Messari values Curve: Why is it the most overlooked DEFI protocol?

Valuation of Curve Finance: The Most Overlooked Protocol

Original source: Mira Christanto, Messari Research

South Wind, Unitimes

Curve Finance is perhaps the most important and overlooked agreement in DEFI. It trades more than $1 billion a day, with about $7 billion in lockups at the time of writing. Many users of major lending platforms or decentralized transaction aggregators use Curve indirectly without realizing it.

In this report, we will first look at what Curve Finance is and explain the economics of its local token CRV. If you are already familiar with the platform, skip to this article's analysis of CRV valuation, as well as an overview of the benefits and risks of the protocol.

The Curve Finance profile

Curve founder Michale Egorov published the "Stableswap" white paper in November 2019 and eventually renamed the agreement Curve Finance on February 10, 2020. Curve is an automated market maker (AMM) protocol designed to provide trading between assets that are expected to have stable prices, such as stablecoins. User adoption was slow at first, when DEFI was a relatively new concept, and Curve attracted only $2 million in deposits (lockups) and $1 million in volume in the first few days after its launch.

The release of Curve Local Token CRV on August 14, 2020, marks a major turning point for the protocol. The amount of deposits attracted by the agreement immediately increased by 180 per cent to $1.2 billion as CRV was incentivified as a new liquidity provider (LPS). Since then, Curve's deposits have grown to nearly $7 billion at the time of this article (and more than $8 billion in mid-May this year).

Above: Change in lock-in value in the Curve Finance agreement. Screenshot by Defi PPSE

While there are currently multiple AMMs (such as Uniswap, Bancor, and Balancer) that allow for token swaps, Curve is one of the pioneering AMM protocols that allows for low slippage transactions between price stable assets such as stablecoins. This allows for low slip point trading between any asset that is expected to be stable, including anchor currencies (such as DAI, USDC and USDT for price anchored USD, RENBTC, SBTC and WBTC for price anchored BTC, As well as steth, Seth, etc.) and vapt tokens (such as CDAI, CUSDC, and YDAI, YUSDC). Consider the four Curve liquidity pools, each of which is anchored to the same asset: 3POOL pools for USD, REN pools and SBTC pools for BTC, and STETH pools for ETH (currently each liquidity pool contains 2-4 assets).

Screenshot: Curve

Since the tokens in each Curve liquidity pool should trade at a similar value, when a user deposits a token into a liquidity pool (that is, offers liquidity), the token will be allocated according to the weight of the different tokens in the pool. For example, the following figure shows the ratio of three assets (DAI, USDC and USDT) in the 3Pool pool at the time of writing. If the user APCE puts 100 USDT into the 3Pool pool at this time, Then 100 DAI deposited in APCE will be divided into 33.41DAI, 27.97USDC and 38.62USDT according to the current ratio. This means that when APCE wants to withdraw liquidity (i.e., withdraw money) from the 3Pool pool, it can choose to withdraw all three assets at the same time, or it can choose to withdraw only one of the three assets (e.g., DAI only).

Screenshot: Curve

This also helps stablecoin keep its correct peg, as it is easy for traders to arbitrage when prices deviate from the peg. In the example above, the USDC ratio (weight) in the 3Pool pool is relatively low (27.97%) and the USDT ratio is relatively high (38.62%), and the optimal balance is when they are equal (since there are three assets in the 3Pool pool, So the optimal balance is 33.3% each). At this point, in order to make the pool more even, a liquidity provider (LP) will get a higher bid to deposit a USDC into the pool (say $1.001) than to deposit a USDT into the pool (say $0.999) (Note: After an LP deposits an asset into a Curve pool, it receives LP tokens for that pool. The number of LP tokens acquired is affected by the number of assets deposited by the LP and the price quoted for that asset. Therefore, if the same number of tokens are deposited in the same liquidity pool, depositing the higher-priced tokens will enable LP to obtain more LP tokens. These LP tokens represent the LP's share of ownership in the pool and are entitled to receive the exchange fee of the pool on a pro rata basis, and the LP can pledge the acquired LP token for mining CRV tokens. Therefore, the situation in the above example can motivate LP to deposit USDC into the pool, thereby obtaining more LP token of 3Pool pool). The same concept is also true in reverse, that when an LP withdraws liquidity from the 3pool or when a user makes a stablecoin exchange in the 3pool, the USDC is quoted higher than the USDT. This balancing mechanism helps maintain anchoring (that is, not overvaluing or undervaluing an asset in the pool) while changing the weight of equivalent assets in the pool: the pool on Curve is always trying to balance the pool.

