One of the more interesting developments in the Ethereum ecosystem is the recent rise of Decentralized Finance, or DeFi for short. Broadly speaking, Defi is an ecosystem of DApps (Decentralized Apps) designed to replicate many of the services that traditional finance institutions provide, but made more efficient and more cost-effective by automating the processes involved and cutting out the middle-men.
This ecosystem consists of a variety of services: collaterized lending and borrowing, crypto token ETFs, crypto asset derivatives, decentralized insurance, along with other new constructs that don’t really exist outside of DeFi.
What is yield farming?
One new construct is the concept of yield farming. Earlier this year, Compound.Finance (COMP), a collaterized lending and borrowing platform, introduced COMP, their governance token. Users who lend out or borrow assets on the platform will receive a proportional allocation of COMP, giving them a voice in the governance process of Compound.Finance. This governance process decides what fees are set by the platform, what assets are available for borrowing/lending, etc.
This resulted in a large demand for lending and borrowing on the platform to earn COMP, as well as a demand for purchasing COMP on the market, which thus drove up COMP prices, making lending and borrowing on Compound.Finance quite lucrative.
This mechanism came to be known as yield farming. They typically involved staking your assets on the platform to provide liquidity for exchanges, or as collateral for lending/borrowing, and in return earning the governance token over time. Soon, a variety of DApps, frequently shoddy clones of existing DApps, emerged with little change except an introduction of a governance token of questionable value and yield farming mechanisms. For inexplicable meme reasons, food became the running theme with names like Sushiswap, Yam.Finance, Sashimiswap, Pickle.Finance, etc.
Thus began DeFi Summer. Over the past few months and ending sometime in late September, these platforms began emerging in rapid succession, echoing the boom (and subsequent bust) of the ICO Bubble in 2017, but on a smaller scale.
Not all of the projects launched in DeFi Summer were clones or outright scams though. Those that survived did so through innovation and iteration, allowing them to stand out from the crowd. Some of these will be catalogued in the list below.
Beyond that, the value of governance tokens (which for some DApps also entitles holders to a share of collected fees) grew in focus because of DeFi Summer. Existing governance tokens like AAVE and NXM grew in value, likewise for newer ones like UNI (Uniswap).
However, not all DeFi governance tokens are created equal, and factors to consider when analyzing them will likely be the subject of a future issue. In the meantime, below is a list of DeFi related tokens that I consider interesting and potentially of value. I may not own them, even if they are listed below. The risks and potential rewards vary in buying these and that’s something you will have to evaluate based on your own risk appetite.
This list is in no particular order:
AAVE – The governance token for the lending and borrowing platform of the same name. Users of AAVE can lock up their tokens as collateral, and in exchange borrow some other asset up to a certain percentage of their collateral value. An interesting feature of AAVE is that users can borrow either with a volatile interest rate or a ‘stable’ interest rate. The volatile rate fluctuates according to supply and demand and depending on market conditions may be more favorable to the borrower. However, if the borrower requires more certainty, they can borrow under a more stable interest rate instead.
AAVE has quickly emerged as one of the top lending/borrowing platforms. The token functions as governance, but also can be staked. Staked AAVE functions as a form of insurance for the platform, where staked AAVE is used to compensate lenders should a black swan event occur and the collateral provided by borrowers cannot successfully compensate lenders. Staked AAVE earns fees and rewards in the form of more AAVE.
UNI – UNI is the governance token for Uniswap, the largest decentralized exchange by volume, with close to USD 3 Billion in liquidity. At the height of DeFi Summer, Uniswap’s trading volume exceeded that of Coinbase, one of the largest centralized crypto exchanges.
However, the tokenomics of UNI are not great in my opinion. A large portion of UNI is allocated to investors, and many more to be minted over time via yield farming and inflation. Yield farming, in particular, can create heavy sell pressure, keeping the token price down. Furthermore, the governance system was initialized with some fairly flawed parameters. In order to create governance proposals, a user needs to own or have 1% of UNI supply delegated to them, making it very difficult to even create proposals. Governance proposals furthermore require 40million UNI worth of Yes votes to pass. There have been 2 governance proposals so far. None have passed. These high thresholds are designed to prevent whales and VC funds with large bags from monopolizing the governance process, but it also introduces the aforementioned problems.
One potential bullish factor for UNI would be the introduction of fees. As of now, Uniswap only collects fees for liquidity providers, those who provide their assets to the platform for trading in exchange for fees. However, the platform also has the ability to collect fees on behalf of UNI holders. Should there ever be a governance proposal to activate this fee collection, and should it pass, one can expect UNI price to pump as investors begin to accumulate the token for the fees.
SNX – The token for Synthetix, a synthetic asset issuance protocol. SNX functions primarily as collateral rather governance. SNX can be locked into their platform as collateral, which allows minting of synthetic assets which are pegged to the value of real assets like USD or BTC. In return for staking SNX, users earn fees/rewards from traders who exchance those synthetic assets, as well as from new SNX minted as part of inflation.
