Synapse Protocol
DACM Special Situations Snapshot
This has been prepared by DACM’s Special Situations Team. This Team is focussed on researching and investing in bleeding-edge technology within the digital asset sector and supports DACM’s fund and proprietary investment functions.
Summary
The Smart Contract protocol space is transitioning from one dominated by Ethereum, to one composed of many blockchains with disaggregated layers. This has been reflected year-on-year with Ethereum’s share of the Total Value Locked (“TVL”) in the Smart Contract market falling from c. 97% to c. 60%. As this trend accelerates, which DACM expects it will continue to do, the flow of value between rollup-layers as well as alternate blockchains will grow exponentially and cross-chain operations will eventually become as ubiquitous as swaps have become on centralised exchange venues.
This trend sets the stage for material value to accrue to the interoperability layer, as bridging and cross chain/layer swap volumes grow. DACM has a number of investments that can benefit from this thesis and within its liquid, long-only funds, has invested in Synapse Protocol ($SYN), a protocol aiming to provide both smooth and secure cross chain swaps and bridging to crypto users reducing transaction complexity and friction. This is a critical ingredient to scaling blockchain technology to meet the wave of new, more outcome (as opposed to the technology) focused users.
Market for Bridging
DACM has had conviction in a multi-chain future since the firm began investing in 2017 and has invested in, and supported a number of layer-1 protocols both at a venture and listed stage. Initial smart contract growth was almost solely around Ethereum and this continued through to 2020’s “DeFi Summer” where almost all transaction activity and app development were still taking place on Ethereum. However, the subsequent overwhelming demand for blockspace combined with the constraints created by Ethereum’s scalability trilemma caused fees to push DeFi usability on Ethereum out of the reach of small and even most medium-sized users.
Without having Ethereum centric rollups in a position to absorb the excess demand, although arguably this likely still wouldn’t have provided the necessary capacity, the scene was set for the emergence of a number of new, super-high-growth smart contract protocols in 2021 as the multi-chain landscape started to take shape. Over the course of the year Ethereum, in TVL terms, ceded nearly one-third of its share in the smart contract platform market — it still grew by a staggering 530% across the year however alternative, non-Ethereum chains grew at 974%.
A multi-chain world created a set of new hurdles — the most relevant being liquidity and user fragmentation, as well as composability degradation (as most blockchains cannot natively interact with one another). To solve this, there are at least 40 bridge/interoperability projects which are attempting to facilitate the flow of information and value between different blockchains, all with varying degrees of design, security, user experience and purpose. As the Layer 1 game of large, mercenary capital flows in addition to organic user and developer activity continues, successful “picks and shovels” projects, of which DACM believes Synapse Protocol can be, stand to benefit from what is likely to be one of the highest growth sectors within crypto.
We have already seen glimpses of this growth in 2021, with the TVL of chain specific bridges growing from $1.27bn to $34.69bn through 2021, representing a c. 2,600% increase.
For a more technical summary of bridges and their mechanics, here is an excellent article by Dmitriy Berenzon which elegantly explains the various ways in which bridges have been designed and much more.
Synapse Protocol Primer
Synapse Protocol is a spin-off from Nerve Finance, which was originally conceived as a Binance Smart Chain AMM designed for low-slippage trading of stablecoins and other pegged assets. Synapse Protocol was reborn as a cross-chain liquidity protocol offering users sub-3-minute bridge times of assets between chains as well as rollup layers, and native cross-chain asset swaps. Synapse Protocol supports bridging and swaps across all major EVM compatible chains, including Ethereum, BSC, Polygon, Avalanche, Arbitrum, Optimism, Fantom and Harmony. TVL currently sits at around $1.1b with Synapse holding the most liquid ETH pool for Arbitrum and Optimism.
Further details of the mechanics of the protocol can be found through these documents and DACM also suggests reading Nick Garcia’s (Messari) excellent thread to help grok key concepts such as multi-party computation (MPC), threshold signature schemes (TSS), and nUSD and nETH.
Synapse is able to offer native cross chain swaps. The advantage of this is that users do not have to hold additional risk in the form of wrapped/pegged tokens which are often custodied by a bridge protocol. Historically speaking, bridge exploits have been all to frequent, with some major attacks this year including THORChain (three times), Poly Network and ChainSwap. Synapse attempts to de-risk this element of bridging for users by designing cross chain swaps to be native < > native.