Figure above: The weight change of three assets (DAI, USDC and USDT) in Curve 3Pool. The weight of these three assets is in a negative and negative relationship.

Curve uses a unique AMM constant sum function (constant sum function, i.e., x+ y = constant) and constant product function (constant product function, That is, x * y = constant) in order to achieve this balancing mechanism. The result of the combination of the two is shown in the blue line below. Curve uses a constant sum function (x+ y = constant) around the equilibrium point to minimize the trading slip-point. When the price of the target asset deviates from this central point, the blue line changes from a constant sum function to a constant product function, thus ensuring available liquidity as prices go to zero or infinity.

Screenshot from: Curve whitepaper

By contrast, the stabling-to-stablin conversion experience is even worse on other AMMSs that use a constant product function, such as Uniswap v2 or Sushiswap, because the price slippage on these AMMSs can be large. As a result, Curve is the most popular stablecoin exchange.

As of this writing, Curve has 35 different liquidity pools, each offering a different return to its liquidity provider (LPS). In this way, Curve also allows token holders to benefit from their tokens with minimal risk of a fickle loss. When LPs deposit their tokens in a liquidity pool, they receive transaction fees in return for providing liquidity, as traders pay a 0.04% fee for each exchange on the Curve (50% of which is allocated by the LPs according to their weight). The other 50% of the management fee for the platform is allocated to those who pledge CRV and get VecrV, which we will explain below).

In addition, some of the Curve liquidity pools provide further incentives to LPS, which means that in addition to splitting the 50% fee, LPS can receive additional Token rewards (not necessarily CRVs). For example, in the example above, the Steth pool provides LPS with an LDO token reward (+7.46% APY at the time of writing) as an additional incentive for the pool to grow even faster; The SUSD pool also rewards LPS with SNX tokens; The Saave Pool provides LPS with STKAVE token rewards; And so on. See below:

Screenshot: Curve

Curve also accepts related tokens from other protocols (such as CDAI, Seth, etc.), Or if LPS chooses to use the liquidity pool of loan and credit agreement to some _ on Curve (for example, Compound pool (CDAI + CUSDC), AVE pool (ADAI + AUSDC + AUSDT) and Y pool on Curve (YDAI + YUSDC + YUSDT + YTUSD) and so on), Curve will automatically "wrap" assets deposited by users when providing liquidity.

For example, users can add DAI to these pools, and Curve will automatically "wrap" the DAI with a prefix to denote other DEFI protocols (usually loan protocols or aggregators) that Curve interacts with. Common prefixes include y, c, a, and s, which represent Yearn Finance, Compound Finance, Aave, and Synthetix, respectively. So DAI that the user stores in it is automatically "wrapped" as YDAI, CDAI, ADAI, or SDAI (see figure below). These packaged assets can earn interest income from different external agreements! For example, owning CDAI means that the user has the right to extract DAI from the Compound agreement and gain Compound interest by lending out their savings. That is, LPs that provide liquidity to Curve's Compound pool earn additional interest from the Compound.

There are several liquidity pools containing Yearn Finance, such as the Y pool and Busd pool in the figure below. Also, Tokens stored can be successively "wrapped" across two platforms using the prefix yc or cy, such as cyDAI, cyUSDC, ycDAI, and so on.

