DeFi Research News January 2023

DeFi TVL Updates

Key DeFi Stats for January:

January was a refreshing month for DeFi TVL: It started at ~$38.8B and ended at ~$48.7B which is a 25% increase. Ethereum chain held its market share with a 58-60% of the total TVL whereas runner ups Tron and Binance chain held around 10-12% each. There was a bit more activity in the DeFi land to get the DEX volume to ~$48B over the past 30 days. Lido Finance stole the #1 spot in TVL from the long term king of TVL, MakerDAO (#1 since June 2022) with ~$7.5B over the past 30 days. MakerDAO slid into #2 spot with ~$6.9B, followed by AAVE and Curve for a tie at the 3rd place with ~$4.4B in TVL and finally Convex Finance took Uniswap over with ~$3.7B in TVL for the #5 spot.

Is stablecoin flow indicating exiting participants?

According to NYDIG Research, the inflow into funds has remained stable over the past two quarters, however, funds continue to be withdrawn from the cryptocurrency space through stablecoins. Despite some concerns regarding certain issuers, such as the Binance Dollar, it appears that the trend reflects a general exit by investors from the ecosystem. Usually, if investors were to remain in the ecosystem but wait for a trade opportunity, they would park their funds in stablecoins. However, the recent decline in stablecoin usage suggests a larger trend of capital leaving the asset class. According to NYDIG Research, the crypto market may not be considered for large investments until the balances of stablecoins stabilize. 

Specifically, this reduction in exposure is highlighted by the free float market cap continuing to decrease across the board for the top 3 stablecoins (USDC, USDT, BUSD). It shows the recent flight to safety from BUSD to USDC and USDT in the wake of recent info about BUSD being undercollateralized in the past. The overall downtrend has been at play since Q1 2022.

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Macro View

Yield Curve And The State Of Inflation

The yield curve continues to get even more inverted, suggesting a high likelihood of a recession. The St. Louis Fed recently cited data from the Philadelphia Fed showing that on average at the eve of a recession, 26 out of 50 states have a shrinking economy. As of Q4 2022, they estimated that the US has crossed that threshold:
Other chart from Lyn Alden:

China Re-Opening

China has abruptly pivoted out of its zero-COVID policy that it maintained for three years. A sharp drop in economic output combined with protests across multiple cities, seem to have convinced officials to reframe the narrative. China and the US are the two largest economies in the world, so in addition to monitoring the US business cycle in rate-of-change terms, we need to see how quickly China is coming back online. This is especially true as it relates to commodities and oil demand. At the moment, it remains unclear to what extent China will stimulate in 2023. 

Regulations Update

US Federal Bank Regulators Warn Of Crypto Custody Risks

The U.S. federal banking regulators, including the Federal Reserve, FDIC, and OCC, marked the beginning of the New Year with a joint statement cautioning banking institutions about the potential dangers of cryptocurrencies and serving crypto-related businesses. The regulators described their current evaluation process of bank proposals to participate in the crypto market as being highly cautious, indicating that it's important to prevent any risks associated with the crypto sector from spreading to the banking system. The regulators also emphasized that they have serious concerns about business models that heavily rely on crypto-asset activities or have significant exposure to the crypto sector.

EU Introduces Strict Rules for Banks Holding Crypto

The European Parliament's Economic and Monetary Affairs Committee recently voted in favor of implementing strict capital requirements for banks that hold cryptocurrencies. Under this new regulation, banks will be required to hold an equal amount of euro capital as their cryptocurrency holdings, with a 1:1 ratio. This will prevent banks from leveraging their crypto holdings, as they must maintain a comparable amount of capital in euros. Member of the EU Parliament, Markus Ferber, expressed his support for the measure, stating that it would help prevent any potential instability in the cryptocurrency world from affecting the broader financial system. The legislation has yet to be officially enacted, as it requires approval from the European Parliament.

Arizona State Senator Proposes Bitcoin as Legal Tender

Senator Wendy Rogers of Arizona proposed legislation that aims to designate bitcoin as a legal form of payment in the state. The bill allows state agencies to collaborate with cryptocurrency issuers, allowing them to accept bitcoin for paying taxes, fees, and other state-imposed expenses.

MiCA Vote Postponed to April

According to the Coindesk article, The European Union has postponed the decision on the Markets in Crypto Assets regulation until April to allow for translation into the 24 official EU languages. The regulation aims to oversee crypto-asset service providers and create a standard EU legal framework for digital asset creation and storage. Although it does not regulate decentralized finance specifically, it is the most extensive crypto regulatory framework yet. The regulations put in place for centralized issuers and exchanges are likely to shape other countries' policies on crypto.

