TokenDance Voice of Chinese: How to Find a Bird's Eye View to Observe On-Chain Dynamics?

Author: TokenDance builder mercury

TokenDance: Committed to bringing 100,000 professionals from large companies into Web3 over the next five years. TokenDance's Voice of the Chinese Community is published weekly, featuring interviews with Chinese Web3 practitioners and entrepreneurs from around the world to understand the thoughts, actions, and local Web3 development levels of Chinese Web3 builders, spreading ideas and inspiring innovation.

This issue's special guest is Jarseed: As an on-chain data researcher who entered the crypto industry in 2018, he has in-depth research on public chain underlying nodes, data structures, quantitative analysis, and DeFi. On the evening of March 26, 2023, he gave a presentation in the TokenDance community on the theme of "How to Find a Bird's Eye View to Observe On-Chain Dynamics." Jarseed shared insights on several topics, including perspectives and dimensions related to public chains, DeFi iterations, and paradigms. This article is a review of the highlights.

Perspectives and Dimensions of Public Chain Portraits

For an industry, data can be considered the most direct reflection of its health status.

In summary, analyzing on-chain data is highly beneficial for investors, developers, and project parties. It allows us to gain insights into market trends, enabling more informed investment decisions; secondly, by deeply understanding project data, we can more accurately assess project value; additionally, analyzing on-chain data helps identify new investment opportunities, giving us an edge in fierce market competition.

The Web3 industry is characterized by data transparency, making it easier to obtain data compared to other industries.

To glimpse on-chain dynamics, we need to utilize some data analysis tools, such as Dune Analytics.

Dune Analytics specializes in blockchain data analysis and visualization, particularly for the Ethereum network. It provides us with a platform to easily query, analyze, and visualize on-chain data, thereby gaining insights into the health of blockchain networks and market trends. Dune Analytics includes many preset data dashboards covering areas such as decentralized finance (DeFi), non-fungible tokens (NFTs), and stablecoins. Moreover, you can create your own custom data dashboards to meet your specific needs.

So, what perspectives and dimensions do we have to understand a public chain's portrait?

1. Discovering Hot Protocols from User Interactions

In the blockchain field, by analyzing on-chain data, we can gain insights into what operations and interactions different users are engaged in.

The above image is a screenshot from Dune. This data indicates that there have been a total of 10,769 interactions with this tester, which refers to the USDT protocol, and we categorize it under stablecoins.

Recently, the airdrop from Arbitrum attracted a large influx of users, and some who missed the airdrop turned their attention to other projects like ZkSync and StarkNet. During this process, the protocols that users interacted with can reflect the market hotspots.

By summarizing new user interactions daily, we can find that many people are interacting with stablecoins, buying, selling, or transferring, while projects like StarkNet and ZkSync have also become focal points for many users. At the same time, areas like DeFi, NFTs, and entertainment have attracted a large number of users. In this context, about a quarter of users are distributed across centralized exchanges.

For veteran users, their interactions with protocols are more mature. Although there is a significant difference in interaction volume between new and old users, overall, veteran users tend to interact more with stablecoins and DeFi. Of course, many are also starting to pay attention to and interact with projects like ZK sync and Stock net.

In the DeFi sector, Uniswap has a very high number of transactions, occupying a significant market share. By statistically analyzing on-chain data, we can observe user behavior from various angles, thereby uncovering quality projects and tokens. In this process, focusing on hot areas like stablecoins, DeFi, and NFTs, as well as the interaction status of various projects, helps us gain a more comprehensive understanding of the blockchain market's development dynamics.

2. Discovering Popular Protocols from Gas Fees Consumed

While the overall situation is as described, we have another way to statistically analyze popular contracts. After an upgrade on Ethereum, it adopted a deflationary model. When people interact with contracts, a portion of gas fees is consumed. In the past, this fee would go directly to miners, but now it is directly burned.

We can measure which protocol is the most popular by counting the amount of Ethereum burned daily, indicating which users interact with it most frequently. On the leaderboard, we can see that Uniswap and Seaport (one for trading various tokens and the other for trading various NFTs) rank at the top of the Ethereum network.

3. Analyzing DEX Trading Volume to Identify Popular Tokens

Since users are buying and selling various tokens and NFTs on-chain every day, we can compile these transactions to understand which tokens are receiving more attention and their daily trading volumes.

