What stage has DeFi developed to?

Original author: Glassnode

Original compilation: Kyle, Babbitt

In Just 8 Months, DeFi Has Attracted Over $100 Billion into the smart contract. These contracts not only realize what traditional finance can do, but also bring new financial primitives. These innovations provide new opportunities for individuals to truly own their assets, participate in global capital coordination, trade through decentralized exchanges, use lending markets, and more.

In this article, we will explore Ethereum-based DeFi , and examine key metrics that help us understand their explosive growth and usability.

Grassroots evolution of DeFi

DeFi is both a technology and a movement, Teams of researchers and engineers are coming together to reimagine financial services. The space has come a long way since the early days of smart contract innovation (such as raising funds through ICOs), to early NFT experiments (such as CryptoKitties), and the first DEX implementations (which first hinted at the decentralized future of finance) road.

The graph above shows the explosive growth of user base and value in the DeFi ecosystem. What we're seeing is a new spirit behind the perfect combination of a storm of innovation and financial incentives. The entire community is self-sufficient by incentivizing participation in DeFi protocols. Incentives to move users to products that efficiently grow and retain users and capital.

In 2019, Synthetix became the first batch of DeFi projects to carry out DeFi liquidity mining experiments. In this experiment, users are incentivized to provide liquidity to the sETH / ETH Uniswap pool. This later sparked a wave of yield farming projects in 2020, especially after Compound Finance launched COMP token liquidity mining on its lending marketplace.

The COMP incentive mechanism is introduced to encourage lenders and borrowers to earn COMP tokens to make the protocol Gaining popularity — the protocol’s total value locked jumped from $100 million to $500 million in a week.

The key innovation here is actually a social one, as participants gain Governance token rewards for use and usage of the protocol.

How to measure the adoption of DeFi?

The growth of DeFi can be expressed in many ways, the most intuitive The best way is to measure active users. Since the start of the DeFi experiment, user growth has been explosive, with over 2.1 million unique addresses interacting with Ethereum DeFi in some way since early 2018.

Data source: Dune Analytics

If we consider that each Ethereum Addresses are all part of the total addressable market (TAM), then we can say that DeFi has so far penetrated less than 3% of non-zero Ethereum addresses (~58 million addresses). As Ethereum adoption grows, so will the potential TAM for DeFi applications.

The "Total Value Locked (TVL)" metric has been popularized to describe the total assets deployed in a smart contract. In the TVL concept, lock, deposit, store, send, lend, provide, these nouns have the same meaning. In the exchange, we can directly treat these assets as liquidity, and in the loan agreement as collateral.

Source: DeFi Llama

The relevance of TVL varies by protocol, so it should always be considered alongside utilization, transaction volume, and other usage metrics. Utilization describes how much supply-side liquidity is being productively used by the demand side of the protocol. Take the classic environmental example of a lemonade stand:

• Suppose I produce 100 glasses of lemonade a day. The quantity available to the demand side is 100 cups.
• Now, assume that the demand side buys and consumes an average of 70 of these cups per day. That's 100-70 = 30 glasses of unused lemonade. We can assume that, as a supply side, I might start making fewer cups per day to more closely meet demand.
• But wait. What if the local government comes in and says they're going to subsidize my lemonade stand by buying an extra 30 cups a day regardless of usage (which roughly equates to the liquidity mining rewards the protocol offers)? Now, we have a legitimate reason to continue serving 100 cups a day.

So while the $124 billion TVL may fluctuate back and forth, this is a nascent market where money will go wherever the best risk/reward is expected. If users are scarce, but liquidity incentives are strong, then rational players will seize these opportunities. To determine whether these protocols are developing a loyal user base, we must delve deeper into the metrics that describe the stickiness of end users and liquidity providers.

DeFi protocol type adopts

Lending Market

Lending protocols are attracting interest as users are attracted by:

• Earn interest on tokens
• Get leverage and have the ability to go short
• Get liquidity on other tokens without selling their current holdings Assets

Maker launches the first A DeFi lending market that allows users to generate DAI against ETH deposits and provide more types of collateral over time.

Compound popularizes lending and borrowing of a wider range of assets, providing more token lending/borrowing tokens. When placing a loan position, the lender receives a cToken representing their deposit. These cTokens can be used as primitives for other protocols.

Aave starts with Compound by offering different token economics, up to 75% user collateral borrowing rate and more variety of token lending/borrowing compete.

