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Introducing DeFi’s Top 5 Projects in Terms of Total Value Locked
While Bitcoin (BTC) is the largest cryptocurrency by market capitalization — and the most popular — it is arguably the Ethereum network that has fueled the most innovation in the crypto space in recent years. With its developer-friendly environment and programmable smart contracts, the Ethereum network promotes the creation of decentralized applications, or DApps, that leverage the distributed network and can communicate with each other, encouraging the creation of entire niches.
One such niche is decentralized finance, which mainly consists of Ethereum-based DApps that offer financial products and solutions. These apps and their tokens can be thought of as blocks that can interact with each other (as long as they are running on the Ethereum network) and facilitate financial activities, such as the decentralized exchange of assets, lending and borrowing as well as the creation of new, tokenized derivatives — all without the need for any central authority.
We’ve seen several DeFi-centric projects entering the space over the last two years, but it was not until recently that the niche started garnering widespread attention and hype in the industry. The total value locked, or TVL, in DeFi projects grew from just under $600 million into the $2.16 billion niche it is today — within a span of 12 months.
Given how the DeFi niche focuses on financial products and services without any centralized body, such as a central bank, one side of the equation depends on users depositing/locking their crypto assets in smart contracts to generate liquidity.
For example, some projects require the issuance of native tokens, in exchange for collateral crypto assets (deposited, or locked in, by liquidity providers). These tokens are then circulated among all users while the liquidity providers receive incentives such as various fees or interest rate earnings for keeping their assets locked in on the platform.
The TVL figure, therefore, represents the total value of ether (ETH) and various Ethereum-based tokens held in each protocol’s smart contracts, acting as a metric of its growth, demand and usage.
In this article, we introduce the top five DeFi projects in terms of TVL and explain their functions and features for readers who want a quick understanding of this trending landscape.
1. Compound — Lending via liquidity pool
Total value locked in USD: $683.4 million
Compound is a decentralized money market protocol built on the Ethereum network. It allows lenders and borrowers to interact with a pool of assets without the need for any central authority. As opposed to peer-to-peer lending, Compound has a liquidity pool that is funded by lenders who deposit their assets and receive so-called cTokens in exchange. These tokens accrue interest and can be redeemed later for the collateral and profit.
Borrowers, on the other hand, can take any supported asset from the liquidity pool by depositing a collateral asset. There are no particular conditions for the loans, such as date of repayment or term, but borrowers are limited by the collateral factor set for the asset they deposit. For instance, if a borrower deposits 100 ETH and the collateral factor for ETH is 70%, the borrower can take any other asset in exchange for that collateral, up to 70% of its total value.
The borrower also pays an interest rate, which is how lenders accrue income, and these rates are decided individually for each asset based on its supply and demand.
Compound recently became the poster coin for DeFi’s resurgence as it launched its governance token, COMP, which saw a meteoric rise from under $100 at launch to as much as $372 in less than 10 days. Similarly, the total value locked into the protocol also rose from under $100 million on June 15 to its current all-time high levels near $700 million. However, the price of COMP has corrected significantly since then, currently hovering around $185.
2. Maker — Lending via stablecoin
Total value locked in USD: $629.3 million
MakerDAO is a decentralized autonomous organization built on the Ethereum network. The Maker protocol’s function is primarily focused on DAI, its native stablecoin — the value of which is algorithmically pegged to the U.S. dollar. DAI is comparable to other USD-pegged stablecoins, like Tether (USDT), except that it does not claim to be backed by real dollars.
The platform’s second token is MKR, which gives holders the right to vote in governance matters — such as on the collateralization ratio, stability fees and savings rates. MKR also acts, at times, as a counterbalance to ensure that DAI’s value remains stable.
Anyone can take out DAI in a loan by depositing ETH or other assets supported by Maker’s DAI-focused DApp Oasis as collateral. The current collateralization ratio for borrowing DAI on Oasis is 200%. The borrower would also need to pay a recurring stability fee. This DAI can then be traded, exchanged and lent on decentralized lending platforms like Compound, or deposited in the “Save” product on Oasis to earn interest.
