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Glassnode Q2 Report: What opportunities are there in a low volatility market?

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Ethereum prices fell again after a brief rebound, while some DeFi tokens experienced “isolated breakouts” despite no significant changes in fundamentals.

Original title: 《 DeFi Uncovered: Finding Alternative Sources of Yield 》

Original source: Luke Posey, Glassnode

Original translation: Moni, Odaily Planet Daily

The most pressing question at present is: Can the market resume upward as soon as possible?

At this stage, the digital currency market seems to have entered a sideways adjustment period, and traders and investors have to find more opportunities and explore new sources of income under low volatility market conditions. If the market resumes upward, ETH prices still have a lot of room to make up for the current income "loss". On the contrary, if it fluctuates downward, the remaining gains in 2021 are likely to be wiped out.

In this article, we will focus on the following aspects:

1. The state of DeFi on Ethereum during market volatility

2. The recent market attention to synthetic assets Synthetix, and potential drivers

3. Review of the "blue chip" income sources in DeFi

4. Finding alternative income source templates in DeFi

Reduce volatility

Ethereum prices fell again after a brief rebound, while some DeFi tokens experienced "isolated breakthroughs" despite not much change in fundamentals.

Historically, volatility growth and decline are relative. When the market fluctuates too much for a period of time, volatility will decrease. In the chart below, we can notice that after the market's daily average revenue was highly volatile in May, the volatility began to gradually decrease from June to July.

If the market resumes its upward trend, ETH prices still have a lot of room to make up for the current "loss" of income. On the contrary, if it fluctuates downward, the remaining gains in 2021 are likely to be wiped out.

Synthetix looks for a "new way out"

At this stage, Ethereum is still in a sideways consolidation phase, resulting in many DeFi tokens seeking other "return paths", Synthetix is one of them, especially in the process of founder Kain Warwick returning to the project, which has enabled it to find greater rebound power.

On July 10, Synthetix announced that it will launch Optimistic Ethereum (OΞ), the Ethereum Layer 2 scaling solution, during the week of July 26, with the final deployment date pending approval by the Spartan Council. As specified in SIP-121, the initial supported synthetic assets are sETH, sBTC, and sLINK. In addition, the SNX price feed is also deployed by ChainLink. In preparation for the transition to Optimistic Ethereum, several additional SIPs will be released in the coming weeks. These include changes to the debt pool caching mechanism, the deprecation of iSynths, and a reduction in the number of Synths (synthetic assets) on L1.

Optimism stakers’ returns hit an absolute low of ~15% in July, but L 1 staking is still profitable (relatively speaking), but with liquidity transitioning to L 2, Optimism stakers can now earn an annualized return on their investment of ~50%, with sUSD/sETH, sUSD/sBTC, and other trading pairs expected to launch in July/August.

Synthetix hopes that the transition to L 2 will mark a new era for the product: an era with more users, more capacity, and more trading activity. To date, the project has struggled with high fees on L 1, resulting in fewer than 100 daily traders and often less than $50 million in daily trading volume. After entering June, the situation became even worse. That month, Synthetix's average daily trading volume was less than 15 million US dollars, and the number of users was even less than 50. But now, SNX token holders can look forward to the transition to Optimism, benefiting from lower fees, and Synthetix's trading activities are expected to grow further.

More importantly, as a mature project, Synthetix has demonstrated a typical research case of L2 migration to the entire digital currency industry.

New target of DeFi "blue chip" funds: risk aversion

Here are some of the three main categories of income in the DeFi industry in the form of fees and liquidity mining incentives:

1. Earn fees by providing liquidity on decentralized exchanges

2. Income from loan assets in the loan pool

3. Earn governance tokens from liquidity mining rewards

As the market demand for safe-haven capital (stablecoins) increases, the valuation of DeFi tokens has become increasingly sluggish recently, and the risk capital invested in this field is also decreasing-all of this has led to a significant reduction in the yield of the entire DeFi industry. So, how will stablecoins affect the DeFi industry? In fact, when stablecoin capital begins to increase, it means that "stable" capital flows begin to compete for the same market value share. As more and more capital enters the yield-generating DeFi protocols, the dollar returns of all participants will be diluted.