For instance, on Uniswap V3, we can see a trading volume list sorted by daily transaction numbers, revealing that Ethereum and USDC trades are very popular. This data helps us understand which tokens are gaining attention on-chain, as trading volume effectively reflects interest.

This perspective can be applied to many Ethereum-like chains, such as Binance Smart Chain (BSC) and Polygon. Different chains may have some dominant projects, but the observation angles are similar. For example, Uniswap accounts for over 50% of trading volume on Ethereum-like chains.

DeFi Iterations and Paradigms

DeFi 1.0: Building projects around the financial infrastructure itself.

The year 2020 was a pivotal moment, as we had just experienced the pandemic. When the pandemic began, the world was significantly impacted, including the effects of monetary policy leading to excessive currency issuance. At this time, DeFi projects experienced explosive growth. I believe many of you have participated in some on-chain transactions or economic activities to some extent. Most people have some understanding of projects like Compound or Uniswap.

During the DeFi 1.0 era, projects were built around financial infrastructure itself. Taking Compound as an example, we can actually compare it to a bank. You can deposit money and earn interest, and you can also borrow and pay interest. This functionality is entirely executed through code in the Ethereum Virtual Machine (EVM). Everyone can view this code to understand how it operates, and the code can automatically manage lending, borrowing, and interest distribution and collection.

Uniswap is easier to understand; it meets the trading needs of people in financial activities. In reality, Uniswap is akin to a trading exchange in real life, such as a stock exchange. Uniswap is a trading platform for various ERC-20 tokens, where anyone and any project can create trading pools. Those who have paired trading tokens can use their tokens as liquidity providers (LPs). As an LP, you can enjoy all the trading fee income generated by transactions on Uniswap. Uniswap itself does not charge any fees from the transaction fees; all generated fees go to LPs.

This is quite different from real life, where liquidity providers are usually not retail investors but large financial institutions or brokerages. However, on Uniswap, even with just a few dollars, you can become an LP. In this model, everyone is strongly motivated to become liquidity providers. Uniswap itself has undergone several major version iterations, with different innovations in functionality each time.

As a liquidity provider, you can not only enjoy the trading fees generated from transactions but also improve your capital utilization. You can collateralize your liquidity-providing LPs in other projects for borrowing. I believe many attendees have experienced this process and will understand what I am saying. However, if you haven't experienced it, this concept might be a bit vague. But that's okay; we can discuss this matter gradually based on everyone's questions.

So, during the DeFi 1.0 era, innovation mainly revolved around making finance modular and pluggable like Lego blocks. This approach greatly improved capital utilization and trading transparency.

Subsequent projects, such as Yearn Finance or dYdX, addressed various issues from different perspectives. However, we can summarize the entire development of the DeFi 1.0 era in one sentence: everyone was competing for liquidity.

Uniswap is a decentralized exchange platform with the largest on-chain trading volume. It maintains its leading position because it returns all trading fees to liquidity providers (LPs) without taking any fees. Compound initially attracted liquidity by issuing tokens, but this method had its problems. For example, when users deposit, they receive not only interest income but also company stock (tokens). If everyone sells the stock immediately after receiving it, the company's stock price will drop, leading to a vicious cycle.

During the DeFi 1.0 era, many excellent projects could not sustain themselves due to insufficient funds to attract liquidity. This led to a problem: Protocols rent liquidity with money, and the better the liquidity, the lower the trading costs, attracting more people to trade.

Uniswap's profit model is not based on charging fees from protocols but rather on issuing a large number of tokens. However, recovering these tokens is very difficult. As Uniswap expands its market share on-chain, how does it solve the problem between profitability and liquidity? It maximizes fee revenue to attract LPs. However, how to distribute profits to LPs while maintaining high liquidity is a problem that needs to be thought about and solved in the future.

DeFi 2.0: Financial protocols with built-in liquidity

Because DeFi 1.0 often relied heavily on users providing liquidity, in the 2.0 era, some projects attempted to address the limitations of liquidity, with Olympus DAO being a representative.

Olympus DAO is a decentralized financial protocol focused on creating a sustainable, self-regulating monetary policy. Its main product is the OHM (Olympus Pro) token, a new type of cryptocurrency with certain stability and inflation characteristics.

