Coral DeFi Market Primer — August 2021

Coral DeFi is a Puerto Rico based Alternative Investment Platform founded by Patrick Horsman, Thomas Mclaughlin and David Namdar focused on Digital Assets and Decentralized Finance Applications. We are thesis based, long term investors empowering the DeFi revolution. DeFi represents one of the first opportunities in digital asset investing that isn’t purely directional. Using DeFi protocols Coral creates exposures and strategies to hedge risk, generate yield and acquire tokens in top projects while protecting principal. We manage several different fund strategies including liquid hedge funds and longer-term venture capital portfolios.

Decentralized Finance Market Overview

Codifying traditional Wall Street verticals remains at the heart of the DeFi bull case. It is our belief that DeFi TVL will surpass $1 trillion within the next 5 years, as an impending wave of crypto native (from existing holders of Bitcoin & Ether) and institutional capital will find its way into the ecosystem, leveraging better economics for financial transactions.

From the standards of other asset classes such as global equities, the profitability (and valuation metrics) for DeFi assets like Sushiswap, Yearn and Curve are incredibly attractive. For example, in only one year of operations with very few employees and no corporate headquarters, Sushiswap features a $2.3 billion fully diluted market cap, extremely high growth metrics and a P/S ratio of 10.9x and P/E ratio of 41.1x. Publicly traded competitor Coinbase trades at a P/S ratio of 70.0x and a P/E ratio of 197.2x, with nearly 9 years of operation and over 1,200 full-time employees. Ultimately the low fixed cost dynamics of DeFi protocols provide the capacity for much better economics to the end user, traders. If traders continue to shift market share to decentralized exchanges (DEX volume surpassed 10% of total market volume for the first time in Q2’21), this difference in valuation metrics will become even more profound.

Source: : Total Value Locked (“TVL”) currently sits at ~$85 billion across major DeFi protocols, a ~28x increase year over year from ~$3 billion in July 2020.

If we take a multi-decade approach to many of these protocols, there is an incredible inflection point today to amass holdings which can compete with and surpass the valuation of traditional financial (“TradFi”) institutional comparables.

Broader Digital Asset Overview

Over the past several months, the digital asset markets have transitioned from a full-on bull market to a steep correction & accumulation phase. During this time period blue chip assets like Bitcoin & Ether had fallen 50% from their highs, while many DeFi focused assets have fallen as much as 90%. The (“DPI”), an indexed product representing a basket of the top DeFi focused protocols, has corrected nearly 70% off all-time highs. Over recent weeks, however, we have experienced a bounce back, with Ether once again breaking $3,000 and Bitcoin hovering around $45,000.

In our opinion the paramount catalyst for the breakdown in the price of Bitcoin was the Chinese government cracking down on China-based digital asset miners. Setting up data centers and transporting hardware requires a significant amount of capital expenditures upfront. As mining operators were forced to unplug and relocate to other jurisdictions, they were required to tap into treasury reserves in order to meet those capital expenditures.

Combined with weakening retail appetite after the buying frenzy, this selling pressure ultimately dragged down the spot price of Bitcoin in predictable fashion. From a long-term perspective, relocation of miners is a positive for Bitcoin as it effectively will eliminate 2 of the most common contra arguments to Bitcoin. 1. Bitcoin is centralized in China and therefore can be controlled by the CCP and 2. Bitcoin is dominantly produced by dirty unregulated energy markets.

With cost declines across the board in renewables crossing over the cost curve of dirty energy sources plus a broadening out of mining geographically, Bitcoin’s antifragile nature is at play.

What looked to be a set up for an extended bear market in recent weeks has turned on a dime and looks to be a prime position for a breakout for Ethereum and DeFi related digital assets.

The key bull catalyst was the EIP-1559 upgrade on Ethereum which radically changed the token economics surrounding Ether. As a part of ETH 2.0 becon chain merger, holders can now stake their Ether to earn a share of the yield generated when users pay fees in Ether to transact value on the blockchain. At a high level, this will provide more clarity to the supply cap on Ether over the long-term as well as locking a large percentage of the float of Ether into staking contracts. All else equal, as the float shrinks with holders wanting to participate in the staking yield, Ether spot price should experience an exponential effect per dollar of buying pressure, as there is the potential for a supply shock. (Due to base fee burn after EIP 1559 gas fee in a block at ~150 Gwei pow is net deflationary for ETH, ~11 Gwei is deflationary after becon merge). These change value accrual mechanisms for ETH as on chain activity now benefits holders directly.

Source: ; Coinbase earnings provide a glimpse into the breakdown of trading volume among investor types and digital asset choices. Institutional capital is flowing into the industry at an increasing pace and investors are allocating to Ethereum and other assets at a faster pace than Bitcoin.

Short-term volatility to the upside from the major digital assets (Bitcoin, Ether & Solana) appear to have kick-started momentum back into the markets. The daily burn on Ethereum has been ~$15m, largely driven by the frantic activity in the DeFi and NFT markets. The smart contract platform narrative has never been stronger, nothing more clearly than the tick up of institutional interest in Ethereum denominated product offerings.

