DeFi Research News April 2023

DeFi TVL Updates

Key DeFi Stats for April:

In April TVL stayed relatively stable in dollars terms around $49 Billion for the whole DeFi market while Ethereum’s TVL recorded a decrease of ~2M ETH. DEX 30day volumes have reduced in dollars terms from March’s $128B to $67B at the end of April. Stablecoin supply stayed flat with USDC losing $2B and USDT gaining it.

Lido Finance is continuing to hold the top spot after snatching it in January from the long-term king of TVL, MakerDAO. Its TVL stands at an impressive ~$12B up 2B from March. MakerDAO is holding the second place with a stable ~$7.3B TVL, followed by AAVE and Curve with ~$5.2B and ~$4.4B TVL for the 3rd and 4th place. Finally Uniswap regained its #5 spot from Convex with ~$4B in TVL.

Macro View

The State Of The US Economy

Well, it seems like the US economy is feeling a bit sluggish lately. Retail spending, construction spending, capital spending, exports, and imports are all showing negative growth rates in real terms. And the latest GDP numbers for Q1 came in at a mere 1.1% annualized, which is below consensus expectations. To add to the woes, the purchasing manager's index is at a contractionary 46.3, and the copper-to-gold ratio is continuing in a downtrend. The yield curve is even flashing a warning signal, and bank lending activity is reaching stall-speed.

It's like the economy is a car that's running out of gas and coasting to a stop. Maybe we need to add some fuel, or maybe we need to start pushing it to get it going again. Who knows? But one thing is for sure; policymakers need to figure it out and make some decisions to avoid a full-blown recession.

Regulations Update

Treasury’s DeFi Risk Assessment

The US Treasury Department released a report called "DeFi Risk Assessment" on April 6th, which examines the use of DeFi by illicit actors and related issues. The report argues that if a DeFi service functions like a financial institution, it must comply with AML/CFT regulations, including the Bank Secrecy Act. However, it recognizes that the current framework is inadequate to address DeFi's decentralized nature. The report recommends strengthening AML/CFT supervision and enforcement of virtual asset activities, including closing gaps in the BSA. The government should also promote responsible innovation of compliance tools and engage with the private sector. 

Banque de France Discussion Paper

The Banque de France published a discussion paper that suggests "disintermediated finance" is a more appropriate term for DeFi than "decentralized finance" due to its high level of concentration and centralized governance. The paper proposes regulatory options to address potential risks and challenges associated with blockchain infrastructure, services application layer, and mechanisms allowing users to access these services. The proposed regulations include minimum security standards for public blockchains, transferring financial functions to private blockchains managed by trusted players, mandatory certification mechanisms for smart contracts, creating statutes for service providers, and strengthening supervision of intermediaries facilitating users' access to DeFi. The paper also suggests subjecting DAOs to supervision and extending EU's MiCA regulations to include front-end websites as intermediaries.

SEC Updates

The SEC is on the hunt for some crypto-savvy attorneys to join their Crypto Assets and Cyber Unit (CACU). They'll be responsible for investigating all sorts of "crypto asset securities" and drafting legal documents. The SEC's Investor Advisory Committee (IAC) expressed support for CACU's activities in a letter to SEC Chair Gary Gensler, stating that virtually all crypto tokens are securities and not supporting legislation to isolate cryptocurrencies from federal securities laws. The letter encouraged the SEC to provide industry guidance and suggested issuing a request for comment to craft additional guidance or propose rules related to the application of federal securities laws to crypto assets.

IMF Calls for “Strict” Crypto Regulation

The International Monetary Fund (IMF) has called for comprehensive and consistent regulation of the cryptocurrency sector following a turbulent year in the market. The IMF cited the collapse of major exchanges, crypto-linked banks, and stablecoins as reasons for urgent regulatory action. The IMF called for "strict" regulation of all critical activities and entities related to the storage, transfer, exchange, and custody of reserves. Additionally, the IMF advocated for the imposition of prudential requirements on stablecoin issuers and entities carrying out multiple functions. The report suggests subjecting stablecoin issuers to reserve requirements and tighter regulations and prudential requirements on larger institutions carrying out multiple functions.

Stablecoin Legislation

The House Financial Services Committee (HSFC) released a draft of a stablecoin bill that proposes developing a regulatory framework for dollar-backed stablecoin issuers, deeming them a financial institution, and placing regulatory authority in the hands of Federal banking agencies, notably the Board of Governors of the Federal Reserve System. The bill would require stablecoin issuers to undergo an application process with the Board and prohibit the issuance, creation, or origination of endogenously collateralized stablecoins for two years. The bill would require a study of CBDCs and their effects, and the Board and listed federal agencies to provide a confidential briefing on the development of international standards related to CBDCs. However, House Republicans intend to revise the bill, as there is no longer bipartisan support. The bill does not seek to limit stablecoin issuance to banks, creating a pathway for non-bank issuers to comply with the regulations.

