Avalanche has become one of the top layer 1 blockchains for decentralized finance (DeFi) on the back of its compatibility with Ethereum, strong native token incentives for blue chip projects, and a vibrant VC, incubator and launchpad ecosystem. AventuresDAO is proud to be one of the many supporters of Avalanche projects, joining other contributors such as Colony Lab, Avalaunch and the Blizzard Fund. In anticipation of the Summit in Barcelona this month, DAO member Rasheed reports on the state of DeFi on Avalanche. This first week covers the history and the status quo, while future blogs will present the AventuresDAO DeFi investment thesis: Where are we, as dedicated members of the Avalanche community, putting our time, money and energy?
Part 1: The Rise of DeFi
Alternative Layer 1s
Decentralized finance was jump-started in the “DeFi summer” of 2020 on Ethereum, still the dominant smart contract platform.
In early 2021, lacking better alternatives, smaller users and lower-value services were driven by spiking transaction costs on Ethereum to cheaper and less secure side chains and Ethereum “forks” (copies) such as Binance Smart Chain (BSC) and Polygon.
These newly-emergent DeFi ecosystems consisted of (often) poor copies of Ethereum’s original protocols. Nevertheless, the savings in transaction costs — “gas” fees — brought in users, proving that there was a product market fit for blockchains compatible with Ethereum, yet cheaper and faster. By May 2021, BSC and Polygon together had attracted $30 billion in “capital committed”, also known as Total Value Locked (TVL).
It wasn’t until the summer of 2021, in many cases after years in development, that newer alternative layer 1s, with better security and reliability, began to attract the attention they deserved. And prices spiked. In the past year, most of the top challengers saw gains in the triple digits.
In terms of attracting capital and users, some highly-specialized chains gained significant traction, for very specific use cases. Terra is focused on supporting and providing a platform for its algorithmic stablecoins, including the fast-growing UST. Solana is a work in progress, attempting to push the limits as to what is possible in order book trading.
Several other chains chose to focus on improving upon Ethereum’s proof-of-work consensus while remaining compatible with its virtual machine (the EVM). Such chains provide an Ethereum-like platform to support any and all applications — gaming and NFTs, of course, but especially DeFi.
Enter 2022, and with Ethereum layer 2s on the rise, the race is on to attract users, developers, new use cases, and the dominant giants of decentralized finance.
Avalanche
In terms of ecosystem development, capital deployed (TVL) and user growth, Avalanche, one of these EVM-compatible proof-of-stake (PoS) smart contract platforms, has been growing its DeFi ecosystem even through the recent crypto market volatility. While the overall market has been shrinking of late, Avalanche has been taking market share from earlier, more centralized and less reliable EVM compatible chains, such as BSC.
Layer 1 season began in the spring of 2021 with Terra scaling up its UST dollar-pegged stablecoin, and offering a 20% annual return in its Anchor protocol. But, by the summer many other layer 1s were growing as rapidly, including Fantom, Solana, Tron, Harmony and of course Avalanche.
Early pioneers built out a full DeFi ecosystem, and users began slowly migrating to the smooth UX and EVM compatibility of Avalanche by the spring. Snowball was the first yield aggregator and the first stableswap DEX (which became Axial). Pangolin was the top DEX for some time. Yet there was so much more to come.
Avalanche timed its incentive program perfectly with layer 1 summer, launching Avalanche Rush, AVAX rewards to entice blue chip protocols to move to Avalanche, in August 2021. Soon after, Avalanche launched its Blizzard ecosystem Fund. Avalanche TVL exploded, and this momentum has carried on into the new year.
While Polygon, BSC, Fantom, Solana and even Ethereum have seen significant declines in the past 30 days, Avalanche, along with Terra, are shrugging off the volatility. Recent launches (Platypus and its ecosystem) and additional volumes in stableswaps (Curve) have been driving the recent growth.
Even without the incentives, Avalanche would have attracted many of the blue chip DeFi platforms, as it’s reasonably straightforward to port Ethereum Dapps over. Solidity developers need to change only a few lines of code. And new Avalanche protocols are also easier to fork from Ethereum, or develop from scratch, as Solidity remains the language of choice for EVM devs.
While NFTs and GameFi have exploded on the network — the Crabada game accounts for over a quarter of all transactions — DeFi is driving Avalanche use. And users in turn are demanding more from DeFi. Avalanche is currently averaging a million transactions per day, not far off of Ethereum’s 1.1 million per day in the past week.
The DeFi primitives
The first order of business for an emerging blockchain is to offer all the tools users require to get on-chain, trade tokens, short assets, leverage their crypto, and manage positions. The protocols needed to recreate an asset trading and speculation ecosystem on-chain include:
- Exchanges.
- Borrowing and lending protocols to facilitate margin borrowing and short selling.