Screenshot: Curve

Use of CRV tokens

On the day the CRV token was launched in August 2020, the amount of deposits (lockups) on the platform almost tripled. This is because LPS (liquidity providers) are incentivized to provide liquidity by CRV. Higher deposits have made Curve Finance a place of high liquidity and efficient trading. While CRVs are used to stimulate mobility and grow communities, their primary uses are voting, staking, and raising incentives -- in order to obtain these use cases, CRV token holders need to lock the CRV into the Curve DAO, To get the Vecrv tokens needed to vote (vote-Escrowed CRV, the vote-managed CRV).

Votes and rewards are measured by the number of locked CRV tokens and the locking time. The longer the lockup, the greater the voting power and the greater the "boost" in returns. Users can lock the CRV for at least a week and up to four years. The longer a user locks in the CRV, the greater the "boost" (up to 2.5 times), which means the more Vecrv the user will receive. This makes sense because the interests of the long-term pledgers are closely tied to the success of the deal. As of this writing, 63.43% of circulation CRVs are locked, with an average lockdown time of 3.68 years. The duration of this is surprising in the crypto market, but it is thanks to pledges from the Curve team and vaults such as Yearn. This is positive for Curve because, as noted earlier, long-term stakeholders are linked to the success of the agreement.

Vecrv is used for the governance of Curve Finance, which is currently controlled by a single DAO (Decentralized Autonomous Organization). Vecrv holders can submit new proposals (if they own at least 2,500 Vecrv), as well as vote on proposals (there is no minimum number). Voting could be useful, for example, by increasing incentives for LPs to deposit money in certain pools of liquidity, or even by changing the economics of CRV tokens, such as burning (destroying) CRV tokens to reduce inflation. For example, shortly after the introduction of the CRV token, someone bought a lot of CRV on the market to be locked into the Curve DAO and then voted to raise the APY (annualized yield) of the Compound pool on the Curve to 308% (see chart below). In a less extreme example, Yearn proposes to funnel more Curve daily rewards to Yearn-related pools.

In addition, users who lock into CRV will receive fees generated by the liquidity pool, as well as fees for deposits and withdrawals. Fees incurred by users who lock in CRVs in exchange for VECRV access to the liquidity pool under the Curve protocol: of the 0.04% conversion fee charged by the platform, 50% is allocated to LPS and 50% to VECRV holders; The deposit and withdrawal fee is more difficult to calculate because it is not a fixed amount.

The supply of CRV tokens

The CRV token was launched on August 14, 2020, with an initial supply of 1.3 billion CRVs and a final maximum supply of 3.03 billion. The distribution of the initial supply of 1.3 billion CRVs (43% of the total issue) is as follows:

5% allocated to Curve Liquidity Provider prior to CRV launch (linear unlock within 1 year)

30% to shareholders of Curve (linear unlocked over 2-4 years)

3% allocated to team members on Curve (linear unlock over 2 years)

5% as a community reserve

The remaining 57% of CRV tokens will be issued to Curve's liquidity providers (LPs) without linear unlocking planning until the ceiling of 3.03 billion tokens is reached. The final distribution diagram is as follows:

Although 1.3 billion CRV tokens were issued at the initial offering, due to the respective linear unlocking program, the initial supply in circulation was zero. About 2m CRV tokens are currently being issued daily and distributed as rewards across Curve's 35 liquidity pools. The supply of CRV will be released at a declining rate until it reaches its maximum supply of $3.03 billion around the year 2320 (i.e., in about 300 years). Here is the projected growth in the supply of CRV tokens through August 2026:

The valuation premium of CRV

Based on current levels, CRV has upside potential for the following reasons:

Growth forecast: High demand for stablecoin transactions is expected, especially in agreements that offer lower slippage points and specific depth of liquidity. In the past 12 months, stablecoin trading volume reached $1.5 trillion, reaching $1 trillion in the first quarter of 2021 alone.