Data source: The Graph

In each protocol, there are There are respective money markets with varying rates and usage, examples for Compound and Aave are listed below. Utilization ratio = 1 - (free liquidity / market size). If $1 billion is deposited and $100 million is loaned out at the same time, the utilization rate is about 10%.

Prices in these markets follow the utilization curve. As total market utilization increases, interest rates will also increase to encourage more lenders to enter the market and borrowers to exit. Conversely, as utilization falls, interest rates fall to encourage more borrowers to join. In the chart below, we note how current utilization affects interest rates in the DAI market on Compound Finance.

You can see that a more utilized market rewards lenders with higher yields to attract more liquidity. It also becomes more expensive for borrowers.

These markets have grown steadily since their launch, with stable Coin markets have the most activity and utilization. We see in the table below that stablecoins maintain a good balance in borrowing and borrowing, with an average utilization rate of over 75% in most cases. Volatile assets like ETH and wBTC are often rich in collateral, but fewer borrowers.

Arbitrageurs will transfer their deposits and borrowed funds Go where you can find higher rates/risks and rewards. There is a risk premium for participating in less liquid markets. Rates have leveled off and normalized, as seen in USDC rates over time between Compound and Aave. New liquidity mining programs and other governance impacts may result in new interest rate volatility.

Liquidity incentives and lenders attracting attractive yields lead to liquidity, with borrower adoption not far behind. This continued liquidity and utilization has led to attractive rates for both borrowers and lenders and continued adoption.

Decentralized Exchange (DEX)

DEX usage has grown significantly in the last year. While lending controls the highest liquidity, DEXs greatly control the most users. Of the 2.1 million users who have interacted with DeFi, 1.53 million have used Uniswap at some point (~73%). In comparison, 316k users (~15%) have interacted with Compound at some point in time.

Data source: Dune Analytics

Liquidity Providers (LP) use capital to earn a portion of transaction fees and liquidity rewards. Users are attracted to the platform through the depth of the market and the availability of the tokens they are interested in. A positive feedback loop is established, with more users generating more fees, and more fees attracting more liquidity. When liquidity rewards expire, sufficiently high user and fee revenues can continue to maintain liquidity in the protocol.

Volumes have been very high in terms of actual demand for these products Strong, with a trailing 12-month volume of $420 billion and a 30-day volume of $67 billion across all Ethereum DEXs, with daily volume peaking in April above $3 billion. Additionally, 1.98 million unique addresses have interacted with the DEX to date.

Data source: Dune Analytics

Measuring the relationship between liquidity and users, we have an interesting view on exchanges that meet the stickiness of supply and demand respectively. The Holy Grail of adoption is when a DEX can attract strong consistent liquidity and volume over a long period of time.

Data source: Uniswap Analytic, Sushiswap Analytic, DeFi Llama

Please Keep in mind that while in Curve's case its liquidity appears to be inflated relative to volume and fees, Curve focuses on stablecoin pairs that are much less volatile. In addition, Curve invests the assets in the liquidity pool into Compound and Yearn Finance to obtain additional income in addition to transaction fees. They are an example of DeFi projects benefitting from composability. Projects like Yearn use their platform as the basis for stablecoin swaps and liquidity mining.

We can also measure the health of an exchange through user maintenance. Some exchanges continue to maintain strong liquidity through incentive programs, but there are some shortcomings when it comes to user retention.

In the breakdown below we see that Uniswap is Lost 240,000 addresses during the month while retaining, returning and adding 615,000 new users. We saw Sushiswap shed 18,000 addresses while retaining, returning and creating 31,000 users. This gives Uniswap a net retention of +375,000 users and Sushiswap a net retention of +13,000 users.

Data source: Dune Analytics

Collateral Stablecoin

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The use of stablecoins has become a core part of DeFi, and the reserve-backed tokens USDT and USDC issued by centralized institutions occupy most of the market share. Stablecoins are already the base currency in most DEX pairs and lending markets.

The biggest attempt at decentralized stablecoin design is DAI, It maintains a soft peg to the dollar through market arbitrage without the need for a central reserve. DAI is MakerDAO’s currency, backed by collateralized debt positions in ETH and other tokens. MKR tokens are used as a last resort asset that can be used to repay lenders in the event of any bankruptcy. To incentivize MKR token holders, MKR tokens will be burned when debt holders repay a stability fee similar to the interest rate that keeps the system stable.