House Financial Services Hearings on SEC Oversight and Stablecoins

The House Financial Services Committee held two consecutive hearings on crypto-related matters. The first hearing, "Oversight of the Securities and Exchange Commission," had SEC Chair Gensler as the sole witness, where he was pressed on the SEC's rulemaking and guidance on digital assets. However, Gensler was unable to provide clear answers on the classification of digital assets and urged market participants to comply with existing securities laws. The second hearing, "Understanding Stablecoins' Role in Payments and the Need for Legislation," discussed the need for stablecoin legislation, but some members and witnesses disagreed on the legislation's shape. Ranking Member Maxine Waters raised concerns that the bill does not adequately address risks revealed by the failure of FTX. The hearings highlighted the ongoing lack of regulatory clarity for the crypto industry, hindering innovation and growth, and suggest that reaching a consensus on stablecoin legislation will be challenging.

Coinbase Applies for Bermuda License as US Crypto Regulatory Landscape Drives Innovation Abroad

Coinbase announced that it obtained a license from the Bermuda Monetary Authority as part of its 8-week international expansion drive to enter new markets with "responsible crypto forward regulatory frameworks." The company is rumored to launch its offshore derivatives exchange in Bermuda as soon as next week. This announcement comes after Coinbase CEO Brian Armstrong's statements on the lack of clear and comprehensive regulatory frameworks for the crypto industry in the United States. Armstrong discussed the "turf battle" between the Commodities Futures Trading Commission and Securities Exchange Commission, which creates confusion and hinders business operations. Coinbase's expansion offshore illustrates the loss of domestic crypto leadership that could occur with continued misguided regulation by enforcement in the US.

Coinbase Sues the SEC

Coinbase has filed a motion in the US Court of Appeals for the 3rd Circuit to force the SEC to respond to its petition made last year calling for the agency to exercise its rulemaking authority and provide clarity on the regulatory status of digital assets. Coinbase argued that the SEC’s failure to respond violated the Administrative Procedure Act, which requires agencies to respond to petitions “within a reasonable time.” Over 1,700 firms and individuals have supported Coinbase's request. Additionally, Coinbase's CEO and CLO responded to the Wells Notice received from the SEC last month and urged the agency not to litigate the case as it would undermine the SEC's enforcement program and harm investors.

EU officially passes MiCA regulation

The European Parliament has approved the Markets in Crypto Act (MiCA), a comprehensive set of rules aimed at regulating the cryptocurrency industry. Providers can become liable if they lose investors' crypto assets. Crypto platforms, token issuers, and traders will have to comply with transparency, disclosure, authorization, and supervision of transactions, and inform consumers about the risks associated with their operations. Stablecoins will be required to maintain ample reserves to meet redemption requests, and those that become too large face being limited to €200m ($220m) in transactions per day. The European Securities and Markets Authority will be given powers to step in and ban or restrict crypto platforms if they are seen to not properly protect investors or threaten market integrity or financial stability. The EU also passed the Transfer of Funds regulation, applying the "travel rule" to crypto transactions which requires financial companies to screen, record and communicate information on both sender and recipient of crypto transactions to help combat money laundering.

Institutional Update

Even though the space is seeing regulations pushback, adoption isn't scared of such things. We provide a list of the most important pieces below coming from Paul McCaffery newsletters:  

The Brits Embrace Crypto

• The Bank of England is increasing its efforts to develop a "Britcoin" by hiring a team of up to 30 people. In February, the Bank revealed plans for a new "digital pound," which will now move into the design phase, with the aim of having the currency in circulation by the end of the decade.

• British banking giant Lloyds Bank has announced a trade digitization partnership with blockchain-based document digitization firm Enigio to encourage the use of digital documentation in trade finance. The partnership aims to expand the application of Enigio's ‘trace:original’ tool and integrate it with wider trade finance products, such as documentary collections and credits, to promote the use of digital documents instead of paper documents. The two companies hope that digitization of documentation will make trade finance processes faster, cheaper, and more secure. With the use of trace:original, the creation of digital documents that can be distinguished from copies and be used in processes that require an original version, can be achieved. The collaboration comes amidst supply chain disruptions, which have caused increased loan demand while banks have tightened their lending policies.

Hong Kong Wants to be the Crypto Hub

• Hong Kong's Metalpha Technology Holding has launched a $100m fund that will invest in Grayscale Investments' crypto products. The fund will allow high-net-worth individuals and institutions to gain indirect exposure to cryptocurrencies through Grayscale's investment products, either directly or via structured derivatives. Since March, Metalpha has raised $20m and has partnered with NextGen Digital Venture to launch the fund. The company said that its regulator-compliant offering would benefit from renewed investor interest in the space, as it provides a legally compliant way for overseas Chinese institutions to access the cryptocurrency market.