Loyal Community: Curve token has the longest lockup period among DEFI, with an average lockup period of 3.7 years. Therefore, both Curve token holders and LPS want to see Curve's long-term success, as their motivation is the same. The average lock-in time of 3.7 years also testifies to Curve's type of community - investors with power and potentially larger balance sheets. In fact, that seems to be the case, with average users of CRV tokens trading several orders of magnitude more per day than other protocols:

Pancakeswap: The Amm Eating Everyone Else's Breakfast

Network effects: Curve plays a key role in the DEFI ecosystem, with major DEFI protocols such as AVE, Synsynthetic, Yearn Finance, and Compound integrated with it. The integration with so many programs enables Curve to maximise returns and gives the agreement an advantage in maintaining market share.

Airdrops: CRV token holders are usually eligible for airdrops, which increases the value of holding a CRV. In October 2020, Stablexswap, a decentralized stablecoin exchange that emulated Curve on the BSC, airdropped StAX to VecrV holders in an attempt to bring stablecoin governance participants into their networks. In addition, Elppsis, a stablecoin exchange platform on the BSC that Curve licensed forked, provided 25% of EPS tokens to Vecrv holders.

Regulation: The regulatory risk of CRV may be less than that of other DEFI peers because CRV token contracts are deployed by an anonymous third party account. On 14 August 2020, anonymous user 0xc4ad tweeted that he had deployed open source CRV tokens and Curvedao contracts on the Ethereum mainnet before the Curve team did. Or perhaps it was deployed by the Curve team itself through an anonymous account to mitigate the founders' future regulatory risk; Or it could be deployed by a third party to benefit from the early liquidity mining rewards, since each block is rewarded with a certain number of CRV tokens, so if only one user is pledging to mine a CRV, he will get all of the block's CRV tokens. This led to about 20,000 CRV tokens being awarded to some early pledgers before Curve officially announced the launch of CRV.

Above: Twitter user 0xc4ad says he has deployed the CRV token contract before the Curve team.

Community Funds: The initial allocation of the CRV allows for approximately 148 million CRVs ($505 million) to be used for community-led incentives.

Transparent data: Curve Finance probably has the most accessible data on its site than any other agreement. This transparency and availability reduces uncertainty and gives investors, users and LPS confidence in the agreement.

Key risks to CRV valuation

The following is an assessment of other risks to CRV's current valuation:

Relatively high inflation: On Curve Finance, new CRVs are issued daily to reward LPs. However, Curve's inflation programme was too aggressive relative to its growth forecasts. For example, Sushiswap and Uniswap had annual inflation rates of 27 per cent and 76 per cent, respectively, through the third quarter of 2022, while Curve had an annual inflation rate of 156 per cent. Thus, this dilutes the unit index of Curve. In addition, this means that more market buying is needed to offset new CRVs issued daily.

Competition from Uniswap V3: Launched in May 2021, Uniswap V3 is expected to offer a narrower slippage with lower risk and greater capital efficiency. Users will be able to choose on Uniswap to offer liquidity for the entire price range (i.e., zero-plus infinity) or for a specific price range (i.e., setting the price range that provides liquidity). Therefore, we can expect Uniswap V3 to reduce the slippage point for stablecoin conversion.

Further fork: Future forks could dilute Curve's market share in the Ethereum stablecoin AMM space, but could increase Curve's overall value. Curve forks are also available on other blockchains, such as Elppsis and Equipbrium on BSC, who are building a cross-chain implementation of Curve on Polkadot. ELPPSIS is a fork of the Curve license, while Equipbrium is developing the Curve technology (bringing the Curve algorithm into the Substrate development framework supported by Polkadot), Meanwhile, the Curve Finance team is overseeing the development and will run the application on Equipbrium's future Polkadot parallel chain, as shown below.

