DeFi Research News February 2023

DeFi TVL Updates

Key DeFi Stats for February:

February was a month of stagnation and suspense for DeFi Total Value Locked (TVL). The TVL started the month at ~$48B and remained unchanged for the entire month. Ethereum chain held its dominance over the market with ~59% of the total TVL whereas runner-ups Tron and Binance chain held ~10% each. Despite the stagnant TVL, the activity in the DeFi ecosystem witnessed a surge, causing DEX volume to increase to ~$54B over the past 30 days, an 11% increase since January. Lido Finance continued its reign as the #1 spot in TVL after snatching it from the long-term king of TVL, MakerDAO, which had held the top spot since June 2022, with an impressive ~$9B TVL. MakerDAO was relegated to the #2 spot for a second consecutive month with ~$7B TVL, followed by AAVE and Curve for a tie at the 3rd place with ~$4.8B TVL and finally Convex Finance held its #5 spot after pushing Uniswap down with ~$4.2B in TVL.

Source: Token Terminal. TVL of each protocol

Macro View

The State Of Inflation

Source: U.S. BUREAU OF LABOR STATISTICS, All Items, Not Seasonally Adjusted

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The financial markets are like a seesaw right now, with improving liquidity on one end and a crummy economic cycle on the other. Better liquidity means more money sloshing around, which has caused a bit of an uptick in inflation. Recent reports show that inflation is still trending downward compared to last year, but it's higher than expected. It's like trying to keep a volleyball underwater - the moment you let go, it bounces back up. Looks like the markets have been loosening their grip on the volleyball a bit in the past few months, huh?

Global Update

Looks like China's playing a game of "now you see me, now you don't" with COVID-19! Their rapid reopening has resulted in a surge of infections, catching a population that's been cooped up with less herd immunity off guard. As a result, some countries have slapped travel restrictions specifically on Chinese travelers. But fear not, we expect these restrictions to loosen up in the coming months and for Chinese outbound tourism to gradually bounce back.

Meanwhile, Europe's economy has been weaker than an overcooked spaghetti noodle, but it seems to be hitting rock bottom now. The energy crisis has simmered down for the time being, giving Europe all of the warmer months of 2023 to prep for the next winter. Hey, maybe they could try their hand at expanding their LNG import infrastructure, coal, and other energy sources. It's all about finding those silver linings, folks!

Regulations Update

Get ready to put on your reading glasses, folks, because the regulatory section is gonna be a doozy! With all the recent regulatory actions hitting the crypto industry like a ton of bricks, it's like trying to keep up with the Kardashians - you never know what's coming next! But hey, at least we can all agree that this is one soap opera that no crypto person wants to miss, right? Here’s the TL;DR of recent regulatory actions summarized by Sam Andrew in his recent must-read article on regulatory crackdown: 

• The Fed and other federal agencies issued a new policy advising banks not to engage with crypto companies.

• Paxos confirmed the SEC is investigating its issuance of stablecoins. 

• The New York Department of Financial Services ordered Paxos to cease issuing the Binance stablecoin. Paxos abided. 

• The SEC charged Terraform Labs and its founder with securities violation. The indictment argues that the stablecoin UST is a security. 

• The SEC charged Kraken with selling unregistered securities as part of its staking business. Kraken immediately shut its US staking business and paid a fine. 

• The SEC proposed a major revamp of asset custody rules. If passed, institutions would struggle to buy crypto. 

Banking restrictions for crypto companies 

It seems like US crypto companies are the black sheep of the financial sector. The collaborative policy specifies that state banks must refrain from engaging in any activities that are prohibited for national banks. This is to prevent state banks from participating in risky crypto ventures that could pose a threat to the stability of the US banking industry. Violation of federal laws by state banks engaged in crypto-related transactions could lead to the termination of their FDIC insurance and/or Federal Reserve access, which would be a major issue for these banks. As a result, crypto businesses are being increasingly excluded from the US banking system, and relationships between the two are deteriorating.

Stablecoins being deemed securities 

Asset-backed stablecoins, as a category, are not subject to the same argument put forth by the SEC regarding UST being a security. On February 16, 2023, the SEC charged Terraform Labs and its founder Do Kwon with “orchestrating a multi-billion dollar crypto asset securities fraud.”

However, it seems Paxos has landed itself in hot water, with news breaking that they received a Wells notice on February 3, 2023, alleging that BUSD is a security and should have been registered under federal securities laws. While the SEC is considering action, Paxos appears to be at odds with the claims. As if that wasn't enough, the New York Department of Financial Services delivered another blow to Paxos on February 13, 2023, ordering them to halt BUSD issuance - talk about a bad day at the office!