We see that this is clearly the case, as the dollar equivalent in DeFi is outpacing the market capitalization growth of Ethereum and token valuations. As more and more capital begins to flow around, there is also a clear demand for high yields in DeFi. But the problem is that this capital is not used to buy spot ETH or governance tokens. Their main purpose of entering the DeFi market is actually hedging.

As capital increases, everyone comes to share a piece of the pie, and the competition becomes more and more fierce.

* Reduced on-chain activity: If the available fees from user activity (such as trading volume) begin to decrease, but the capital trying to absorb these fees is static or increasing, it will lead to a decrease in the opportunity for liquidity providers to obtain high returns.

In the second quarter, the use of decentralized exchanges on all blockchains declined, and indicators such as lending demand, speculative demand, and utilization were suppressed. Overall, although the market investment in DeFi remains strong, the actual use indicators of DeFi have begun to weaken. As a result, the annualized yield of "safe havens" of well-known DeFi protocols such as Aave, Compound, and Yearn has dropped below 5%, and even though Aave and Compound have introduced liquidity incentives, the annualized yield is still only 3-5%.

* Low token prices: If the (USD equivalent) rewards used to subsidize liquidity in DeFi protocols depreciate, then the overall yield will also decline. As more and more money flows into these DeFi tokens, the value of the tokens will continue to decline because the USD value of these tokens is on a downward trend.

The correlation between a few DeFi tokens and ETH has begun to weaken. When the price of ETH falls, the price of some DeFi tokens actually rises. But overall, compared with historical highs, DeFi token prices are still seriously low. In the second quarter, governance token stakers have lost more than 60% of their staked capital. DeFi tokens that provide yield farming are usually in the same situation as staked tokens, so the value of "mining" rewards has also lost about 60% or more.

* Summary: Due to the combined effects of reduced usage and fees, low token prices (and reward value), and increasing participation in stablecoin capital, the yield of the entire DeFi industry has been greatly reduced.

Today's market environment is a bit "weird" - capital is very abundant but most tokens cannot find marginal buyers. In this environment, how can traders find new sources of income?

Frankly speaking, it is difficult to find high-yield alternatives now, and in many cases, investors and traders need to strengthen risk management and have a deeper understanding of the underlying mechanisms of DeFi tokens. There are indeed some high-yield DeFi projects in the market, and their trading is not crowded (because they are not well-known), but it should be noted that these DeFi protocols may be more risky.

In fact, there are three main factors that "drag" traders to obtain high returns:

1. A large number of participants/liquidity

2. Low utilization/low transaction volume

3. Falling token prices

So, how to solve the above problems? We also have three ways to deal with it:

1. Find early mining pools with low participation

2. Find "diamonds" in "rough stones" with higher utilization

3. Identify projects with price appreciation potential

Derivatives

In the DeFi market, derivatives have always been a relatively quiet corner, mainly due to the high gas costs of most derivatives on the Layer 1 network, coupled with other problems, which keep liquidity at a low level and reduce the overall user experience.

Despite the lack of traction in the derivatives market at this stage, many derivatives from traditional financial markets and some new ideas have begun to be established. Derivatives transplanted from traditional finance include options, futures, swaps and other products, which are usually different from other digital currency markets and offer different types of risk/reward.

Options

Today, many options platforms have been developed in the DeFi market, but most of them have poor liquidity and high gas costs. In the second quarter, there have been dozens of venture capital transactions to fund new options platforms, but so far, most transactions have either not been launched or cannot find liquidity/users.

Perpetual Contracts

With the continuous decline in user activity in the DeFi field, it means that the returns that liquidity providers can get will also shrink. However, perpetual contracts have been a bright spot in DeFi derivatives, and this "cake" has been getting bigger and bigger in the past few months, among which Perpetual Protocol and DyDx have been very strong and growing in volume month by month.

Every token holder wants a piece of the pie from transaction fees and liquidity mining rewards. At least for now, Perpetual Protocol (PERP) stakers can get an annualized rate of return of about 40%. It is reported that Perpetual Protocol is about to release version V2, and the annualized rate of return may increase.

The above is an overview of the DeFi market in the second quarter. For most investors and traders, the most pressing question at present is: Can the market resume its upward trend as soon as possible? Perhaps only time can give us the answer.