DeFi & dApps: A Closer Look (3 of 6)
Before we begin, if you have not read articles 1 and 2, I highly recommend before continuing on…
Introduction
This category refers to general category of decentralized finance applications and decentralized apps. Often times, definitions in crypto get distorted and end up meaning something totally different than what they were intended to.
If you couldn’t tell, that statement was to cover myself in case you think I mischaracterized your favourite project (possible, but unlikely)…
To determine ‘winners’ in this section I am primarily evaluating their current fundamentals and balancing that analysis with what I believe to be their growth potential, design/incentive strengths, tokenomics (token economics), and market dynamics.
When it comes to the fundamentals for DeFi/dApps I put the most weight on revenue generation, trading volumes, total value locked in the platform, and relative comp ratios like price-to-sales and price-to-earnings.
Note: I have used a different form of quant analysis (modern portfolio theory) in the past to determine maximally efficient, risky portfolios using covariance matrices to come up with optimal allocations. I no longer do this as often.
While I acknowledge the value in this method, I am also aware of it’s limitations - especially in a space where historical returns are even less useful for predicting future returns than traditional asset classes. Thus, a return to the fundamentals is as good of a prescription as any.
Revenue is as good a proxy as you can get for a protocol’s ability to contribute to ecosystem growth. I like to combine that with trading volumes to see where the dollars are and who is capturing the most attention. After that, I look to total value locked (TVL) to signify stability, longevity, and staying power. Lastly, the comp ratios are the icing on the cake and can tell you which protocols have more room to run and grow.
Taken together, you (or rather, I) have a pretty good set of indicators for if a project will perform. There are many nuances of course, but we can discuss them as we look closer at each pick.
My DeFi/dApps Picks
Convex (CVX): Convex is a relatively new DeFi yield-aggregator that boasts over $17b USD in total value locked and is the single largest holder of staked CRV (Curve governance token).
This means that it influences CRV trends and operations, thus liquidity providers will have to acquire CVX to boost voting power and rewards (or pay for votes). Convex has placed itself a level up from Curve from a strategic standpoint and cleverly fabricated its own sustained competitive advantage and value proposition. This allows it to compete for Curve liquidity with other established heavy-hitters like Yearn. Oh wait, Isn’t Yearn also on this list?
Yes. In my eyes, selecting one category killer is infinitely harder than selecting a couple high value prospects. I like to think this indicates a lack of hubris.
Yearn Finance (YFI): Now to Yearn, which I see as a very solid pick in the DeFi category. It is quite strong in the fundamentals: Third-highest revenue, second-highest volume, and has first-rate multiples.
5.6x price to sales, 12.51x price to earnings — well below peers.
On top of that, it has great supply economics which supports the price and will be initiating large-scale buybacks and fee distributions to token holders throughout 2022.
Synthetix (SNX): Synthetix is a great example of a pick that relies more on its speculative growth potential to earn itself a spot on this list. It is no slouch in terms of revenue, but where it really shines is in capturing the focus of DeFi investors through innovative financial products and options. This is best displayed through its impressive 24hr volume metrics at $77m USD (at time of writing).
Here is how I would frame it, there are lots of people building within the project (doubled the number of monthly developers from 2021), money being thrown around on Curve pools to boost their incentives, and a heavy focus on interoperability. Taken together, these could mean big things for Synthetix in 2022.
As an aside, I’ve always been massively bullish on DeFi derivatives, and Synthetix is boldly leading the way as more and more projects use sUSD and the ecosystem starts to play together. For people in jurisdictions where the barriers to securities are high, getting exposure to blue chip equities and crypto all in one place is not something that should be brushed off.
Alchemix (ALCX): From a fundamental’s standpoint, Alchemix is not the most standout player, but don’t be misled.
This is a quality project with a relatively lower adoption rate that I believe to be just a temporary misrepresentation — an oversight by the market.
I tend to see this trend more with projects that had rocky starts: no matter what changes they make to improve their products, they go less noticed than new shiny tokens rising fast in the coinmarketcap top 200.
Alchemix is the first self-repaying loan protocol and is one of the most exciting designs that have come to decentralized finance in the last couple of years. Combine that with an ambitious, hungry team and you have the perfect recipe for growth.
I am of the opinion that this protocol could be used as the foundation for other projects and ecosystems, which will contribute heavily to it’s growth throughout 2022. For these reasons, and the primary objective of outperforming BTC/ETH, I have assigned Alchemix a higher allocation than one might have expected within the DeFi/dApp category.
Aave (AAVE): One of the most mature players in the lending space with a clear dominance by market cap, revenue generation, and volume. In fact, it only falls short to MakerDAO (also on this list) in total value locked.
It saw tremendous growth throughout 2021 driven by massive dApp adoption as a whole. As one of the largest protocols, Aave enjoyed much of the capital inflows. With partnerships, alliances, and community funding on the horizon, I can see the protocol performing well in 2022. The reason it is not higher up on this list is that I do believe it is more mature and has less room to grow than the other picks.
Compound (COMP): Compound being a steady revenue generating platform and having high value locked means it is a safe pick in my eyes for the purposes of extracting value from general DeFi growth. It is second among its peer group behind Aave for both aforementioned metrics.
I see compound as a more mature, blue-chip DeFi pick (if that exsits) — in that it will continue to perform well as the ecosystem expands, but without significant innovation to their tokenomics or product offerings won’t see as much growth as those higher up this list.
MakerDAO (MKR): The thesis for MakerDAO is pretty straightforward. It is extremely stable from a total value locked perspective, generates high revenue, captures a large percentage of volume and propagates the fifth largest stablecoin by market cap (DAI).
They have built themselves an impressive ecosystem for DAI and are not slowing down in terms of product development. Similar to compound, it is not as high risk as other, more speculative options, but a solid pick nonetheless. I predict the demand for decentralized, algorithmic stablecoins to grow (like FRAX) and thus prop up MakerDAO throughout the year.
A caveat on comps for Yearn, Compound, Aave, and MakerDAO: Across these protocols total value locked is high and revenue generation is strong, following that, the comparative ratios are also very favourable. I would caution against using these statistics to inform value-based investment decisions as it appears, in my opinion, that this class of projects (lending/borrowing/liquidity markets) does not play by the same rules as others. Rather, I think their low multiple represents not that they are undervalued necessarily, but perhaps that they are more appropriately valued given that they are driven more so by the fundamentals and less by speculative and growth-focused vectors.
Honourable mentions
Ribbon (RBN): Less favourable fundamentals, will take time for people to adopt, but worth it if you have some money burning a hole in your pocket — don’t underestimate the potential growth of blockchain powered options and financial instruments
Reflexer (FLX): A protocol I am bullish about, but was overshadowed by MakerDAO in this list. It’s price-to-sales ratio indicates that it may be overbought, though I would not be surprised if the project makes me regret not including it in my main list
Alpha Finance (ALPHA): Self-contained ecosystems suffer a bit in my eyes when they try to expand and leverage other platforms. I wanted to acknowledge the great work Alpha Finance Lab has done, but it was not enough to make it on the list. Aside from that, their price-to-earnings ratio also indicates that it might be overvalued at this time. I have this coin on my watchlist and will be regularly monitoring its performance
That’s it for today!
Please keep an eye out for articles 4–6 in this series that detail the analysis behind the rest of the categories and picks there within.
Full Disclaimer: The information provided on this website does not constitute investment advice, financial advice, trading advice, or any other sort of advice and you should not treat any of the website’s content as such. Kiran Malik does not recommend that any cryptocurrency should be bought, sold, or held by you.