Apart from the 200% collateral, DAI’s stability is also backed by MKR tokens. In case the value of collateral assets drops significantly, MKR tokens are issued and sold on the market to increase collateral and bring DAI’s price back to the $1 peg.
One of the most interesting aspects of Maker is its tokenomics and the relationship between MKR and DAI. Since MKR is the governance token, MKR holders are, by default, invested in the project’s success and growth. The quality of their decisions is, according to the platform’s design, reflected in MKR’s price movements — decisions that encourage growth result in increasing DAI generation, which in turn accrues more stability fees, which are then used to buy MKR tokens back from the market to ultimately be burned.
The regular burning of MKR tokens inevitably increases their price by cutting down supply, thereby rewarding the holders for their good governance. Similarly, poor governance decisions or issuance of MKR tokens to balance DAI’s dropping collateral will slow down this burn rate, thereby negatively affecting MKR’s price.
It is this dynamic — and its automated, algorithm-driven nature — that makes Maker stand out in the crypto and DeFi space.
MKR is currently trading at around $467, down -74% from its January 2018 all-time high of $1,798 but up 176% from its March 2020 low of $168.36.
3. Synthetix — Decentralized derivatives
Total value locked in USD: $392 million
Synthetix, rebranded from Havven, is a decentralized derivatives platform and exchange built on the Ethereum network. Users can lock-in, or stake, SNX tokens in order to generate so-called Synths, which are blockchain-based derivatives. Synths track the value of real-world assets, including fiat currencies, digital currencies, equities, indexes and commodities.
For example, a user who wants to issue $5,000 worth of USD Synths (sUSD) can stake SNX tokens worth 800% as collateral — this is the current collateralization ratio — i.e., $40,000. These Synths can then be traded freely among users on the platform’s decentralized exchange and can be used to buy other Synths — such as synthetic gold (sXAU) — incurring exchange rate fees, which are distributed to SNX holders in the proportion of their staked tokens.
The chart above shows the sXAU/sUSD market on Synthetix Exchange, and the fees for any trade, as highlighted, are broken down into Exchange fee and Network fee, with the former going to SNX holders who issued the XAU Synths.
Apart from earning exchange fees, the major incentive for users to hold SNX is the chance it will grow in price as a result of the platform’s growth. As the number of SNX tokens locked into the project increases, the tokens become scarcer on the market — in theory, boosting their price.
It should also be noted that the creation of Synths can be long or short, with the “s” variants, like sUSD, denoting long positions (as they track the underlying’s price directly) and “i,” or inverse Synths like iUSD, denoting short positions (as they track the underlying’s price inversely). These long/short divisions, as well as other useful statistics, are publicly visible on the Synthetix Dashboard. At the time of writing, over 78% of the SNX supply is staked on the platform.
SNX tokens are currently valued at $2.90, as per CoinGecko, up more than 770% from early July 2019’s price of roughly $0.33.
4. Balancer — Decentralized algorithmic exchange
Total value locked in USD: $161.6 million
Launched in March 2020, Balancer takes the concept of automated market-making and implements it in the crypto space using the Ethereum network.
On the Balancer platform, liquidity providers (i.e., capital owners) create private pools (or contribute to shared pools) where they lock-in their assets, define the proportion (or weight) of each asset in the pool, and set the trading fees. Users can lock a minimum of two and a maximum of eight different ERC-20 tokens into a pool. As the value of each token in a pool changes with price appreciation or depreciation, Balancer sells or buys them to third-party traders in order to return the pool to its predefined proportions. In the process, the liquidity provider earns fees paid by the traders who, by default, also end up re-balancing the pool.
An example would be a pool with two tokens, MKR and DAI, which are set at 50% each in terms of weightage. This means Balancer will ensure that the pool’s total value is always halved between the two tokens.
