Coral DeFi Market Primer — September 2021
Off the back of a major retrace in the digital asset markets, late July into early August brought a surge in spot valuations, none more prevalent than the blue-chip Layer 1 smart contract platforms like Ethereum and Solana. With renewed interest from institutional and retail investors, we are witnessing another wave of leverage and an increase in the deposit rates on stablecoins, typically the tell-tale indicators of uptrends in the market.
In this edition of the DeFi Market Primer we will take a deep dive into prevalent Layer 1 & Layer 2 blockchains: Solana (“SOL”), Avalanche (“AVAX”) & Arbitrum; in an effort to educate on the technical underpinnings and opportunities available to investors on each of these networks.
DeFi Market Overview
The Total Value Locked (“TVL”) metric is a proxy for overall growth in the DeFi ecosystem. According to DeFi Llama, $107.8 billion was locked in DeFi protocols on July 1st, which peaked to $191.7 billion on September 6th, and is now at $174 billion. TVL is not a perfect barometer, as it tends to fluctuate with asset prices, it provides insight as to where capital is being deployed in DeFi.
Q3 was once again a highly volatile quarter for the broader digital asset markets. The digital asset market in Q2 ended with sharp volatility to the downside, with Ether falling from May highs of ~$4,200 to ~$2,100 and ~$1,800 in the beginning and end portion of July respectively. The digital asset market remains very reflexive. When prices are falling, everyone runs for the door and when blue chip assets rise 10% in a week, investor capital floods in. For this reason, the strong rebound from mid-July lows was a bullish outcome.
Following the EIP-1559 upgrade to Ethereum on August 4th, paired with explosive growth on alternative Layer 1 & Layer 2 blockchain networks like Solana, Avalanche & Arbitrum; we’ve seen an explosion not only in the price of digital assets but in yield farming opportunities in general.
The outlook for opportunities to generate yield in DeFi has never been more enticing. In Q3, Layer 2 network Avalanche announced a $180m liquidity mining initiative. In addition, Solana and Arbitrum are both sitting on enormous treasuries which will trickle down to investors providing liquidity on their platform.
Solana Overview
Ticker: “SOL”
Current Market Cap: $41.4B
Market Cap Ranking: #7
Current TVL: $8.6B
Year Founded: 2017, Launch in 2020
Solana dates back to its whitepaper in 2017, while not launching its mainnet beta until March 2020. One of the key limitations to the Ethereum blockchain is the time duration it takes to order transactions & reach consensus for each block. Solana unveiled a novel approach toward scalability referred to as Proof of History (“POH”).
Unlike most competing blockchains which feature the Solidity coding language, Solana utilizes RUST, a coding language which dates back to 2010, which allows it to tap developer talent that otherwise has not yet entered the digital asset ecosystem. In addition, Solana scales with the amount of compute power supporting the network, and hence ideally will scale with computing advancements & Moore’s law. As a unified chain, and unlike most other scaling solutions, apps on Solana benefit from full composability on it (no bridging and chain hopping required).
One of the key champions of Solana is FTX and Alameda Research Founder Sam Bankman-Fried, commonly referred to as “SBF”. Solana’s meteoric rise, has been in lockstep with the emergence of SBF as one of the few larger than life figureheads of the crypto industry.
The explosive growth of Solana has not been without hiccups. In mid-September Solana network went offline for almost 18 hours after a transactional overload occurred. In addition, many point to deception in the way Solana reports its transactional volume, as many of the transactions are not user generated but rather a result of the system architecture.
Out of the box, Solana’s network lends itself to being able to handle significantly more transactions per second than Ethereum mainnet. Although there are tradeoffs from a security and decentralization standpoint, cheaper and faster transactions have found Solana product market fit with a large number of DeFi & NFT investors. Many users who were priced out by the exorbitant gas fees on Ethereum have ported over to Solana to trade and speculate on NFTs. The already large number of applications up and running, combined with a passionate user base make the Solana ecosystem the most robust outside of Ethereum mainnet.
With almost $40B in market cap and high-profile investors like SBF throwing capital at building out the Solana ecosystem, our view is that Solana will emerge as one of the most profitable areas to generate yield in the near future. Similar to the early yield farming opportunities on Ethereum with protocols like YFI, Sushiswap and Compound; comparable applications on Solana will gain market share and become billion-dollar protocols within the next 12 months (several already have).