• Hong Kong's largest digital bank, ZA Bank, has announced that it will be extending its services to crypto. The bank plans to offer users of locally-licensed crypto exchanges the ability to enter and exit the crypto market using Hong Kong dollars, Chinese yuan, or US dollars. This move comes as Hong Kong attempts to regain its economic edge following the pandemic, and will participate in a forum with domestic and international crypto firms later this month.

Meanwhile Canadian and American Shun Away Crypto Giants

• Paxos, a provider of financial services in the cryptocurrency sector, has decided to withdraw from the Canadian market. In an email to Canadian customers, Paxos explained that due to regulatory issues, it will no longer provide services to customers in Canada. Customers with unfunded accounts have been informed that their accounts will be disabled on May 9th, 2023.

• Paxful, a peer-to-peer bitcoin marketplace, is shutting down its platform due to "key staff departures" and challenging regulatory conditions. CEO Ray Youssef wrote in a blog post that he couldn't share all the details, and suggested customers explore self-custody and trade elsewhere. Youssef also said that a lawsuit filed by a Paxful co-founder drove away all the senior-level team. It is unclear if the platform will return.

• Binance.US has cancelled its deal to acquire assets from bankrupt crypto lender Voyager Digital. Instead, Voyager will distribute cash and crypto to customers using its own platform as part of a "toggle" in its court-approved restructuring plan. Binance.US cited the uncertain regulatory environment in the US as the reason for cancelling the deal, which had aimed to help Voyager's customers access their crypto.

Other Noteworthy News/Events in April

eToro Partners with Twitter

Through a recent partnership with eToro, Twitter has expanded its live price chart feature for select financial assets, marked by the $Cashtag symbol. Under the collaboration, Twitter users will have access to a broader range of assets represented by $Cashtags, from stocks and ETFs to crypto and commodities, and will also be able to click through to the eToro platform to access further information and potentially invest. The partnership provides eToro a broader audience reach and engagement opportunity, while also allowing Twitter to offer more value-added services to its users.

Central Bank of Montenegro partners with Ripple for CBDC Pilot

The Central Bank of Montenegro (CBCG) is teaming up with Ripple to develop a central bank digital currency (CBDC) pilot program, even though it already uses the euro. The CBCG will create a design to simulate the CBDC's circulation and identify practical applications, with the project focusing on "the protection of end users’ rights and privacy," according to Governor Radoje Zugic. Although Montenegro is not an EU member, it uses the euro, and the ECB and EU are expected to make a decision on the digital euro in 2023.

Societe Generale subsidiary Forge issue Euro stablecoin on Ethereum

Societe Generale's crypto arm, Forge, announced plans to launch a euro stablecoin called "CoinVertible" (EURCV), a euro-pegged ERC-20 token, on the Ethereum blockchain. The stablecoin is based on the Compliant Architecture for Security Tokens (CAST) framework and will offer "robust" settlement options for on-chain transactions, on-chain liquidity, and a solution for intra-day liquidity needs. The euro stablecoin market on Ethereum is relatively small compared to the US dollar stablecoin market. CoinVertible will be listed on exchanges and third-party platforms in the coming months. Additionally as per @etheraltog on Twitter, the address (an EOA) that registered EURCV.eth ENS domain also registered other popular FX currencies such as usdcv.eth, gbpcv.eth, jpycv.eth, and chfcv.eth hinting that EURCV will not be the only one. Furthermore some security analysts were quick to point out that the token has a function that allows Societe Generale to transfer and even burn your funds from external wallet whenever it wants. Makes you wonder what’s the point of launching a token on permissionless blockchain like Ethereum if it is coded to be controlled by the issuer? 

On-Chain Metrics & Data

Bitcoin Update

While March had the mempool filled close to ATH, in April it drastically came down while recording a short lived rebound and is now starting to increase again at a more rapid pace with Transaction (Tx) fee getting expensive while the mempool is only half of what it was in March. The question is: what is pushing the increase in Tx fee, Ordinals or purely send/receive Txs? 

Let's find out what insight on chain analytics can uncover. 

March saw the creation of the BRC-20 standard by Domo, so that Ordinals issuance and transfer could be facilitated while allowing them to become fungible akin to Taro but not on LN. Usage started slow, but now it drives a considerable amount of Txs in Bitcoin blocks while increasing the fee per byte rapidly as shown above.   

Analytics show that Ordinals, both BRC20 and non-BRC20, are adding transactions in blocks on top of the usual 400,000 Txs that Bitcoin records on a daily basis. On April 30th, Ordinals inscription represented 50% of the total Txs.  

