DeFi Outlook: Overview of Mainstream DeFi Protocols Q2 Progress

Original Title: 《Q3 Protocol Outlooks》

Author: Rasheed Saleuddin, Blockworks

Compiled by: Kyle, DeFi Path

Key Points:

• We expect value to flow into DeFi protocols that generate revenue for the remainder of the year.
• With the launch of Fraxlend and fraxETH, Frax has the potential to gain more market share. So far, the protocol has generated $36.3 million in revenue.
• Synthetix and GMX continue to dominate perpetual trading volume and TVL on Optimism and Arbitrum, with daily revenue of approximately $100,000 to $300,000 per protocol.
• dYdX (DYDX) and Uniswap (UNI) are expected to make significant progress in the appreciation of their tokens.
• The announcement of crvUSD and GHO marks a potential new narrative around stablecoins specific to certain protocols. Among other features, native stablecoins allow protocols to generate additional revenue and enhance the utility of their governance tokens. Curve is optimized to provide deep stablecoin liquidity, making it likely to become a battleground for this narrative.

Our Q2 final report focuses on the evolution of DeFi assets during the bear market and explores the future developments of major protocols.

From the era of Maker's dominance, to the DeFi summer led by Synthetix and Compound, to the false hopes of "DeFi 2.0" and "unstable" stablecoins, and now to the revival of OG primitives, DeFi has been a long struggle. During that time, TVL was used as the best metric for measuring success.

As users were attracted by unsustainable inflationary native token rewards, TVL lost its usefulness as a product-market fit (PMF) metric. Users joined projects to farm and dump their rewards. Once rewards slowed or stopped, users left. The drop in token prices meant that promised APYs became unattainable.

One project paid out 14.7 times its initial allocation within the first five months after launch, driving TVL to an all-time high in 2021. As the rate of token release fell to double-digit annual inflation rates, TVL fled. By the end of Q2, monthly rewards had dropped 99% from a high of $20 million per month to $200,000.

Source: DeFi Llama, Coingecko. July 31, 2022

PMF can be better measured by the fees users are willing to pay for services. Temporary rewards can help lower customer acquisition costs, but protocols need users to stick around after rewards end.

While few protocols currently provide real value to protocol treasuries or token holders, users pay to borrow and trade tokens, bribe liquidity pools, and invest outside of DeFi. Users also earn real fees through ETH staking and minting taxes. Uniswap, dYdX, Convex, Frax, Aave, GMX, Synthetix, Curve, and MakerDAO all rank in the top 20 for DeFi fees.

Growth stocks rarely (if ever) pay dividends. Early crypto protocols may similarly consider accumulating and reinvesting fee revenue to grow their businesses. Total fees will continue to be a key metric in terms of token holders' rights to eventually profit from the successful enterprises they support, regardless of whether their revenue is paid out or reinvested.

We believe the next bull market will be driven by tokens that have current or future value appreciation. In this report, we present the latest news and bull cases for protocols we believe are critical to the future of DeFi. All covered protocols have proven product-market fit (PMF) and earn real fees from real users.

Lending

Aave

Aave launched its V3 product on six different chains at the end of Q1 2022, bringing some key new features to the market:

• Portals are "permissioned listing" bridges that facilitate cross-chain transactions, allowing assets to flow seamlessly between Aave V3 markets deployed across different chains. They help address the issue of fragmented liquidity.
• The efficient mode (e-mode) allows users to achieve higher borrowing capacity within the same asset class, enabling borrowers to maximize returns from collateral.
• The isolation mode allows Aave governance to isolate certain newly listed tokens and determine maximum loan-to-value ratios, thereby limiting the protocol's exposure to high-risk assets.
• Gas optimization features reduced transaction fees by 20-25%.
• L2-specific features enhanced the user experience of Ethereum scaling solutions.