Security: As with all DEFI protocols, Curve is exposed to smart contract risk in its own protocols and in all protocols integrated in its network. While Curve's smart contract is audited by Trail of Bits, a security audit doesn't completely eliminate risk. For example, in December 2020, Curve found the problem of Idle tokens, which made the Idle pool unsafe in the long run, as shown in the figure below.

In March 2021, Curve Finance tweeted that the Pool Factory V1 version had found a bug and advised users in V1 to immediately use crv. Finance to withdraw funds. Curve.Fi and Pool Factory V2 pools are not affected. The team also said that while the vulnerability was serious, it only affected the V1 pool and could not be used by hackers to steal user funds, as shown below.

User experience: Andre Conye, founder of Yearn Finance and one of the most experienced developers at Defi, also had a hard time at first figuring out how Curve worked. There is an educational process involved in learning how to use the Curve protocol, which can be annoying to users who are not familiar with Defi. Examples of Curve Finance's UX challenges include:

Liquidity pools differ from the way a typical centralised exchange operates. As a result, new users may not be accustomed to trading with these related liquidity pools that contain more than two tokens.

Some of the tokens in the Curve pool have prefixes or suffixes, such as 3CRV (LP token representing the 3Pool pool), veCRV, CRV, etc. New users have no idea what this is or how they can use these pools of liquidity. In addition, we can even see further composability of tokens such as TUSD3CRV-F, FRAX3CRV-F, and WAUSD3CRV-F.

Not only do CRV holders need to pledge their CRV tokens, but they also need to choose a specific lock-in time, which can affect how much they receive an enhanced reward. While the four-year lock-up period puts token holders closely tied to Curve's success, it can also be a daunting time to maximise revenue gains.

The CRV lock is irreversible, so users will not be able to unlock their CRV in advance.

Curve Finance's user interface looks like an old Windows 3.1 and is arguably harder to build than modern Web sites.

There is a delay of at least 8 days between when users lock their CRV tokens and when they can claim rewards. Under current standards, fee rewards are only available for 24 hours after midnight UTC on Thursday.

Screenshot: Curve

Centralized voting: Voting on Curve Finance seems to be controlled by only two parties: the Curve team and Yearn Finance. Shortly after its launch on August 23, 2020, the Curve founders controlled approximately 80% of the governance power of Curve DAO. Since a 30 per cent participation rate is needed to achieve a quorum (the minimum required for a vote to pass), the team has too much power, even in deciding which proposals can be blocked from a vote. According to Curve, this weighting is a response to the 50% control gained by a wallet that represents the YFI community, so the Curve founders want to dilute YFI's control before Curve Governance goes live on August 28. In addition, only 6.7 percent of CRV supply in circulation was locked up at that time. In November 2020, Yearn launched a machine gun pool (VAPT) that permanently locks the CRV on a 4-year cycle and has no withdrawal function. In return, depositors of the machine gun pool will have the right to charge Curve DAO management fees on all Yearn products in perpetuity. This may further increase YearN's control over Curve's governance, leading to further centralization of Curve's voting rights. As a result, the value of holding CRV for voting purposes is reduced, despite the bonus fees, because both parties wield too much power. While this is antithetical to DEFI's culture, a strong team representation can also be positive, especially if some significant incentives align with token holders.

Above: Trends in the voting weights of Yearn (red) and Curve's founders (green). Source: The Block

conclusion

Curve is the basic building block of the DEFI ecosystem. While it hasn't received much recognition yet, it provides liquidity on the back end for many large platforms. Given the growing focus on the importance of stablecoins, we believe there is potential for the valuation of CRV tokens to rise. However, it may be difficult for CRV tokens to meaningfully overtake their DEFI counterparts as increased competition threatens to erode Curve Finance's dominance of the sector. On a valuation basis, we believe CRV has 108% upside potential, although it far outweighs the limited capabilities of its peers.

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