenue have been strong in the past six months, there are still many uncertainties and challenges in its future development. Specifically:

Ecological position: Raydium, like Uniswap, faces the same problem of ecological position, and in the Solana ecosystem, aggregators represented by Jupiter have greater influence, and their trading volume is far greater than Raydium (Jupiter's total trading volume in June was 28.2 billion, and Raydium's was 16.8 billion). In addition, Meme platforms represented by Pump.fun gradually replaced Raydium in launching projects, and more Memes were launched through Pump.fun instead of Raydium, although the two parties are currently in a cooperative relationship. The Pump.fun platform gradually replaced Radyium's influence on the project side, and Jupiter also surpassed Raydium's influence on traders on the user side. If this situation is not improved in the long run, if Pump.fun or Jupiter, which are located upstream of the ecosystem, build their own Dex, or turn to competitors, it will have a significant impact on Raydium.

Market trend changes: Before this round of Solana's Meme whirlwind, Orca's market share of trading volume was 7 times that of Raydium. This round of Raydium's standard pool has allowed Raydium to regain its share because it is more friendly to Meme projects. However, it is difficult to predict how long Solana's Meme trend will last and whether the chain will still be dominated by local dogs in the future. When the types of market trading products change, Raydium's market share may face challenges again.

Token emission: Raydium's token circulation ratio is currently 47.2%, which is not high compared to most Defi projects. The selling pressure after the token is unlocked in the future may cause price pressure. However, considering that the project currently has a good cash flow, selling coins is not the only option. The team may also destroy the unblocked tokens to dispel investors' concerns.

High degree of centralization: Raydium has not yet started the governance process based on Ray tokens, and the development of the project is completely controlled by the project party, which may lead to the inability to transmit profits that should belong to the holders. For example, how to distribute the Ray tokens repurchased by the agreement is still unresolved.

3. Staking: Lido

Lido is the leading liquidity staking protocol on the Ethereum network. The launch of the beacon chain at the end of 2020 marked the official start of Ethereum's transition from PoW to PoS. Since the retrieval function of the staked assets was not yet launched at that time, the staked ETH will lose liquidity. In fact, the Shapella upgrade that allows the retrieval of staked assets on the beacon chain occurred in April 2023, which means that the earliest users who entered ETH staking will not be able to obtain liquidity for two and a half years.

Lido has pioneered the track of liquidity staking. Users who deposit ETH in Lido will receive stETH certificates issued by Lido. Lido has incentivized deep stETH-ETH LP on Curve, thus providing users with a stable service of "participating in ETH staking to earn income and being able to withdraw ETH at any time" for the first time. It began to develop rapidly and has since gradually developed into the leader of the Ethereum staking track.

In terms of business model, Lido obtains 10% of its staking income, of which 5% is allocated to staking service providers and 5% is managed by DAO.

3.1 Business situation

Lido's current main business is ETH liquidity staking services. Previously, Lido was the largest liquidity staking service provider for the Terra network and the second largest liquidity staking service provider for the Solana network, and was also actively expanding its business in other chains such as Cosmos and Polygon. However, Lido later wisely made a strategic contraction and shifted its focus to the staking services of the ETH network. Currently, Lido is the leader in the ETH staking market and the DeFi protocol with the highest TVL.

Source: DeFiLlama

With the deep stETH-ETH liquidity created by a large amount of $LDO incentives, and investment support from institutions such as Paradigm and Dragonfly in April 2021, Lido surpassed its main competitors at the time - centralized exchanges (Kraken and Coinbase) at the end of 2021, becoming the leader in the Ethereum staking track.

Lido spent a total of approximately US$280 million in 2021-2022 to incentivize the liquidity of stETH-ETH Source: Dune

However, there was a discussion about whether Lido's dominance would affect the decentralization of Ethereum. The Ethereum Foundation was also discussing whether it was necessary to limit the pledge share of a single entity to no more than 33.3%. After Lido's market share hit a high of 32.6% in May 2022, it began to fluctuate between 28% and 32%.

ETH staking market share history (the light blue block at the bottom is Lido) Source: Dune

3.2 Moat

The moats of Lido’s business are mainly the following 2 points:

1. The stable expectations brought by the long-term market leadership make Lido the first choice for whales and institutions to enter ETH staking. Justin Sun, Mantle before issuing its own LST, and many whales are all users of Lido. The network effect brought by the wide use cases of stETH.

2. stETH has been fully supported by the leading DeFi protocols as early as 2022, and the newly developed DeFi protocols will try every means to attract stETH (such as the LSTFi project that was once popular in 2023, as well as Pendle and various LRT projects). stETH has a relatively stable position as the basic income asset of the Ethereum network.

3.3 Valuation Level

Although Lido's market share has slightly declined, Lido's staking scale is still rising with the increase in ETH's own staking ratio. In terms of valuation indicators, Lido's PS and PF have both hit record lows recently.