Despite the clear dominance of USDT and USDC, DAI's growth as a stablecoin has been impressive, reaching over $3.6 billion in circulation since its inception quantity.

Historically, DAI has maintained a relatively stable peg with the US dollar. Although the offering is managed by MakerDAO, traders typically try to profit from arbitrage opportunities, going short when DAI reaches above $1 and going long when DAI reaches below $1. The essence of this behavior is to withdraw collateral by depositing ETH to mint DAI, or reversely repaying CDP.

To illustrate this, we can see which DEX liquidity providers have established Pegged to the deepest liquidity pool centered around $1. If the price of DAI diverges too much in either direction, this has the opportunity to capture any spread and transaction fees.

We also noticed the use of DAI in various DeFi protocols. Maintaining the peg is all well and good, but actual usage in top DeFi projects is more important.

In the lending market, DAI is the stablecoin, and DAI collateral is #2 in Compound , ranking third in Aave. This is pretty healthy considering the total outstanding supply of DAI is less than 10% of the total supply of USDC, USDT and DAI.

Observation of DAI supply side in decentralized exchanges shows good flow DAI accounts for about 19% of the stablecoin liquidity on Uniswap.

On the demand side, DAI's trading volume (including DAI) accounts for about 100% of Uniswap's trading volume per day 15%. USDC and USDT account for about 43% each.

Stablecoins are one of the most widely adopted assets in DeFi. The strength and stickiness of stablecoins in DeFi has some key characteristics:

• USDC, USDT and DAI represent the main DEX trading pairs
• Stablecoins provide ample liquidity and strong utilization in lending markets
• DAI maintains peg and growing adoption without requiring USD-backed reserves

Yield Aggregators

Aggregators are competing applications in DeFi, and Yearn Finance has won the clear victory so far.

Yearn Finance is a yield aggregator that leverages various Strategies to manage user funds. It works by moving pooled funds around various DeFi protocols, giving it the advantages of scale and ease of use for users.

They provide competitive strategy and pace of ease of use for project integration and individual users Has driven its TVL to $4.5 billion (as of May).

Users lock their assets in Yearn smart pools that automatically distribute funds across various strategies. The basis for these strategies described in the Yearn documentation is this:

• Use any asset as liquidity.
• Use liquidity as collateral and algorithmically manage collateral to avoid default.
• Borrow stablecoins.
• Use stablecoins for liquidity mining and/or earn fee income.
• Reinvest earnings to create compound growth.

For example, the DAI smart pool utilizes a complex network of policies and interoperable protocols to generate Depositor's income. This level of complexity and strategy is too complex for the average user, so Yearn provides users with a one-click solution without fully understanding the complexities of how their money is invested. They charge a 2% management fee and a 20% cut of proceeds for their efforts, unlike typical hedge funds.

Due to relatively little smart contract utilization, developer and strategist skills, and the consistent With a consistent competitive rate of return, users' trust in the Yearn system has been improved.

Data source: Dune Analytics

The revenue aggregator has been used by various DeFi Adopted by users and projects, it becomes the critical infrastructure. Users turn to Yearn for easy ways to participate in DeFi opportunities while minimizing gas fees, complexity, and liquidation risk. Projects are integrating Yearn as key infrastructure for their projects - Badger DAO and Alchemix have each deposited $300 million in the Yearn pool, and more projects continue to add to Yearn.

With strong growth so far, capital continues to accumulate in Yearn and other aggregators with little sign of slowing down.

Conclusion

In less than 12 months, decentralized finance (DeFi) has grown from a niche industry in cryptocurrency to a leading one. While total value locked ($124 billion) is a useful metric for overall DeFi adoption, it hardly tells the full story of true adoption and product-market fit. Instead, more useful metrics can be used to gain a holistic view of both the supply side (liquidity) and demand side (volume, users, utilization, user retention, etc.).

In just 12 months, DeFi has achieved :

• 2 million+ users (unique addresses)
• All DeFi-related smart contracts locked $120 billion+ Worth
• Daily transaction volume on DEXs typically exceeds $2B
• Stablecoin utilization on lending platforms with $10B+ liquidity is typically >80%
• Decentralized stablecoin (DAI) has $3 billion+ in circulation and stability
• The most exciting part is that this is just the beginning of the future of finance.

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