Aave V3 now sees more DAUs than Aave V2:

Looking ahead, all eyes are on Aave's recently proposed stablecoin: GHO. The vote to issue the GHO stablecoin passed with overwhelming support on July 31. This stablecoin will allow Aave users to mint GHO using their collateral, which continues to earn interest. This could be a massive revenue opportunity for Aave DAO, with 100% of borrowing income going to the Aave treasury. Common concerns on the Aave forum include the need for proper vetting of potential facilitators (i.e., those with GHO minting/burning privileges), the importance of a peg stability module (PSM) similar to MakerDAO, controversies around DAO control of interest rates, the significance of a supply cap to avoid risks to the Aave protocol, and the risks involved in using Chainlink oracles to track GHO prices. The GHO smart contract is currently undergoing an audit, after which a separate proposal will be put forward outlining a strong initial state for GHO.

MakerDAO

Maker has made significant progress on its real-world asset strategy, deciding to allocate $500 million from the PSM to short-term government bonds and corporate bonds, and partnering with two major institutions:

• Societe Generale for the tokenized collateralized bond refinancing worth $30 million DAI.
• Huntingdon Valley Bank for a loan partnership of up to $1 billion DAI, expected to generate $30 million in protocol revenue annually.

This continues to form two camps to address their governance issues: the camp that seeks decentralization at all costs, and the camp that supports a board-style governance structure for efficiency and growth. The governance vote for the Lending Oversight Core Unit had the highest participation rate in its history, with over 293,911 MKR tokens participating, valued at approximately $300 million. The vote rejected the implementation by a margin of 60% to 38%, suggesting support for a more decentralized governance structure.

Maker remains one of the leading protocols in DeFi, maintaining the highest TVL among all DeFi protocols at approximately $8.5 billion. As a lending platform, Maker is well-positioned to meet the significant demand for leverage in the cryptocurrency market. This typically corresponds with the expansion and contraction of DAI supply. Although DAI supply decreased by 27% in the first half of the year, it has since been expanding. Much of the rise in early July was due to the growth of the PSM, but since July 27, $150 million in DAI has been minted from non-stablecoin collateral as market demand for leverage slowly recovers.

Maker will also continue to prioritize RWA as it enters H2 and its long-term vision for the protocol. They believe that creating a "Maker standard" for incorporating real-world collateral into DeFi will position Maker as a leader in market share for RWA and create a playbook for other DeFi protocols to begin incorporating them. Teej, a member of the Real World Finance Core Unit, believes that after securing funding from the SME lending platform Monetalis Clydesdale and the Swiss bank Backed Finance, which aims to tokenize short-term bond ETFs, RWA could account for 10% of total collateral and a 10x surplus buffer, compared to the current 2% of total collateral and a 2x surplus buffer. The increasing RWA, combined with Maker's flagship crypto lending product, provides a very reliable revenue stream.

Derivatives Trading Platforms

dYdX

dYdX is a decentralized exchange for trading perpetual futures. In Q2, dYdX improved its user experience and feature set. New assets listed include TRX, XTZ, ICP, CELO, RUNE, LUNA, NEAR, and ETC, with governance proposals to add 15 more. The rapid listing of tokens has positioned dYdX to compete with any perpetual futures exchange in terms of supported asset sets. New order types and higher maximum position sizes provide the tools needed for large funds and traders to migrate to dYdX. Trading fees have been broadly reduced, and as of August 1, fees have been completely waived for users with monthly trading volumes below $100,000. Additionally, they launched their own iOS app to provide a seamless mobile trading experience.

dYdX has a complete roadmap. By the end of 2022, dYdX plans to migrate from Layer 2 ZK-Rollup to its own sovereign PoS chain built using the Cosmos SDK. Order book storage, matching, and validator sets will be decentralized, increasing the protocol's resistance to censorship. The DYDX token will have a new value appreciation mechanism, as a PoS token, with trading fees distributed to stakers. There are some obvious challenges ahead, but dYdX is fully positioned as a leader in the on-chain derivatives narrative and seems to be gaining momentum.