Source: Token Terminal

With the successful launch of Shapella upgrade, Lido's market position is stable, and the profit indicator reflecting the "income-token incentive" indicator has also performed well, with a cumulative profit of US$36.35 million in the past year.

Source: Token Terminal

This also triggered the community's expectations for the adjustment of the $LDO economic model. However, Hasu, the actual helmsman of Lido, has said more than once that compared with Lido's current expenditure, the current income from the community treasury cannot sustain all the expenses of Lido DAO in the long term, and it is too early to distribute the income.

3.4 Risks and Challenges

Lido faces the following risks and challenges:

1. Competition from newcomers. Since the release of Eigenlayer, Lido's market share has been on a downward trend. Any new project with sufficient token marketing budget will become a competitor to projects such as Lido that have a leading advantage but whose tokens are close to full circulation.

2. The Ethereum community, including some members of the Ethereum Foundation, have long questioned that Lido has too high a share of the staking market. Previously, Vitalik had written a special article to discuss this issue and sorted out various solutions, but he did not express a clear preference for the solution in the article (Mint Ventures wrote a special article on this issue in November last year, and interested readers can go and check it out).

3. The SEC clearly defined LST as a security in its June 28, 2024 accusation against Consensys. The behavior of users casting and purchasing stETH is "Lido is issuing and selling securities that have not been registered with the SEC." Consensys is also suspected of "issuing and selling securities that have not been registered with the SEC" because it provides users with the service of staking ETH to Lido.

4. Perpetual Contract Exchange: GMX

GMX is a perpetual contract trading platform, which was officially launched on Arbitrum in September 2021 and Avalanche in January 2022. Its business is a two-sided market: on one end are traders, who can trade with up to 100 times leverage; on the other end are liquidity providers, who sell the liquidity of their assets for traders to trade and act as counterparties to traders.

In terms of business model, GMX's revenue is composed of transaction fees ranging from 0.05% to 0.1% charged to traders, as well as funding fees and borrowing fees. GMX allocates 70% of all revenue to liquidity providers and the other 30% to GMX pledgers.

4.1 Business Situation

In the field of perpetual contract trading platforms, due to the frequent emergence of new projects that have openly stated that there will be retroactive airdrops (such as Aevo, Hyperliquid, Synfutures, Drift, etc.), and the common existence of similar trading mining incentives in old projects (such as dYdX, Vertex, RabbitX), the data on trading volume is not very representative. We will select TVL, PS and profit indicators to compare the data of GMX and competitors horizontally.

In terms of TVL, GMX currently ranks first, but the TVL of the old derivatives protocol dYdX, Jupiter Perp, which has a large amount of traffic entrance to Solana, and the unreleased Hyperliquid are also at the same level.

Data source: DeFiLlama

From the PS indicator, among the projects that have issued coins, whose main business is perpetual contract trading, and whose average daily trading volume exceeds 30 million US dollars, GMX's PS indicator is relatively low, only higher than vertex, which still has relatively high transaction mining incentives.

From the profit indicator, GMX's profit in the past year was 6.5 million US dollars, which is lower than DYDX, GNS and SNX. However, it is worth pointing out that this is largely due to the fact that GMX released all of the 12 million ARBs (based on the price of ARB during the period, an average of about 18 million US dollars) obtained in Arbitrum's STIP activities from November last year to March this year, resulting in a significant reduction in profits. We can see GMX's strong profit-making ability from the slope of profit accumulation.

4.2 Moat

Compared to the other DeFi projects mentioned above, GMX's moat is relatively weak. The frequent emergence of new derivatives exchange projects in recent years has also greatly impacted GMX's trading volume. The track is still relatively crowded. The main advantages of GMX include:

1. Arbitrum's strong support. As a native project of the Arbitrum network, GMX contributed nearly half of the TVL of the Arbitrum network at its peak. At that time, almost all new DeFi projects on Arbitrum were "developed for GLP". In addition to being able to obtain official exposure from Arbitrum, it also obtained a large number of ARB tokens (8 million initial airdrops and 12 million STIPs) in previous ARB incentive activities, which enriched GMX's treasury and increased the valuable marketing budget for the fully circulated GMX.

2. Positive image brought by long-term industry leadership. GMX led the narrative of "real income DeFi" from the second half of 2022 to the first half of 2023. It was a rare highlight in the DeFi field during the bearish market. GMX took this opportunity to accumulate a good brand image and accumulated a lot of loyal users.

3. A certain degree of scale effect. Trading platforms such as GMX have scale effects, because only when the LP scale is large enough can it accommodate larger transaction orders and higher open contracts, and higher trading volumes can in turn give LP higher returns. As the leading derivatives trading platform on the chain, GMX has become a beneficiary of this scale effect. For example, the famous trader Andrew Kang once opened long and short positions of up to tens of millions of dollars on GMX for a long time. At that time, GMX was almost his only choice for opening such a large position order on the chain.