If either of the allocated tokens grows or falls in value, the allocation percentage will naturally fluctuate. That is where Balancer comes into play, by selling the over-allocated token to traders or buying the under-allocated token from traders.
Balancer actively achieves this “balance” by defining swap prices between pairs of tokens in the pool in order to encourage traders to buy and sell using the pool’s liquidity, as shown below.
The screenshot above reflects the swap mechanism on Balancer, where a trader selling 10,000 SNX tokens (native to the Synthetix platform discussed earlier) for KNC is given an automatically calculated swap price (1 SNX = 1.13682 KNC) and will be able to complete this trade using varied allocations from four Balancer pools selected by the protocol.
In terms of returns, all the fees generated in the continuous balancing process go directly to the liquidity providers. There is also an exit fee, which applies when a liquidity provider leaves a pool. This exit fee is divided between the remaining liquidity providers and a portion of it also goes to Balancer Labs.
The Balancer Governance Token, BAL, allows holders to participate in the protocol’s governance and decision-making processes. Since liquidity providers are considered the most important stakeholders for Balancer, the project introduces what it calls “Liquidity Mining,” where liquidity providers earn BAL tokens based on the proportion of their locked assets.
One BAL was valued at $0.60 during Balancer’s seed funding series and is currently trading at $9.72.
5. Aave — Decentralized money market
Total value locked in USD: $158.2 million
Like Compound and Maker, Aave — rebranded from ETHLend, which started in November 2017 — is another decentralized lending (or money-market) platform that uses smart contracts on the Ethereum network. Lenders can deposit their assets to provide liquidity and in turn receive aTokens, which bear interest and begin compounding. Instead of allowing the interest to accumulate in the same wallet as the tokens, this “interest stream” can also be directed toward a different address to be stored separately.
Borrowers, on the other hand, can take over-collateralized and under-collateralized loans, where they can get up to 75% of their collateral value in loans or execute “flash loans,” which are typically reserved for developers due to their advanced nature.
Flash loans are arguably the more interesting offering by Aave. In simple terms, a flash loan is uncollateralized, which means the borrower does not need to put down any capital to take out the loan. However, the loan must be fully returned with an additional fee before the entire transaction concludes — the entire process happens simultaneously with the use of multiple smart contracts all executing together.
Flash loans can be used to profit from arbitrage opportunities without needing to put up capital. For instance, a developer can notice a difference in price between two assets on two different platforms but doesn’t have the capital to take advantage of it. The developer can then use a programmed flash loan to take out a loan in one token, swap it for another, sell the new token(s) on the more profitable exchange, convert back to the originally borrowed token, and return it with a small fee all at once using smart contracts. In this process, the developer pockets the extra tokens that they earned by taking advantage of the price difference on the second exchange.
LEND is Aave’s native token and entitles holders to reduced fees, while additional governance rights are expected to be added soon. At the time of writing, LEND is trading at $0.19, up over 5,500% from its August 2019 all-time low of $0.0033.
Is DeFi worth the hype?
This $2 billion+ question is tough to answer, as a lot of the recent hype around DeFi is due to the headlines made by COMP on its sudden, speculation-fueled rise. While the underlying technology and its use in these projects present an exciting preview of the future of finance, it would be overly optimistic to consider the DeFi niche ready to go mainstream and change the entire financial landscape.
Vitalik Buterin, the co-founder of Ethereum, put this succinctly in a recent Tweet, highlighting the temporary nature of hype and inherent risks at play. The Balancer hack just last month should serve as a reminder of these risks and the fact that the niche needs a lot more stress-testing before it can be ready for mainstream consideration.
Disclaimer: This material should not be taken as the basis for making investment decisions, nor be construed as a recommendation to engage in investment transactions. Trading digital assets involve significant risk and can result in the loss of your invested capital. You should ensure that you fully understand the risk involved and take into consideration your level of experience, investment objectives and seek independent financial advice if necessary.