GMX

GMX is a spot and perpetual exchange that supports low swap fees and zero price impact trading on Arbitrum and Avalanche, continuing to gain adoption throughout Q2 despite the overall market slump. Trading is supported by a multi-asset pool (GLP) that earns LP fees through swaps, market making, and leveraged trading. It has become the largest dApp on Arbitrum, with approximately $300 million in TVL, and continues to gain traction on Avalanche with less than $100 million in TVL. Some highlights from the last quarter include:

• On June 28, a record 7,273 new users surged in, possibly driven by the Arbitrum Odyssey event (which has been postponed).
• Surpassing 63k unique users.
• Over $50 million in trading fees generated for LPs.
• Historical trader PnL or partial LP income now stands at $36 million.
• An average of about 1,000 DAUs, compared to 150 last year.

Source: https://stats.gmx.io

Investors expect GMX to add some significant new features in the second half of 2022, in addition to UI polish and platform reliability. Synthetics are expected to launch in the coming months, providing traders using the product with more options. After this release, the GMX team will begin deploying on other chains and X4: an AMM designed to provide greater flexibility for pool creators and projects in their pool functionalities. In standard AMMs, pool creators have few customization options. The GMX team believes they can outperform existing AMMs in this regard and capture a significant market share. Some interesting features include dynamic fees for pools, allowing traders to access custom price curves for various tokens, pools with yield tokens, or aggregating trades through other AMMs like Uniswap V3. GMX's plans are ambitious, and they aim to build an AMM that becomes a platform for other projects to leverage or even build upon.

Synthetix

In Q2, the rise of atomic swaps on Synthetix allowed for instant execution of trades involving synths without slippage. Atomic swaps, which offer better prices than direct pair trading, have daily trading volumes of up to $350 million. As Q3 begins, atomic swaps remain a primary revenue source for Synthetix.

While 1inch has been a major source of demand for atomic swaps, they still missed a trading routing route: users can swap from USDC -> sUSD -> sETH and vice versa, but the last step of sETH -> ETH must be done manually. 1inch will soon add this last step to its router, meaning we can expect more routing through synths, allowing SNX stakers to earn more revenue. Additionally, other aggregators have begun implementing atomic swaps, including OpenOcean, which has already routed ETH -> USDT using synths. With Curve announcing their OP grant proposal, we can expect to see atomic swaps used for Optimism as well. We anticipate that atomic swaps will continue to be widely used for routing order execution in Q3.

The Synthetix ecosystem has also seen tremendous growth on Optimism, primarily due to Kwenta's perpetual futures daily trading volume exceeding $80 million. Perpetual trading on Kwenta will upgrade to V2, significantly reducing fees in the second half of this year, with more markets available. V2 also includes mobile UI support, cross-margin trading, limit orders, stop-losses, and the launch of the KWENTA token (along with potential airdrops for traders). SIP-254 also proposes allocating 20% of SNX inflation to reward perpetual traders on the platform, further incentivizing traders to use Kwenta as their platform of choice.

Since our recent research report, Synthetix has made several key advancements in vision and upgrade implementation. Synthetix intends to launch "liquidity as a service," allowing anyone creating new derivatives to quickly increase liquidity by directly connecting to synths, leveraging existing routing and deep liquidity. This also includes a new proposal enabling the protocol to take ETH delta-neutral positions to allow for the expansion of sUSD and other synth supplies to meet demand fully. Voting-staked SNX will bring higher token inflation and fee revenue to those who lock SNX for longer periods. There are also some more significant SIPs related to V3 that are inherently more technical, which may indicate that V3 is very close to code audit and release.