This means that a non-negligible portion of fee received by miner are being paid by people minting and transferring ordinals. Those fees are totaling ~$8M as of this writing or 284 bitcoin, with daily USD fees reaching a high of $800,000 or 28 bitcoin.

To that we add the analysis proposed in March’s DeFi Research News, coming from 

the excellent thread from Timothy Peterson (@nsquaredcrypto) explaining that the reason for the high number of transactions waiting to be processed in Bitcoin's mempool may be because people want to move their Bitcoin into self-custody wallets ‘urgently’. This is supported by the data from ‘1 to 3 months hodl curve’ which gained 2% (from 5.6% of bitcoin supply to 7.6%).

Ethereum update

State of Ethereum

In the State of Ethereum report for Q1 2023 by Messari, it was noted that the crypto market had recovered from its previous turmoil. Ethereum's decentralized financial infrastructure and neutral stateless money were seen as important solutions during the turbulence in traditional finance. Across the Ethereum ecosystem, DEX volumes, NFT volumes, and total value locked saw significant growth. Stablecoin supply fell by $13 billion, with USDC briefly depegging, and Paxos announcing the discontinuation of BUSD under regulatory pressure. Layer-2 solutions, such as Arbitrum and Optimism, continued to boom, contributing 45% of transactions across Layer-1 and Layer-2. 

Shapella hard fork finalizes, enabling withdrawals for Ethereum stakers

The Ethereum network has completed its transition to a full-featured Proof-of-Stake (PoS) network with the activation of the Shanghai/Capella (Shapella) upgrade. The most significant update enabled the withdrawal of ETH from the staking contract, which has resulted in a net outflow of 320,000 ETH from the contract, with a gross total of around 2 million ETH withdrawn since the upgrade. 

There are two types of withdrawals - 

• Full or principal withdrawals - When a validator decides to stop validating on the Ethereum network, they can withdraw their entire staked amount of 32 ETH along with any staking rewards they've earned. This process is known as a full withdrawal and requires the validator to enter a withdrawal queue, which takes a minimum of approximately 27 hours to complete.
• Partial or rewards withdrawals - Upon updating their withdrawal credentials, validators automatically receive staking rewards from the network. This distribution is mandatory because Ethereum considers a fixed amount (32 ETH) as the effective stake per validator, irrespective of the actual amount staked.

Within the first hour of the hard fork, a total of 12,859 Ether were unlocked in 4,333 withdrawals, according to Ethereum block explorer beaconchai.in. The majority of withdrawals at this time range between 2.8 to 3.2 ETH, which suggests that it’s mostly staking rewards that are being withdrawn at this time. After all, the average price of staked ETH is $3,149 and it could be another reason why validators are not withdrawing the whole amount. The ETH price is currently trading just under $2,000 with the price acting as key resistance, so maybe it's better to hold on to some chips for now. The next upgrade is Cancun/Denneb, which is expected to reduce transaction costs on rollups by 10-100 times. 

Centralized exchanges have played a significant role in the withdrawals of Ethereum, with 82% of the total ETH withdrawn being from these exchanges. Kraken is the largest contributor, accounting for 48% of the ETH withdrawn. It had to stop its staking program in the US due to a settlement with the Securities and Exchange Commission. Binance and Coinbase follow Kraken, accounting for 18% and 11% of the full withdrawals, respectively.

It is worth noting that Lido, which is the biggest provider of staking services, does not allow full withdrawals. Despite this, the value of their derivative product called Lido-staked ETH (stETH) suggests that there is no significant pressure for people to withdraw their funds.

Ethereum DEX Volume Dominance Decreasing

Ethereum's position as the king of decentralized exchange (DEX) trading is starting to wane. This is because other Layer-1 DeFi ecosystems have become more popular and there have been market downturns. The decline of Ethereum's dominance in DEX volumes began in 2021, but reversed in March 2023 during the USDC depeg, when it reached 80% dominance. However, following the event, volumes are moving away from Ethereum again, and this trend is likely to continue with the maturation of Ethereum's Layer-2 DeFi ecosystem. Users who move from Ethereum mainnet to L2 DEXs are less likely to return to Ethereum than those who leave for alternative L1s because L2s inherit their security properties and base asset from Ethereum.

A look at the top DeFi protocols based on the revenue generated

And finally let’s look at the top 5 DeFi/NFT protocols/ecosystems with the most fees generated over 30 days, which generally translates to the most active protocols. In some cases, the protocols take a % of the fee as revenues (eg. Lido Finance) in other cases its distributed almost entirely to the Liquidity Providers Stakeholders (eg. Uniswap Liquidity Providers) hence their revenue varies based on such parameters. 

Here are the top 5 protocols for the month of March:

Four out of the top 5 protocols from March have continued to stay in the top 5 in April as well. OpenSea gained a few spots kicking dYdX from the 5th place. 

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