The ecosystem of Decentralised Finance (DeFi) is certainly picking up steam on Ethereum. Inspired by the recent editions of the Our Network newsletter, it is a good time to do a quick review of some of the major protocols and applications.

To be honest, I am blown away by the pace of development of the Open Finance space on Ethereum, it is almost as if ever week there is a brand new protocol hot off the press. I recall seeing commentary that the total ETH locked in DeFi applications how now surpassed the demand during the ICO boom.

This is quite interesting given that ETH/BTC price has had a terrible 12 months. At a high level, I sense that the market right now is pricing in the following:

Bitcoin as a safe haven asset – The market is accumulating top dog. It is the most established and has the most brand recognition. Value flows to Bitcoin first and only after confirmed uptrend will value flow to riskier altcoins.

The market is still pretty dumb – I mean take a look at the top 20…it’s a disgrace. Under this framework, there are a lot of crypto-assets that are undervalued right now. DCR and ETH being the two primary ones that I have long-term conviction in.

Ethereum 2.0 risk – cannot be ignored. This is an immense engineering feat. Nonetheless, progress is being made, the community is excited and early test nets look promising. The market is discounting for the risk.

So if we assume that the Open Finance space and smart contracts are a valuable asset, lets have a look at some of the top protocols which could be worthwhile or overly risky to interact with.

Pool Together

Pool Together is a super simple yet extremely compelling idea. It is a No Loss Lottery.

It works by having individuals send DAI to a smart contract, 1 DAI = 1 Lottery Ticket. All the DAI is pooled together into a Compound Finance interest account. Each week, a random ticket is called and that user wins all the interest accrued during the week.

At any time, users can withdraw their DAI, having lost nothing except the opportunity cost of earning interest on that DAI. If your ticket does not get called, you just roll over to the next week.

To be honest, it is almost crazy not to throw $10 worth of DAI in, just to be in it to win it. Prizes are usually around $400 per week and $10 gets you odds of around 1:22,000.

Since Launch, the protocol has seen strong growth with over 1500 unique players and $350k worth of DAI locked up.

Uniswap

The darling of DeFi and the largest decentralised exchange on Ethereum. It has no ICO token, no known back-door and it the most native main-stream application to the Ethereum chain. It’s secret sauce is simplicity.

It has an extremely clean and easy to use interface. It achieves liquidity by users with a token (say MKR) sending equal USD value of ETH and MKR to a smart contract. This creates liquidity on both sides of the order-book and the protocol automatically adjusts the price spread based on available liquidity. The chart below shows the growth of various tokens inside Uniswap with many being over 2M in liquidity reserves, this is very impressive.

Where there is a deficiency of liquidity, users are incentives to arbitrage the price by selling one token for the other and profit from the spread. To pay the liquidity providers, 0.3% of the trading fees is paid out.

In addition, other protocols are starting to use the Uniswap liquidity pools as a back-end for their stacks. This creates an increased liquidity and composable ecosystem. Pretty neat.

Users like us can benefit from both ends. It provides, in my view, the best and cheapest DEX on Ethereum. If you hold tokens like MKR and ETH long term, you could pool liquidity to gain a share of the trading fees. Chart below shows that over 1M in trading fees have been distributed so far. Again, very impressive for 12 months of operation.

Set Protocol

I covered the fundamentals of Set Protocol back on 1-Dec-2019 if you want to check out that RSC newsletter. In short, it is a protocol that baskets up various tokens and employs trading strategies in an automated manner. It is a trading bot in a token.

I have been experimenting with ETH-BTC 26-EMA strategy to hedge my ETH exposure. So far, it has experienced a little bit of loss due to chop however, as expected during the recent sell-off, has become quite profitable. Overall, it has increased the ETH value by around 7.5% in 2 months, not a bad return and I sleep easier.

Now it would have been more profitable to use the equivalent USD strategy given BTCs price drop at the same time. That said, my gut feel is that we are transitioning into a more bullish market. Thus the BTC Set will outperform in that context. A share of both is even more sensible.

The protocol is also experiencing growth, with cumulative lock up in an uptrend. It appears that volume spikes perhaps once a week  on average which may mean people or large holders are using Set as a trading strategy or hedging instrument. Either way, it is a good sign for the protocol.

Synthetix

Here is a protocol that simultaneously gets the award for ‘most confused’ and ‘crowd favorite’.

Synthetix is a platform that creates synthetic derivatives backed by collateralised loans. At it’s core, the protocol is a series of oracles that track the price feed of assets like ETH, Gold, fiat currencies and even baskets of Exchange tokens like BNB, KCS and LEO. This allows people to invest in ‘synths’ that track the price of the underlying.

The award for ‘crowd favorite’ comes from the new token model which has lucrative staking rewards (like 100%+ per year) on the native SNX token. It recently experienced a mini parabolic rally from a few cents to $1.30 as people jumped on board to get a share of the staking rewards. Everyone got very excited, locked up their SNX to stake and also took out the product stablecoin sUSD to get a share of trading fees.

Everyone leveraged up on SNX, took on debt and hoped to get paid for free to do so…I’m going to hazard a guess that about 200 to 300 whales who are the only ones on this protocol both as traders and stakers of any meaningful size.

There is a catch. SNX is a horrendous token. It requires a collateralization ratio of 750% which means that each ‘synth’ has loads of SNX behind it…but…

When the price of SNX drops even a little bit, the whole system is underwater. Now since SNX has dropped back down to $0.80, the system is now undercollateralized to 500%. An nobody…is paying back their debt…

There is no incentive to do so. You still get SNX rewards just not trading fees. After the boom in trading during the ‘crowd favorite’ award ceremony, trading volume has more than halved.

The Synthetix platform is a great idea (synthetic assets) crippled by needing to keep ICO investors happy. The token model is defunct. I believe they are planning to introduce ETH as collateral to fix the system which relegates SNX to a governance token…Buy my token to vote on which oracle to build…

The award for ‘most confused’ definitely goes to Synthetix. At this stage of the game, I’m not holding my breath for this platform to change the world. A competitor without the token however, more likely.

Compound

The final project covered this round is the Money Market protocol Compound Finance. It functions as a smart contract for pooling liquidity and facilitating loans. Users earn or pay an interest rate depending on how much they have deposited or borrowed.

Compound has always been a multi-asset system with multiple tokens that can be collateralised and borrowed against. The first chart below shows that almost 600M worth of collateral is currently locked up in the protocol. That is a lot of value in the system. The dominant collateral types are ETH, SAI and USDC, representing approximately 25-30% of the pool each.

What is quite promising to see is that the cumulative borrow value is under $150M. That means that system wide, Compound is operating at a collateralization  ratio of 400%. The dominant assets borrowed are SAI and USDC, most likely borrowed to go leveraged long on ETH.

Summary

Reviewing five unique DeFi applications, we can generally see one thing. Uptrends in the amount of usage and collateral locked up in the protocols. This is a good sign, both for Ethereum, ETH value and validation that there is demand for these products.

Say what you will about the design and challenges of Ethereum, there is demand for this technology right now, even if only from a small group of people. Given the demand for DeFi is what I would consider cleaner and more sustainable than that for the ICOs, there is a potential bull case here for ETH. It could be undervalued in this light.

At a minimum, take a look into Pool Together. It seems like a no brainer to throw a small amount of DAI that won’t be missed in the hopes of landing the prize. Good Luck!