Investment Navigator: Decentralized Finance

Table of content

• Overview of Sectors
• Sector Deep Dive: Decentralized Finance  
• Sub Sector Spotlights 
• Key Metrics of Top DeFi Products 
• Glossary

Executive summary

We are now 18 months into crypto winter trying to unwind from bad actors while dealing with regulatory pressure and a tight macro landscape. Yet, after a promising first quarter that felt like spring, the second one was characterized by some retracements especially outside the Cryptocurrency Sector. Especially Bitcoin kept the whole market afloat on the back of another wave of asset management giants embracing the space. BlackRock’s filing for a Bitcoin spot ETF has revitalized the market and triggered a strong rally for Bitcoin. The collective assets under management of entities that filed for an ETF recently totals approximately $15.39 trillion, a giant pool of assets that open up to crypto if approved.

While Ethereum and its smart contract platform peers performed rather flat, other key Sectors such as DeFi, Utility and Culture slowed down and gave back some of their first quarter gains. As I experienced attending EthCC in Paris, the largest annual Ethereum community conference, the market performance does not necessarily reflect the progress happening at the protocol and infra level. While other bear markets led to apathy and low attendance, this year’s EthCC had impeccable energy, a vibrant community, and an innovation pace at all-time highs. The key topics ranged from MEV, L2s, Account Abstraction, Distributed Validator Technology, Shared Sequencing, Verifiable Credentials to novel DeFi applications. Among Mantle, Linea, Starknet Appchains or Chainlink CCIP, other notable reveals included Gnosis Pay, Lens V2 and Uniswap X.

Most of DeFi’s key metrics are up in the second quarter and allow for excitement. As such, total active loans grew ~13%, decentralized exchanges gained more share of the total trading volume from centralized exchanges, staked assets went ballistic and are up almost 24% across the industry while derivatives volumes grew up to ~5%.

Established and novel Dapps tune their tokenomics and protocol mechanisms into more sustainable business models. First wave DeFi projects like Aave, Maker and Synthetix kept building while DeFi baskets lost ground against ETH and experience a revival based on improved fundamentals and fresh capital allocation within their smart contracts. Some of them become hubs with an extended range of USPs as they merge formerly isolated DeFi offerings into one hybrid solution in order to bootstrap flywheel effects. For instance, Frax, Curve or Aave now offer not only credit facilities but also money market like functionalities and proprietary stablecoins backed by multiple collateral types including LSTs.

As the SEC continues to witchhunt CEXs, users will increasingly turn to DEXs and Derivative platforms that are already gaining momentum. With scaling enabled perp design by Layer 2 technologies and an influx of innovation in the decentralized Exchange Sub Sector, decentralized trading tools are primed for growth.

Credit applications proofed that they are moreover not limited to attractive interest rates for lenders while central bank rates are low, they are also capable of attractive rates for borrowers in an environment of tight monetary policy. While the 30 year mortgage rate recently hit a new decade high at 7.4 %, you can borrow at a rate between 2.7-3.8 % on Aave. Some of the more recent stablecoins such as Liquity can be even minted for zero interest rates at a one time borrowing fee as low as 0.5 %. At the same time, protocols such as Maker increase their exposure towards RWAs, now effectively lending $614 million to the U.S. government via tokenized Treasury products at near 5% risk-free rate. Novel LST backed stablecoins such as Prisma however tackle that space by utilizing the risk free rate of the crypto industry, Ethereum’s staking rewards, and bake them into highly capital efficient, liquid and yield bearing stablecoins.

With the Shapella upgrade and the emergence of Liquid Staking, a Cambrian explosion in Dapps is shaping up to heavily drive back momentum towards DeFi. Recent data highlights an increasing confidence in ETH as a productive, yield- bearing and deflationary asset. On the back of that transformative narrative, we observe plenty of new developments driven by Liquid Staking such as LST backed stablecoins, new primitives such as restaking, novel business models and first attempts to establish fixed rates within the DeFi ecosystem. The potential growth for protocols utilizing this additional design space is substantial and will likely act as structural tailwind for the entire technology stack.

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