Stablecoin Rates & Flows

Q2’21 started with USDC yields on Compound & AAVE holding 10–13% APY on a normal basis. Ultimately this yield was derived from a supply/demand imbalance in the markets for stablecoins. Traders were depositing their Bitcoin & Ether to lending & borrowing protocols and borrowing stablecoins to invoke more leverage. Combined with a regulatory hurdle to mint new USDC, stablecoins could not enter the system fast enough to offset the demand.

USDC issuance in particular jumped from $5.9 billion to $25.2 billion in a single quarter, as more liquidity flowed to the markets to take advantage of incredible money market deposit rates on USD backed stablecoins. In the past month Compound and Coinbase both launched products offering investors 4% guaranteed APY on USDC deposits (links in “Relevant Links’’ section at the end), still ~10x the standard TradFi rates for comparable financial products.

Increase in supply of USDC, combined with lower borrowing demand and new institutional onramps combines for a market dynamic where we expect the USDC deposit rate to remain depressed until there is a market turnaround. Compound’s all-in yield on USDC deposits continues to float around 3.3%, a level we expect to hold as the ceiling for the duration of the current market conditions. It’s plausible that the first generation defi killer app for traditional finance will be its money markets. With safe yields possibly far in excess of traditional finance, large players such as PayPal, Compound institutional API, Coinbase high yield savings are moving in and extending these products to the public.

Source: ; Compound’s all-in rate on USDC deposits currently sits at 3.3% with a utilization ratio of ~60%, both well below the one-year average of 8.3% and 85%, respectively.

Attractive yields in stablecoin markets now require more expertise and flexibility in allocations. Taking advantage of liquidity mining programs and allocating to LP (“liquidity pools”) for stablecoin assets provides a much better return profile, relative to simply supplying to a protocol like Compound at the moment.

Yield Farming Market Overview

The Yield Farming market continues to evolve and play out at an incredible rate, as capital flows across multiple layer 1 blockchains. While Ethereum Mainnet remains the undisputed leader in terms of transactional volume value settled on chain, yield farmers found increasingly attractive returns on Layer 2 blockchain Polygon for the majority of Q2.

When a new blockchain (layer 1 or 2) launches, there is historical precedent for handicapping which protocols are likely to gain traction as the ecosystem emerges. One of the core areas of competence we have built at Coral DeFi is the ability to take advantage of liquidity mining programs for financial protocols launching on new chains which we have seen succeed in previous iterations.

For example, as DEX’s (“decentralized exchanges”) clamored for market share on Polygon, there was a wealth of liquidity mining rewards for liquidity providers to order books. Savvy investors were able to leverage their books to capture attractive yields on Sushiswap and Quickswap in particular, in most cases only supplying pairs of stablecoins (meaning close to zero principal risk) and capturing double digit plus APY for several months at a time.

In addition, these investors can accumulate substantial stacks of the governance tokens from these protocols, many of which have an additional yield element or voting rights on the protocol, which can be extremely valuable in the future as the TVL of the industry continues to grow.

Conclusion & Market Outlook

All in all, the DeFi markets remain strong, both in terms of TVL and yield generation opportunities. At the moment, Ethereum mainnet remains the clear leader in terms of TVL and yield farming opportunities. However, in recent weeks we have seen a surge in activity on the Solana blockchain, and Terra ecosystem largely due to the unique and creative approach to Terra’s native stable coin.

Not all is bullish in the industry, as regulatory headwinds potentially loom large. Of recent note, the infrastructure bill introduced by US Congress included a stipulation that could have a significant impact on the regulatory landscape of the crypto industry in the United States moving forward. The proposed language, while vague, could potentially regulate DeFi platforms as “brokers” beginning in 2023. The outcome to this bill has yet to be resolved. While this bill would not substantially change our investment thesis or core allocation process, we believe a negative outcome could have repercussions short-term on asset prices.

All scenarios remain in play for the remainder of 2021. A breakout to the upside driven by increased activity on layer 1 blockchains like Ethereum & Solana could result in enormous gains across all relevant metrics for DeFi markets. A stronger mix of institutional capital, should insinuate stronger conviction and longer time horizons, thus tapering some of the selling in a broad sell-off. However, recent history has shown us that volatility is always right around the corner. We are only beginning to see the signs of increased leverage in the system, thus a large move to the downside always remains in play.

Predicting the prices over a short time horizon in such a volatile asset class is a difficult task. However, we expect to see increased usage in DeFi protocols across the board. Our expectation is for TVL to surpass $125 billion by the end of 2021 with 25 protocols breaking the $1 billion TVL threshold (Currently we are sitting at $85 billion & 15 platforms respectively). With this as a backdrop thesis, and a $1 trillion TVL expectation within 5 years, DeFi remains one of the most opportunistic areas to deploy investor capital in today’s markets.


DeFi Asset Manager