Avalanche Overview
Ticker: “AVAX”
Current Market Cap: $15B
Market Cap Ranking: #11
Current TVL: $2B
Year Founded: 2018
Avalanche (AVAX), is a blockchain framework project initially aimed and designed to host unified world financial markets. There were some notable early-stage design decisions which provided a differentiated backend/platform when compared to Ethereum or Solana. Most notably, AVAX allows developers to create their own custom blockchain &/or sets of blockchains as needed. Each of these “subnets” has a set of validators responsible for securing zones of the blockchains within it, and hence create a consensus within the subnet of finality and state. In aggregation, this means there can be many sets of blockchain networks each with custom rule sets such as: KYC enforced gating, region dependent, etc. Theoretically if enabled, those subnets can communicate with other AVAX subnets (collections of custom blockchains).
Central to the Layer 1 war, is the transactional scalability of the networks. Project estimates of 4500TPS per chain per subnet (collection of chains) on Avalanche, combined with the ability to scale linearly with the number of nodes on the network, give Avalanche a novel and potentially bright future in the race to become the internet of value’s monolithic settlement and trustless compute layer. It is not another copy and paste GETH (Ethereum client) such as Binance Smart Chain (“BSC”).
Zooming in on the current state of the network, the “C-chain”, a EVM (Ethereum Virtual Machine — can run all Ethereum apps cut and paste) and is where the majority of initial settlement action is occurring. With the launch of the AVAX bridge on July 29th, assets have migrated over at an exponential pace, primarily from Ethereum Mainnet. Investor’s bridging are seeking: greater yield, lower transaction fees, and a piece of the Avalanche sponsored liquidity mining incentive program. About $2 Billion USD in value has been bridged (transferred) thus far.
On the investment and tokenomic side, AVAX has a hard cap of 720M tokens, of which all have not been minted yet. Transaction fees, as well as network fees for actions such as creating a subnet are all paid in AVAX, and burned upon receipt by the network. The pseudo “risk-free” monetary rate for owning AVAX (delegating to a node to secure the network), currently hovers around 9% paid in-kind.
In sum, while this is just a brief overview of the Avalanche protocol, readers should take away that: 1) Avalanche is a novel and genuine front runner for the layer one trustless compute and world settlement layer; 2) Avalanche continues to pull in assets from other chains with the high yield provided by its growing ecosystem and represents a preeminent alpha generation and trading environment.
Arbitrum Overview
Ticker: N/A, no token
Current TVL: $2.2B
Year Founded: May 2020
The Arbitrum Ecosystem is a layer 2 solution, forked from another layer 2 solution called Optimism, built to improve scalability and throughput of the Ethereum ecosystem by a factor of 100’s. It works by optimistically accepting transactions on a network built on top of Ethereum, and periodically sending batched transactions to the main Ethereum chain to be verified by Ethereum miners.
Since all transactions are verified by Ethereum’s main consensus mechanism, Arbitrum bootstraps the main chain’s security. This is a big deal for many of the early Ethereum investors and larger stakeholders, commonly referred to as the “purists,” as they don’t believe side chains or alternative layer 1’s are nearly as decentralized or secure enough for their preferences.
Since the public launch of the Arbitrium ecosystem, there was a pool-2 farm set up called Nyan-Cat which offered 1 week of “risk-free” farming on ETH tokens. This project jump started substantial growth on Arbitrum, as it alone brought close to $2B of value in the token ETH. Aside from the one-off projects, we expect to see Arbitrum sustain long term growth as other projects continue to be built on the platform. While the tracking and metric sites show declining TVL on the layer 2, we find they are slower in measuring the growth of natively created tokens in the ecosystem.
As we expect to see continued organic growth on the Arbitrum chain, we have also seen the inevitable race of copycats to the new chain. With each new EVM compatible chain, we often see successful projects replicated or even original project expansions. This brings many opportunities with it, as we can more accurately model expectations for a particular project’s growth.
One of the cases that goes against growth expectation for Arbitrum is the lack of a coin to represent it as a Layer-2, as it uses the main ETH token for gas consumption. This makes it harder to compete with other scaling solutions or alternative layer 1’s that can boost user growth through liquidity mining incentives. The team has stated they are not interested in creating a token for farming incentives as they want to ensure the project is as decentralized as possible. This does not however, preclude projects from subsidizing liquidity mining on an application level. We have already witnessed many of the blue-chip DeFi protocols building out their support for Arbitrum.
In conclusion, Arbitrum will be an interesting case in the development of Ethereum and DeFi. Without a native token, the expected yields on liquidity mining at a network level will likely be unable to compete over the short-term with competitors such as Avalanche and Solana. However, the out of the box support from top-tier DeFi protocols, combined with an impending wave of TVL from Ethereum purists is likely to set up Arbitrum for long-term viability.
About Coral DeFi
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.