- Yield aggregators to manage token awards that compensate for capital inefficiency (and more!).
- Bridges that represent assets from other chains on Avalanche (e.g. BTC wrapped as wBTC to be used on Ethereum).
Tokens can be traded on-chain on decentralized exchanges (DEXs), both for spot and perpetual swaps (perps). Due to Ethereum’s limitations, most DEXs were designed to be automatic market makers (AMMs). Liquidity providers (LPs) deposit tokens in a trading pool passively, allowing traders to swap one token for another on-chain, non-custodially and permissisonlessly.
Using the x * y = k model, prices are set equal to the ratio of the two tokens on the exchange. On its own the system is far from ideal, but arbitrageurs who trade on centralized exchanges and other decentralized exchanges keep prices consistent.
Leverage and shorting are facilitated by the borrowing/lending protocols. In an Aave or Compound type platform, users borrow tokens by depositing (overcollateralized) other tokens. This is often best for obtaining the means to short sell. Collateralized Debt Position (CDP) protocols such as MakerDAO and Alchemix mint a stablecoin in return for an overcollateralized deposit. That stablecoin can then be sold to buy more of a risky asset, effectively a decentralized form of margin lending.
Liquidity provision in passive automated market makers are not only capital inefficient, but they generally expose depositors to impermanent loss (IL). At the same time, borrowing and lending protocols often require so much overcollateralization that using the protocol can be uneconomic. Inflationary token rewards are used as incentives to compensate for capital inefficiency and sometimes even IL.
Managing these rewards can be complex, inefficient without scale, and time consuming. As a result, yield aggregators, “autocompounders” and so-called “bribing” protocols were developed to manage the optimization, “harvesting” and reinvestment of rewards.
Including bridging protocols that facilitate interoperability between chains, the four primitive use cases account for over 90% of all-chain DeFi, as measured by TVL.
Any chain that wants to DeFi must have a diverse selection of such protocols. Avalanche, of course, is no exception.
The DeFi explosion on Avalanche
The Rush incentive program met its goals in bringing the big cross-chain DeFi protocols to the Avalanche network. But homegrown DeFi also developed alongside.
Other than a slight bias to borrowing/lending (45% versus 35% on Ethereum), Avalanche has replicated the DeFi primitives in much the same ratio as Ethereum.
The keen-eyed will see that Trader Joe is the most successful native protocol on Avalanche, first among non-stableswap DEXs and third in borrowing/lending TVL.
Trader Joe as a case study: Incentives x innovation
Before Avalanche Rush, most dismissed Avalanche’s Trader Joe AMM DEX as another Uniswap v2/Sushiswap fork. Then degens “aped” while the incentives were more than competitive with Ethereum DeFi.
As a result, Trader Joe was responsible for a significant amount of Avalanche’s total TVL rise as the Rush incentive program kicked off. At its highest in the fall of 2021, Trader Joe accounted for over one third of all TVL. Rush benefited Trader Joe, which benefited the Avalanche DeFi ecosystem.
But TVL is far from the only story. In fact, Trader Joe is one of the highest-earning protocols in all of DeFi, for its LPs and for JOE token stakers. Trader Joe is currently tied for fourth highest grossing DEX with Sushiswap, with only Uniswap (Ethereum and layer 2s/Polygon), PancakeSwap (BSC) and Spookyswap (Fantom) ahead.
While Uniswap does not accrue fees at all, JOE tokenholders can stake on the platform to earn 0.05% of every swap. As a result, JOE stakers receive higher returns than all but three DEXs, and platform earnings put Trader JOE just inside the top 10 in all of DeFi. Annualized at current levels, at today’s prices ( ~ $1) Trader Joe has a price-earnings ratio of 12x on a fully-diluted basis, almost unheard of in DeFi, and incredibly cheap for even a traditional growth company.
Trader Joe didn’t stop at being a fork of a traditional AMM, and has continued to innovate and grow. The solid earnings suggest that users enticed to Avalanche and Trader Joe for the incentives stayed for the use cases. In addition to dominating trading volumes on Avalanche and generating fees for LPs and stakers alike, Trader Joe is one of the top borrowing/lending protocols.
Trader Joe is also a launchpad, responsible for bringing some important tokens to market in just a couple of months. Rocket Joe is on its fifth launch. An NFT marketplace, JOEPEG, will be launched any day now.
In successfully integrating borrowing/lending and a launchpad, Trader Joe has pulled off what Sushiswap had intended: to offer all of the DeFi primitives on one platform.
Trader Joe has also innovated on its tokenomics. The Sushiswap model of staking JOE for xJOE without locking served a purpose when incentives were high, but new staking began to fade late last year. In fact, JOE stakers were dumping their rewards, putting pressure on the JOE token. xJOE staking had leveled off in the 90 million tokens range for some time.