Synthetix has grown very rapidly over this past year. In particular, its stablecoin, sUSD, could potentially topple DAI as the biggest decentralized stablecoin as Synthetix’s economics seem to function better than DAI’s.
YFI – The governance token of Yearn.Finance. Yearn started off as a yield farming aggregator, a platform that automatically moves your assets between yield farming platforms for the purposes of maximizing yield. Since then, it has developed into an ecosystem of automated investment products. Yearn functions essentially as an automated investment manager. If you have assets of various sorts, you can use Yearn to earn interest on those assets, with the assurance that your profits are maximised without requiring any intervention on your part.
Yearn.Finance is a remarkable product. It was developed without external investors by a core collective of developers who work on the project without any central management and without any legal entity representing them. Even their salaries are managed through decentralized governance systems. Some of their developers are probably the best smart contract developers out there.
The YFI token was distributed via yield farming to early users of the platform. It entitles holders to fees collected from users of the platform and also allows governance participation. It has a hard capped supply of 30,000. Combined with high demand for the token, it has pushed YFI price to incredible highs, with an all time high of around USD40,000. This gives YFI some ‘meme potential’, as 1 YFI is more valuable than 1 BTC, and the psychological desire for a holder to want to own at least 1 YFI might drive its price to new speculative highs, beyond its already strong fundamentals. I’m quite bullish on YFI, as you can infer.
COMP – The governance token for Compound.Finance. Compound.Finance is a collaterized lending and borrowing platform much like AAVE. One of the earliest lending/borrowing platforms, it has not innovated as fast in my opinion and the list of supported assets is rather limited.
COMP allos governance participation, but does not collect fees. COMP is still actively being distributed to platform users, and combined with the fact that it is governance only has led to selling pressure and little demand, leading to declining price.
MKR – The governance token behind Maker, which is the platform governing DAI. DAI is a decentralized stablecoin, pegged to the USD. DAI is minted by users locking up ETH and other collateral on that platform. This DAI can then be traded for other assets at a value of 1 USD (or at least very close to it). MKR tokens allows governance of the platform as well as collecting fees from users who mint DAI.
As the original decentralized stablecoin, demand for DAI has grown massively over time and it is the most popular decentralized stablecoin out there. However, MKR price has not really reflected this growth. There are various reasons. Users who wish to own DAI can do so through 2 ways: buying on the open market or minting DAI by locking up collateral. Buying DAI on the market increases demand, but not supply. If demand for DAI on the open market exceeds supply, the value of DAI will increase, drifting away from 1 USD. To prevent this, MKR holders have to make it more attractive to mint DAI, thus increasing supply, by locking collateral. To do this, they can vote to decrease the fees collected from minting DAI.
However, reducing the fees collected also reduces fees earned by MKR holders. So, to increase the the available supply of DAI, MKR holders have to sacrifice their fees, making it less desirable to actually own MKR. The incentives are misaligned.
Compare this to Synthetix. In Synthetix, fees are collected from the trading of sUSD, rather than the minting of it. Instead, SNX holders are the same users who mint sUSD by locking up SNX as the collateral. So, increasing supply to meet demand also leads to greater rewards for SNX holders. The incentives are better aligned here than in Maker.
CRV – CRV is the governance token of Curve.fi, a decentralized exchange specialized in exchange of stablecoins. Curve is designed to allow stablecoin exchanges with very little slippage. Think of it as a very efficient foreign currency exchange service.
CRV allows for participation in governance. Furthermore, fees collected from the exchange can also be used to buyback and burn CRV tokens. CRV is earned by providing stablecoins to the platform as liquidity for the exchange.
CRV, however, has a pretty harsh inflation schedule, resulting in a great deal of sell pressure, reflecting in its ever declining price. I don’t believe CRV is a good investment.
HEGIC – Hegic is a decentralized options trading protocol. Options are a fairly advanced type of financial derivative that has grown in popularity within cryptocurrency in the recent months, with exchanges like Deribit and FTX emerging to the forefront. Hegic is designed to act as a decentralized alternative, providing more flexibility to options traders.
HEGIC tokens earn fees when options are settled, and can also be used for governance. HEGIC inflation is quite unique. There is no continous inflation. Instead, additional HEGIC is released in staggered stages that ‘unlock’ whenever HEGIC marketcap hits certain milestones. The released HEGIC can be purchased at certain fixed prices, with fractions of the revenue collected going to existing HEGIC holders.
Hegic is fairly new, only really emerging in September. However, it seems to be gaining popularity among traders and it’s something I’m watching closely.
This list is getting quite long, so I shall continue it in a future issue…
Note: Most of these tokens are ERC-20 tokens (i.e built on top of the Ethereum blockchain). One of the easiest way to buy these is through the decentralized exchange (DEX) Uniswap. Other exchanges like Binance may have them as well.
All of this is for informational purposes only. This isn’t financial advice. Cryptocurrency trading and investment is risky. I am not liable for your financial gains or losses. You are encouraged to do your own research. I provide no guarantee that any information in this newsletter is factually accurate.
The article originated from crypticthoughts, by Benedict Lee. Do check out his awesome content related to the crypto world!