Institutional Update

Noteworthy VC money Raised

• Ethereum restaking protocol EigenLayer is raising $50 million
• Web3 music startup Arpeggi Labs is looking to raise $11 million
• Natural gas-focused Bitcoin mining infrastructure startup Giga Energy raises $10 million in Series A funding
• Blockchain security firm Sec3 raises $10 million in seed funding
• Longevity-focused decentralized autonomous organization VitaDAO raises $4.1 million from Pfizer Ventures and others
• Bitcoin infrastructure firm Blockstream raises $125 million to expand mining services
• Crypto infrastructure firm QuickNode raises $60 million at a $800 million valuation
• Metaverse training software firm Gemba raises $18 million in a Series A
• Web3 infrastructure firm Spatial Labs raises $10 million in seed funding

Genesis vs Gemini Battle

Our CEO Max Galash wrote an article on LinkedIn providing an inside view of the mechanics behind the closed curtain of crypto shadow banking and pyramid-like relationship structures accusing the Genesis of accounting fraud that made their balance sheet appear healthier than it actually was, fraudulently inducing lenders to keep underwriting loans. The summary: Gemini loans the customer's funds to Genesis, which was lent to DCG, which was then lent to 3AC, which was invested into Grayscale Investments, which was posted as a collateral to borrow more capital from DCG to be continued. 

Digital Currency Group Update

Digital Currency Group, which is a crypto “empire” that owns Grayscale, Genesis, and a number of other subsidiaries, continues to have legal and financial questions around it. According to a Bloomberg article, US authorities are digging into the internal financial dealings of Barry Silbert’s expansive crypto empire. Their cash cow product is the Grayscale Bitcoin Trust (GBTC), which is currently trading at a 45% discount to net asset value. GBTC has over $10 billion in assets under management, and at a 2% annual fee (which is too high) it earns over $200 million per year. Valkyrie, a registered investment advisor and operator of a futures-based bitcoin ETF, has proposed themselves to become the new sponsor and manager of GBTC. 

Other Noteworthy News/Events in January

Future on CME’s Pro-shares gains inflow from Pro-shares short ETFs , showing strength from Institutional Investors

Arcane Research report shows that the net flow contribution from ProShares’ ETFs was positive. This is predominantly caused by substantial outflows from ProShares’ short BTC ETF, BITI. Interestingly, this month’s strength was accompanied by growing participation from active market participants on CME as the active market participant contribution to OI grew from 42% to 50%, while CME’s OI grew to 80k BTC. The current non-ETF contribution to CME’s OI of 50% is the highest level recorded since the FTX collapse and aligns with the highs recorded in May and June of 2022. This is the first time since March 2022 that we have seen increased direct activity in CME’s BTC futures alongside rising futures premiums. 

Global Bitcoin mining uses more than 50% renewable energy

In Q4 2022, global Bitcoin mining sustainable energy mix consumption decreased by 1% from Q3 as per the Bitcoin Mining Council (BMC) to 58.9%. Members of the BMC account for ~48.5% of the total Bitcoin Hashrate and the total sustainable energy mix consumption is 63.8% made of renewable energy. 

The data seems to show that China crypto ban (May 2021), with subsequent geographical relocation of miners led to the purge of Bitcoin miners which were using non-renewable energy as per BMC. 

Something to keep in mind is that calculation methodologies are very important as they can tell very different stories, as highlighted by the discrepancies between BMC’s vs CCAF’s and Batcoinz vs CCAF’s data.

Also, BMC’s calculation for Global Bitcoin mining sustainable energy mix is only overstated by 6.62% than the “Complete calculation (using CCAF + Batcoinz) to the credit of the BMC as they use a reporting methodology.

MANGO exploiter likely to lose the lawsuit, DAO seems to struggle to find legal footing in traditional legal system

Eisenberg, who faces criminal charges over the $114 million that he “stole” from Mango Markets on Solana, using a ‘highly profitable strategy’ had negotiated a deal with the Mango DAO to make sure they would not sue him. Members of Mango DAO had voted not to hold Eisenberg accountable in exchange for him returning $67 million in crypto. But that negotiated proposal holds no legal water, according to lawyers at Canadian law firm McMillan LLP interviewed by CoinDesk. The deal was on a smart contract created with the principals of on-chain governance in mind. This shows that a vote on a smart contract by a DAO holds no legal footing in the traditional legal system.