Stablecoins

Frax

Frax has further integrated into the Curve ecosystem through several new mechanisms and introduced some products set to launch soon:

• Frax Base Pool: A new stablecoin pool that pairs with Curve to drive more demand for FRAX and encourage capital efficiency for partners.
• Frax whitelisted for locking CRV: Curve passed a proposal allowing Frax to vote-lock its CRV tokens used for veCRV, granting Frax greater governance power over Curve.
• Fraxswap: Frax launched a new DEX that allows users to time-weight purchases of various assets over a period to reduce price impact. This primitive may be very useful for protocols looking to manage their treasuries.
• $20 million FXS buyback: Frax is currently using accrued revenue to buy back FXS tokens on the open market. The FXS will be burned or distributed to veFXS holders. $2 million of FXS has already been purchased.
• Fraxlend: Frax plans to launch a new lending dApp that will support permissionless lending pairs and custom debt structures, paving the way for real-world asset lending, bonds, and under-collateralized lending.
• FraxETH: Frax revealed it is running two validators on the beacon chain. Frax plans to create an ETH collateral derivative (fraxETH) to support its treasury and create new ETH products. We can assume that all proceeds from fraxETH will somehow benefit veFXS holders.

In the second half of this year, Frax's FXS token may see a significant surge due to the launch of new products. After nearly halving earlier this year, FRAX supply is slowly rebounding, ultimately bringing more value to FXS. Since the launch of Frax Base Pools, the supply of FRAX has increased by approximately $100 million. Currently, Frax's treasury holds $36.3 million in accrued profits. Fraxlend and Fraxswap open up the possibility of generating more revenue for the protocol, which will benefit FXS holders in the long term.

Fraxlend will mark a milestone for the protocol, serving as a complete suite of decentralized banking service software, including AMM, lending platforms, and stablecoins. The protocol plans to launch fraxETH collateral on day one, allowing users to borrow FRAX against their staked ETH collateral. Fraxswap adds two new liquidity pairs, FRAX/SYN and FRAX/OHM, which can bring more trading volume to the AMM. The synergy between Frax, Curve, and Convex offers attractive yields for participants looking to access their product suite.

Decentralized Exchanges

Curve and Convex

Both Curve and Convex felt the pain of the bear market in Q2. Last quarter we saw:

• Over $1.3 billion in UST deposited into Curve, leading to a 76% contraction in TVL for both Curve and Convex.
• The launch of Frax Base Pools and the approval of FIP-95 deepened the ties between Frax, Curve, and Convex. Based on the current cvxCRV price, Frax will swap up to 95% of CRV rewards for cvxCRV through Curve pools or deposit CRV directly into Convex, stabilizing the cvxCRV peg.
• Convex unlocked a record 27.5 million vlCVX on June 30. While traders heavily shorted CVX during the event, most of the CVX was immediately re-locked, causing a temporary short squeeze. Notably, the Terra wallet re-locked its CVX, opening the door for new stablecoins in the Terra ecosystem.

Curve is launching a native stablecoin (crvUSD), with founder Michael Egorov stating that the coin will be over-collateralized and feature a revolutionary liquidation mechanism. The white paper has not yet been released, so we can only speculate on its design and implications.

Developers closely associated with the protocol indicate that LP tokens and CRV could serve as initial collateral for crvUSD. The specific assets backing the stablecoin are crucial to its success, so Curve may whitelist accepted collateral through a process similar to its introduction of new metrics. Convex currently holds 53.9% of the voting power in Curve, so the approved LP tokens are likely to be Convex LP tokens rather than Curve LP tokens, benefiting both protocols. Convex is also able to whitelist cvxCRV, and additional utility will help strengthen the cvxCRV/CRV peg and increase the amount of CRV permanently locked in Convex. If CRV must first be vote-locked as veCRV to qualify as collateral, Convex still holds a strong position with over $360 million in veCRV in its treasury. Convex can use its veCRV to mint crvUSD and begin farming its own CRV. The new revenue streams generated CRV can be permanently locked as cvxCRV and paid to Convex LPs and vlCVX vaults, enhancing Convex's value proposition while benefiting the Curve ecosystem by reducing supply.