Additionally, the xJOE design was suboptimal from a UX perspective, as the contract prioritized gas saving. Avalanche does not have this same constraint, and sought to improve tokenomics without concern for the high gas fees on Ethereum.
So in February xJOE became sJOE, where protocol fees were paid in the USDC stablecoin rather than in JOE, and stakers could also earn rJOE, which offered access to new token launches on Rocket Joe. Finally, Trader Joe is about to introduce veJOE, which mirrors Curve’s vote escrowed staking tokenomics. veJOE earns boosted rewards for liquidity providers, and allows stakers to vote on which pools receive JOE incentives.
With all of this innovation — access to new launches, boosted LP rewards, voting and fees paid in stablecoins, JOE is accruing more value in more ways than ever. Though Trader Joe is now maturing, and other protocols have begun to drive new capital to Avalanche, it is hard to exaggerate the boost Trader Joe gave to the Avalanche ecosystem early in its DeFi journey.
Avalanche — Some final observations
DeFi on Avalanche is competitive and innovative. Cross-chain blue chips are major players, of course. Two of the biggest blue chips are very active on Avalanche, with Aave being the largest protocol in terms of TVL, followed by a strong showing by Curve, the dominant stableswapper. Alpha and Sushiswap are some way behind.
Drilling down, however, we can see some differences remain as compared to DeFi primitives on Ethereum. There are several native champions, as there are on most chains, with Benqi and of course Trader Joe being two of the largest.
Stablecoins and stableswaps: CDP stablecoins on Avalanche are indeed tiny, and algorithmic stables are non-existent. While stablecoin protocols such as MakerDAO (DAI), Terra UST, Frax and Abracadabra (MIM) are some of the largest platforms in all of DeFi, only minute quantities of Avalanche native stablecoins H20, MIM and MAI exist.
Yet perhaps Avalanche doesn’t need to re-invent the wheel when other chains are already ahead. Bridged stables such USDC.e are already readily accepted and traded on Avalanche, while native fiat-backed stablecoins USDT and USDC appeared in Q4 of last year.
Curve leads stableswap TVL on both Ethereum and Avalanche, but competitor Platypus is catching up using similar veCRV tokenomics. With enhanced bribing but with less experimental stablecoins (MIM was recently deprecated), will Vector/Yield Yak/Echidna on Platypus be able to replicate the Ethereum “Curve Wars” on Avalanche?
Order-book DEXs: Somewhat surprising in the reliance of old-technology Uniswap v2 forks for market making on Avalanche. Trader Joe, using Uniswap’s v2, absolutely dwarfs Uniswap on Ethereum as a percentage of total DeFi.
Even though Avalanche technology permits the popular central limit order book (CLOB) system for matching orders, GMX (for perps) and soon Dexalot are the only up and comers in the space. Who will be the innovators that optimize for Avalanche’s high throughput and fast finality?
Yield aggregators: Avalanche has a significant number of bribing, yield optimization, leverage and autocompounding platforms. Whereas Ethereum is dominated by Yearn (autocompounding and managed yield strategies) and Convex (adding bribing), Avalanche has six protocols in the top 20. Two of these are exclusively bribing protocols, even though there are few bribing opportunities in the current market. None of these yield protocols are particularly significant to the DeFi ecosystem.
Alpha offers leveraged farming, leaving Yield Yak as the dominant aggregator, yet with only less than 3% of DeFi TVL. So there are lots of small competitors in a small market. Is a shakeout due, or will the market grow into Avalanche’s yield aggregation capabilities?
Final Thoughts
Based on our recent early stage investments and the exciting new opportunities we are seeing at AventuresDAO, we expect Avalanche devs to build on the existing primitives to expand the DeFi ecosystem. While some incumbents look well-entrenched (e.g., Trader Joe), others such as Platypus for stableswaps are starting to reveal their potential.
Next week I will highlight where the gaps and opportunities lie, and what the future holds for the Avalanche DeFi.
Some useful tools and news sources
https://www.weekinavalanche.com/
https://explorer.avax.network/
About Rasheed
Rasheed Saleuddin, PhD CFA is an ex-hedge fund manager and experienced crypto angel, currently investing and advising with AventuresDAO, TheBoringDAO and the Cosmic Cartel. He also researches digital assets at the University of Cambridge Judge Business School (CCAF), where he was a finance post-doc.
About AVentures
AVentures is an investment DAO composed of OG Avalanche community members on a mission to support the ecosystem. The team boasts multiple successful blockchain developers and project owners, content creators, advisors and domain experts that have come together to channel our expertise to support the Avalanche ecosystem.
AVentures DAO:
- Provides advisory and marketing support to new Avalanche projects
- Supports Avalanche projects by investing in seed/private rounds
- Incubates new projects via mentoring
- Publishes technical analysis on DeFi projects