The main features of Olympus DAO are as follows:

1. Self-owned liquidity: Traditional DeFi projects typically rely on users providing liquidity, while Olympus DAO achieves self-owned liquidity through innovative means. The protocol purchases and locks liquidity tokens, making it a permanent participant in the liquidity pool, thereby reducing reliance on external liquidity providers.
2. Monetary policy and protocol revenue ownership: Olympus DAO introduces a native token called OHM and employs monetary policy to adjust token supply for price stability. Additionally, Olympus DAO incentivizes participants by distributing protocol revenue to holders.
3. Decentralized governance: Olympus DAO adopts a decentralized governance model, allowing community members to participate in project decision-making. This helps the project develop long-term and adapt to market demands.
4. Game theory and economic models: Olympus DAO combines game theory and economic principles to design an incentive mechanism that encourages users to participate and maintain the protocol's stability. This mechanism rewards behaviors that benefit the protocol while punishing those that harm its stability.

In Olympus DAO, if all users stake their tokens in the protocol, it would be an ideal state, as the token price would continue to rise. In this case, everyone would stake their tokens in the protocol, driving the token price up continuously, which is a very favorable situation.

However, in another scenario, if someone buys tokens at a low price while others continue to stake, this situation is also acceptable. But if everyone starts selling tokens, the price of the tokens issued by the protocol will face a serious decline.

Regarding Olympus DAO, my personal assessment is that it may just be a phase product, and there are still certain doubts about this model. However, it is worth noting that Olympus DAO experienced rapid growth during a certain period, with annualized yields (APY) from staking reaching tens of thousands. This phenomenon is very eye-catching, but investors need to be cautious about such high yields and understand the associated risks.

DeFi 3.0: Maximizing Rights from Protocols

In the DeFi 3.0 phase, we begin to focus on some new issues and challenges. A representative DeFi 3.0 project is Solidly. This project was proposed by AC and involves concepts such as Ve(3, 3) and Vote Escrowed. We will detail Solidly in the next section, but first, we need to understand the Curve project, as it is closely related to Solidly.

The Curve project is a well-known project in the blockchain industry, led by Michael Egorov. Originally called Stable Swap, it is a swap protocol for stablecoin exchanges. If you are interested in Curve's white paper, you can read it for more information. Compared to Uniswap, Curve has made some improvements to the exchange of stablecoins, reducing slippage.

Curve initially focused on stablecoin exchanges and later issued its own token, Curve (CRV). VeCRV is generated after locking CRV and has the following rights:

1. Boost income: By locking CRV, users can increase their liquidity provider (LP) income in the Curve protocol.
2. Receive protocol income: A portion of the Curve protocol's income is allocated to the treasury, while the remaining income is given to LP providers.
3. Participate in voting: Users holding VeCRV can participate in votes related to the protocol.

It is important to note that the process of locking CRV to generate VeCRV is irreversible, meaning VeCRV cannot be unlocked back into CRV. However, there is a linear time release function, where users can choose a time parameter during locking, which determines the locking time and the amount of Ve CRV obtained.

We just discussed the comparison between Curve and Uniswap. Many people complain that Uniswap makes money, but holders of Uniswap tokens do not receive income from the protocol. In contrast, users holding Curve tokens can receive income from the protocol, which is a significant difference between Curve and Uniswap. There are various controversies surrounding these two protocols. Some believe that Uniswap's design philosophy is to maximize liquidity provider (LP) profits, while Curve's design philosophy is not only to increase LP profits but also to maximize token holder profits.

However, Curve also has its own issues. First, Curve tokens are inflationary, meaning it has an inflation model. Secondly, the voting function of Curve tokens did not have much practical effect early on, and many people may not care about the protocol's future direction. Thirdly, Curve lacks liquidity; when users lock CRV to become veCRV, veCRV has no place to trade in the market, which contradicts the principle of maximizing capital utilization.

Next, let's discuss how the VeCRV and Bribe systems address these issues. The Bribe system allows a project to quickly gain liquidity by bribing VeCRV holders. This incentivizes LP holders to vote for projects that offer higher yields, thus providing better liquidity for those projects. This bribery mechanism has been adopted by many projects, including Velodrome on Optimism and at least 2-3 other projects.