Intel custom ASIC chip have been deployed in Sweden and Canada by Hive Blockchain

According to Coindesk article, Hive Blockchain, a Bitcoin mining company, has implemented its first set of machines utilizing Intel's Blockscale chips. Intel advertised an energy efficiency of 26 joules per terahash for the chips in April, which may not surpass Bitmain's S19 XP series, but is competitive with or surpasses other models currently available. The Intel-powered machines, numbering over 1,500, have already been established at Hive's mining facilities located in Canada and Sweden.

NOSTR - Twitter decentralized alternative is gaining traction

Nostr is an open protocol that aims to create a censorship-resistant global social network. According to an article in Protos, Nostr is popular with bitcoiners partly because most implementations of it support payments over Bitcoin's Lightning Network. ‘Damus’, one of several Nostr projects which is Twitter-like application, just got listed on Apple's App Store after being denied 3 times. It is important to note that it is not a venture-backed startup. Instead, it’s another experiment in decentralized social networking. The app’s promise is an open social network without a central authority that makes decisions about the network’s content or who’s allowed to participate. 

On-Chain Metrics & Data

Bitcoin Update

Bitcoin relief rally happened after chopping along the $15,000 to $17,000 prices since November 2022. Macro liquidity dynamics are still not great, and so demand for bitcoin continues to be relatively weak.

“HODL Waves is a Bitcoin chart that uses blockchain data to show the amount of bitcoin in circulation grouped into different age bands. It uses different colors to show the various age bands and how the amount of bitcoin in each of the bands changes over time, creating wave-like patterns on the chart.” as per Look Into Bitcoin. It can be segmented in three time horizons: 

• Short term:  24h to 6 month waves; decreasing trend from 45% average to 20% of bitcoin current supply.
• Medium term: 6 months to 3 years waves; stable trend representing 50% of bitcoin current supply on average
• Long term: 3 years to 10+ years waves; individually decreasing since Dec 2015 and 2018, uptick since 2022, representing more than 20% of bitcoin supply.

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What does it mean? The HODL Waves chart can help us understand Bitcoin market cycles, specifically the process of older, more experienced market participants selling their bitcoin when prices are high to newer and inexperienced market participants. 

The charts clearly point out the opposite with long term hodlers continuing to accumulate bitcoin supply at the expense of inexperienced market participants.

Bitcoin Miners Update

Bitcoin Yardstick

Now lets look at another fundamental indicator that investors should be aware of; Bitcoin Yardstick = market-cap / hash-rate, normalized over 2 years of data. The Bitcoin Yardstick is a metric developed by Capriole Investments as a simple, rule-of-thumb tool for Bitcoin valuation. The Hashrate Yardstick is similar to the concept of a PE Ratio (Price to Earning ratio), except instead of stock earnings, it takes the ratio of the energy spent to secure the network in relation to Market Cap.

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Lower Bitcoin Yardstick means Bitcoin is cheaper, in turn making a better value investment. Since October we entered a prolonged low Yardstick reading, which has never happened before, and recorded its second lowest reading for the metric in all of Bitcoin's history.

In short, “this means that on a relative basis, Bitcoin is extraordinarily cheap given the amount of energy being used on what is the most powerful computer network in the world” as per Charles Edwards, founder of Capriole Investments.

Ethereum Update

Ethereum has spent its second time since the merge in the deflationary zone. Last time was November 2022. Since EIP-1559 implementation, however, Ethereum has seen a steady deflationary pressure of around -1.06% per year.

On the other hand, node operators and especially relayers are enforcing OFAC sanctions on blocks that are compliant with OFAC rules. Potentially creating an attack vector for regulators to sanction Ethereum. This past 30 days a whopping 66% enforced OFAC compliance. Back in October 2022, this was only 43%. 

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While it can be argued that this trend of centralization concerns a significant portion of the Ethereum community, it is also a crucial component if we want institutional players to participate. They are heavily regulated by AML and Anti-terrorism Financing rules and in no case would they prefer to use a chain that doesn’t censor non-OFAC compliant blocks.

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 most fees generated over 30 days, which generally translates to 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). 

OpenSea NFT Marketplace saw the highest amount of activity with $49.9M fees generated, followed by Uniswap as the leading DeFi protocol with $44.1M fees generated. Lido Finance (ETH Liquid Staking Protocol), Convex Finance (Platform to boost rewards for CRV) and GMX(Decentralized Perpetual Exchange) have generated $34.5M, $15.5M and $13.0M respectively over the same period. 

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