Proposed custody rules that cut off institutions from crypto 

On February 15, 2023, the SEC announced a proposal to amend existing rules for Registered Investment Advisors. Registered Investment Advisors are required to have custody of the “securities and funds” they manage on behalf of their clients with “Qualified Custodians.” Qualified Custodians are vetted entities that hold client “securities and funds” in segregated accounts among other things. The proposed rule change would expand “securities and funds” to “any client assets of which an adviser has custody.” including crypto. SEC Chairman Gensler said:

“the current business model in crypto exchanges does not meet the qualified custodial standard.”

So if RIAs can’t interact with centralized exchanges, they can’t trade crypto, which means they won’t offer it to their clients. From SEC’s viewpoint, they might be thinking about this from TradFi's perspective. The regulation of custody and trade execution functions in US equity markets is divided between separate entities that are subject to regulatory oversight. Conversely, in the crypto space, centralized exchanges typically handle both custody and trade execution services. The SEC's proposal seeks to address concerns related to customer fund manipulation and bankruptcy claims, which is certainly a welcome move. But one can't help but wonder - will this new approach prove to be the solution the crypto industry needs, or will it create new challenges to navigate?

Staking services considered securities offerings

The SEC charged Kraken on February 9, 2023, with “unlawful offer and sale of securities” in violation of the Securities Act of 1933. Kraken’s staking-as-a-service product constituted the sale of unregistered securities. Kraken agreed to immediately terminate its US staking business and settled the charges by paying a $30 million fine. Here’s why Kraken’s service falls under securities law: Kraken advertised a program where people could invest their money and get back returns of "up to 21%." Kraken was in charge of the program and kept clients' money safe. They combined everyone's money together in a pool. Even though the rewards could change, Kraken paid a set amount. They also paid interest at a certain time, even if they didn't receive rewards yet. Lastly, Kraken made sure there was a pool of tokens that could be used to take money out of the program whenever anyone wanted. Remember “invests money in a common enterprise and reasonably expects profits or returns derived from the entrepreneurial or managerial efforts of others,” the offering constitutes a securities contract. Kraken is the common enterprise. Clients expected a return from Kraken’s efforts. So let's take a deep breath because it turns out that the panic over the SEC cracking down on staking was as overblown. That's right, staking is still alive and kicking, whether you prefer to stake your crypto with the centralized bigwigs at Coinbase or roll with the decentralized protocols like Lido and Rocket Pool.

Charlie Munger Wants To Ban Cryptocurrency

Charlie Munger, one of the smartest investment polymaths in modern history, is back at it again with his opinions on bitcoin and cryptocurrency. He's advocating for an outright ban on crypto in the United States and even giving props to the Communist Party of China for their own ban. But, let's be real here, has he done the required able to discuss the implications of bitcoin’s utility? Has he heard of Segwit and Taproot soft-fork updates to Bitcoin, or is he too busy hoarding his bags of cash? Does he have an opinion on appropriate block size and the associated discussions around decentralization, or whether the base layer should be Turing-complete? Can he articulate key technical differences between BTC, ETH, SOL, and AVAX? Is he familiar with the usage of bitcoin, stablecoins, and related assets by people in war-torn, authoritarian, and/or persistently inflationary developing countries to preserve and/or move some of their purchasing power? Probably not, eh?

Institutional Update

Coinbase launches an Ethereum Layer-2 blockchain

Did you hear the news? Coinbase just announced that they're launching their own blockchain! According to their blog, Base is a secure, low-cost, developer-friendly Ethereum L2 built to bring the next billion users to web3. Base will serve as both a home for Coinbase’s on-chain products and an open ecosystem where anyone can build. They are collaborating with Optimism team to use their tech stack to build this rollup. Talk about the world's first public company to launch its own permissionless decentralized blockchain. They're not just launching a blockchain, they're launching a token too! Just kidding, they explicitly said they're not doing that, but of course, crypto markets never let facts get in the way of a good pump. So a completely unrelated token called BASE token shot up like a rocket from under a dollar to over $7!

source: Coinmarketcap

So how else will Coinbase make money from this? Jesse Pollack, Senior Director of Engineering at Coinbase recently joined the Bankless podcast to explain this. You can watch it at this time stamp to skip to the answer. Long story short, Coinbase will offer easy to use and trustworthy User Interface for the DApps built on Base.

Noteworthy VC money Raised

• Galaxy Digital closes $44 million acquisition of self-custody platform GK8
• Abu Dhabi starts $2 billion initiative to back Web3 startups
• Bitcoin mining consulting firm Sabre56 raises $35 million to build 150MW of hosting sites
• DeFi yield startup Affine Protocol raises $5.1 million in a seed round
• Multichain wallet Blocto closes a Series A funding round at a valuation of $80 million
• Chaos Labs raises $20 million in a seed round led by Galaxy Digital and PayPal
• User privacy Web3 dapp ecosystem Beldex raises $25 million
• Indian Web3 gaming studio Kratos raises $20 million seed round at a $150 million valuation
• NFT trading platform Blur set to raise at a billion dollar valuation
• NFT animation shop Superplastic raises $20 million from Amazon, Google, Animoca Brands and others
• White label blockchain node staking-as-a-service firm BlockJoy raises $12 million
• Solana-based crypto payments platform TipLink raises $6 million in seed funding
• Kaito AI raises $5.3 million to build ChatGPT-powered search engine for crypto
• Digital asset firm Taurus raises $65 million in a Series B round led by Credit Suisse
• Digital assets protection firm Coincover raises $30 million