4.3 Valuation Level

GMX is now fully circulated. We have made a horizontal comparison with peers above. GMX is currently the mainstream derivatives exchange with the lowest valuation.

Compared with historical data, GMX's revenue is relatively stable, and the PS index is historically at a medium to low level.

4.4 Risks and Challenges

1. Strong competitors. GMX's competitors include not only the old but still active DeFi protocols Synthetix and dYdX, but also various emerging protocols: AEVO, which exchanges tokens, and Hyperliquid, which has not issued tokens, have both achieved quite high trading volume and exposure in the past year. Jupiter Perp, which has a large number of traffic entrances to Solana, has achieved a TVL close to GMX and a trading volume that exceeds GMX by using a mechanism that is almost exactly the same as GMX. GMX is also preparing to expand their V2 version to Solana, but the track is generally very competitive and does not have a relatively certain pattern like other DeFi tracks. The common transaction mining incentives in the industry reduce the switching cost of users, and user loyalty is generally low.

2. GMX uses oracle prices as the basis for transactions and liquidations, and there is a possibility of being attacked by oracles. In September 2022, GMX lost $560,000 in the Avalanche network due to an oracle attack on AVAX. Of course, for most assets that GMX allows to trade, the cost of the attack (manipulating the price of the corresponding token on CEX) is much greater than its benefits. The V2 version of GMX has also targeted isolation pools and transaction slippage to deal with this risk.

5. Other Defi projects worth paying attention to

In addition to the Defi projects mentioned above, we have also investigated other Defi projects that have attracted attention, such as the old stablecoin project MakerDAO, the emerging star Ethena, the oracle leader Chainlink, and so on. However, due to the limited space, all of them cannot be presented in this article. On the other hand, these projects also face many problems, such as:

Although MakerDAO is still the leader of decentralized stablecoins and has a large number of "natural holders", who hold DAI just like holding USDC and USDT, the scale of its stablecoins has always stagnated, and its market value is only about half of the previous round of highs. Its collateral uses a large number of off-chain US dollar assets, which is also gradually damaging the decentralized credit of its tokens.

In sharp contrast to MakerDAO's DAI, the scale of Ethena's stablecoin USDe has soared, from 0 to 3.6 billion US dollars in about half a year. However, Ethena's business model (a public offering fund focusing on perpetual contract arbitrage) still has an obvious ceiling. Behind the large-scale expansion of its stablecoins is the premise that secondary market users are willing to take over its token ENA at a high price and provide high income subsidies for USDe. This slightly Ponzi-like design can easily lead to a negative spiral in business and coin prices when market sentiment is not good. The key point of Ethena's business turning point is that USDe can one day truly become a decentralized stablecoin with a large number of "natural coin holders". So far, its business model has also completed the transformation from a public arbitrage fund to a stablecoin operator. However, considering that most of USDe's underlying assets are arbitrage positions stored in centralized exchanges, USDe is not on both ends of "decentralized anti-censorship" and "strong credit institution endorsement", and it is difficult for it to replace DAI and USDT.

After the Defi era, Chainlink is preparing to usher in a wave of hidden and unreleased giant wave narratives, namely the RWA narrative promoted by financial giants represented by BlackRock, which have gradually actively embraced Web3 in recent years. In addition to promoting the listing of BTC and ETH ETFs, BlackRock's most noteworthy move this year is the issuance of a US Treasury bond fund with the code Build on Ethereum, whose fund size exceeded US$380 million in 6 weeks. The subsequent experiments of traditional financial giants on financial products on the chain will continue, and they will inevitably face the problems of tokenization of off-chain assets, as well as on-chain and off-chain communication and interoperability. Chainlink has been quite advanced in this regard. For example, in May this year, Chainlink completed the "Smart Net Asset Value" (Smart NAV) pilot project with the Depository Trust and Clearing Corporation (DTCC) and several major financial institutions in the United States. The project aims to establish a standardized process to collect and disseminate fund net asset value (NAV) data on private or public blockchains using Chainlink's interoperability protocol CCIP. In addition, in February this year, asset management companies Ark Invest and 21Shares announced that they would verify position data by integrating Chainlink's reserve proof platform. However, Chainlink still faces the problem of business value being separated from tokens. Link tokens lack value capture and rigid application scenarios, which makes people worry that holders will find it difficult to benefit from the business growth of their parent company.

Summary

Just like the development process of many revolutionary products, Defi has also experienced the narrative fermentation in 2020, the rapid bubble of asset prices in 2021, and the disillusionment stage after the bear market bubble burst in 2022. At present, with the full verification of the product PMF, it is coming out of the trough of narrative disillusionment and building its intrinsic value with actual business data.

The author believes that as one of the few tracks in the encryption field with a mature business model and a growing market space, Defi still has long-term attention and investment value.

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