While LP token collateral creates demand for asset deposits and increases Curve's TVL, CRV and veCRV collateral will remove CRV from circulation, which is essential for Curve's sustainability. The total amount of locked CRV has steadily increased throughout the year to 41%, with an average lock time of 3.6 years. Additionally, the release rate of CRV decreases by 15.9% annually, with the next reduction occurring on August 14. The increased demand for locked CRV and the reduced supply of CRV create a bullish environment for CRV for the remainder of 2022.

The announcements of crvUSD and Aave's GHO stablecoin mark a potential new narrative around stablecoins specific to certain protocols. Among other features, native stablecoins allow protocols to generate additional revenue and enhance the utility of their governance tokens. For example, Frax generates minting tax revenue through FRAX mining, while Aave allows stAAVE holders to pay lower interest rates for borrowed GHO. If this trend continues, many stablecoins will compete for liquidity, and Curve is likely to become a battleground as it is optimized to provide deep stablecoin liquidity. The bribery market built around Curve and Convex allows other protocols to effectively rent liquidity for their pools by leveraging CRV releases. New pools will drive increases in TVL and swaps, benefiting the Curve ecosystem. Additionally, other protocols can pair native stablecoins with Frax Base Pools on Curve (USDC and FRAX) metapools, generating FXS and CRV rewards for LPs. The fact that FraxBP has the potential to become the de facto base pool for stablecoin liquidity further solidifies the flywheel.

Uniswap

Uniswap's foray into NFTs has just begun, and there will certainly be more news in the second half of the year. In June, Uniswap Labs acquired the NFT aggregation platform Genie. This integration will enable Uniswap to facilitate trading of all digital assets, not just ERC20s. Uniswap plans to integrate with sudoswap, allowing traders to provide liquidity for their NFTs instantly.

With the addition of two new deployments in Q2, this AMM is now deployed on seven chains, including Gnosis, Moonbeam, Optimism, Polygon, and Arbitrum. Uniswap has maintained its position as the DEX market leader, with average monthly trading volumes exceeding $47 billion in Q2. Since its launch, Uniswap V3 has completed over $1 trillion in trading volume. In a short time, Uniswap's total fees have been the highest among all platforms, surpassing Ethereum and Bitcoin.

UNI governance is preparing to test the fee switch feature. On July 21, a governance proposal measuring UNI holders' sentiment on implementing the fee switch passed. While specific details have yet to be determined, a trial may soon be conducted to extract a certain percentage of swap fees from V3 LPs and reallocate them to a treasury controlled by the UNI DAO. This is big news for UNI's appreciation. We will release an in-depth look at this trial later this week.

Sushi (Sushiswap)

Sushi has been busy delivering new products. They deployed a cross-chain AMM using Stargate for bridging, released MEV-protected trades with SushiGuard, and launched MISO 2.0. Miso is an initial DEX offering (IDO) platform that allows anyone to easily raise funds for new tokens. The exchange now operates on nine chains, allowing users to trade with a single click. Sushi has launched limit order functionality and passed a proposal to restructure the DAO organization to help combat micro-governance.

Sushi is looking for new leadership ("head chef") and is hiring for numerous positions. With a new head chef and a better payment contributor mechanism, Sushi is expected to bypass the leadership controversies they have seen in the past. Like Uniswap, Sushi has also seen significant developments in the NFT market Shoyu, including rare tools, better UI, discounts, shopping features, gas efficiency, and social features.

Final Thoughts

Despite unfavorable market conditions, developers of active DeFi protocols continue to release code updates. We have listed some of the market's favorite protocols and their corresponding catalysts that may yield positive results in the future. Currently, DeFi on Ethereum continues to dominate the space. For investors, seeking revenue-generating products and tokens with appreciation potential may be a good strategy for the remainder of the year.