We believe Synapse Protocol has a potential UX edge, as users never have to interact with central exchanges (no KYC/AML), and can seamlessly bridge to/from anywhere in the EVM world in a permissionless, low friction manner all from one user interface. When this is coupled in the future with Rust, IBC and UTXO bridges, Synapse will offer potentially market-leading bridging coverage for users.
Synapse Protocol’s simple UI and broad chain offering has seen it process $5.1bn in bridging volume since launch in August 2021, alongside >30,000 unique users since early November 2021. The protocol is currently processing ~$100m in cross-chain bridge volume and ~5k unique transactions on a daily basis.
This compares favourably with many other bridge protocols such as RenVM which processes approximately $10mn per day, Celr Network which processes $20mn — $50mn per day and THORChain which has not reached its full unguarded mainnet yet.
Roadmap
Synapse Protocol remains in active development with a capable and growing team. The roadmap can be categorised into the following three phases:
- The Hadean Phase: A time of growth and rapid development, while having numerous guardrails ensuring safe deployment of new features. Validators are selected based on community governance and consensus. This is the current phase of the Synapse Protocol.
- The Archean Phase: Further validator decentralization is introduced, primarily via the launch of the Synapse Chain, economically secured via Delegated Proof of Stake (DPoS). Validators and delegators are incentivized via SYN rewards and protocol fees. In order to maintain the honesty of individual validators, and thus the security of the network, they will be subject to slashing of their staked SYN upon engaging in either negligent or malicious behaviour. Delegators will be subject to the same slashing as their chosen validator. The Synapse Chain will create a cross-chain interoperable ecosystem, secured by SYN, connecting all chains.
- The Proterozoic Phase: The Synapse DPoS Chain continues to grow and harden. The network is further decentralized by integrating Zero Knowledge Proofs, allowing anyone to relay and settle cross-chain transactions.
Beyond this, the Synapse Protocol team has a UTXO-EVM and Rust-EVM bridge in development. Each of these bridges could be significant drivers of volume in the near future, allowing swaps as well as transfers natively to Bitcoin and Polkadot parachains.
Finally on the roadmap, there was this alpha leak recently from the Discord tweeted by Aurelius, Synapse Protocol’s lead:
Tokenomics
Currently SYN is a pure governance token, however, with the implementation of SIP-6 and eventual transition of Synapse Protocol to a DPoS chain, the token model will significantly change. Under the simple governance model of value, the value of SYN can be looked at in terms of protocol income, but with the transition to a sovereign DPoS chain during the “Archean Phase”, security value becomes a dominant factor as validators begin to stake SYN.
Potential Catalysts
- Continued growth of the multi-chain and multi-layer world driving value accrual to the interoperability and interchain service oriented projects.
- Increased user activity on rollup layers increasing demand for fast transfers/bridges, which is a core Synapse offering.
- New EVM bridges to Bitcoin and Polkadot could increase volumes materially.
- Significantly improved token model arising from the transition to the “Archean Phase”.
Risk Considerations
- We believe the bridging market offers compelling growth prospects but it is also very competitive and users are likely to demand increasing tight pricing outcomes.
- Bridge projects are some of the riskiest in terms of exploits/loss of funds. Synapse therefore runs a heightened risk of being exploited vs. an average application layer or protocol asset.
- Applications desiring to use their own bridge integrated into their UI may end up accounting for large amounts of bridging volume, and will essentially be abstracted away from the user. Application specific interoperability projects like Synapse may suffer if they cannot get backend integrations.
Conclusion
The interoperability of blockchains is a key investment thematic for DACM — both within the Firm’s VC and liquid portfolios. Finding focused, differentiated investments outside of the key layer-1s, has been difficult albeit DACM has a number of positions we believe have excellent positioning. Synapse Protocol is one of the market leading bridging protocols being developed by some very talented anons and has potential to become essential infrastructure in the emerging multi-chain paradigm — a strategic and valuable position to hold and the reason DACM’s liquid funds hold long-term positions in SYN.