Other Noteworthy News/Events in February

Galois Capital closed down due to $40M loss to FTX bankruptcy 

According to Coindesk, Galois Capital, a major player in the crypto investment world, has shuttered its doors after experiencing significant losses in the collapse of the FTX crypto exchange. With a sizable $40 million of its capital trapped at FTX, Galois was forced to sell its bankruptcy claims for a fraction of their original value, ultimately resulting in the decision to return the remaining funds to investors. The news of Galois Capital's demise is sending shockwaves through the crypto community, as the loss of such a significant player is sure to have a ripple effect on the industry as a whole. As the world of crypto continues to evolve and change, stories like this remind us of the risks and rewards that come with investing in this exciting and unpredictable world.

One of Bitcoin’s most prolific contributors steps down

Bitcoin Core maintainer Marco Falke has announced his intention to step down, adding to a growing list of notable Bitcoin developers who have recently reduced their roles or stopped all contributions, often citing stressful environments and social harassment. This harassment is likely coming from Craig Wright followers that try to evangelize and harass everyone against their guru’s opinion i.e Craig Wright = Satoshi Nakamoto. This raises important questions about Bitcoin Core’s technical progress and the funding of its development The need to fund the development and maintenance of a public good like Bitcoin is becoming increasingly topical, as part-time work on the complex codebase is difficult to achieve. Sponsoring Bitcoin Core developers has been the first and most convenient way to support the technology and, in the case of Marco Falke, he was previously sponsored by grants from the VC firm Paradigm and the exchange Okcoin. But there is still much to be discussed in terms of allocating resources so that Bitcoin Core developers can work in a good environment while ensuring the continued progress of the cryptocurrency.

On-Chain Metrics & Data

Bitcoin Update

Although the total weight of the mempool has decreased since the beginning of February, it remains multiples higher than during January. The weight of the mempool refers to the Bytes size of all Tx pending on Bitcoin.

The increase corresponds to high competition for block inclusion because of Ordinals protocol. This protocol allows anyone to inscribe NFTs into satoshis on Bitcoin by leveraging taproot, a major Bitcoin upgrade since SegWit in 2017. Ordinals protocol has receive a lot of criticism from both thought leaders and critics of Bitcoin.

Confirmation that this increased activity came from an inscription on Bitcoin is this chart from Pierre Rochard, Research Director at Riot Blockchain. The craze has subsided with Ordinals utilization not filling up the blocks anymore.

Can we infer long-term benefits to miners' revenue if Ordinals utilization remains high?

Hard question to answer, but the change will not be meaningful as during the top of the craze mid-February, the Tx fee from Ordinals amounted to less than 0.6% worth $170k at the time, and is now hovering around 0.15%. The positive outcome for miners might come in with renewed interest for MEV (Maximal Extractable Value) on Bitcoin and Lightning Network.

Bitcoin Miners Update

Bitcoin Difficulty Regression Model

The Bitcoin difficulty regression model “is an estimated all-in-sustaining cost of production for Bitcoin. It considers Difficulty as the ultimate distillation of mining 'price', accounting for all the mining variables in one number. Thus, the value reflects an estimated average production cost for BTC by the mining industry, without requiring a bespoke breakdown of mining equipment, power costs, and other logistical considerations.” as per Glassnode. 

The oscillator in red/green shows the cyclical nature of Bitcoin production ‘price’. While in the green zone, it is expensive for miners to continue operating with difficulty on average adjusting downward, in red it is cheap for miners to operate hence more miners come online driving the difficulty higher.

Recent bankruptcy filings from well known miners like Argo Blockchain or Core Scientific are examples of the cyclical nature of bitcoin production ‘price’ and its impact on miners. 

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Source: Glassnode

Ethereum Update

ETH continues to be deflationary, currently at -0.084% annually. This is an incredibly bullish indicator for ETH to be deflationary even in a low-activity environment. Once the activity picks up, it is estimated to be even more deflationary. With Coinbase building its own rollup on Ethereum, the ecosystem is bound to benefit from the network effects of all Coinbase users. Price action-wise, it has been relatively flat, hovering around $1500. Meanwhile, the post-merge OFAC-compliant blocks have gone down from 66% in January to 47% in the past 30 days. 

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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). 

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

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Compared to the top 5 for the month of January: 

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Four out of the top 5 protocols from January have continued to stay in the top 5 in February as well. However, Blur NFT Marketplace, launched as a no-fee non-fungible token (NFT) marketplace targeting "pro" NFT traders, stole the show from Opensea. 

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