As an avid DeFi user and investor, I was scrolling through Twitter and stumbled upon this fascinating report on how to value DeFi Lending tokens:
In short, Christanto explains that a ton of capital went to DeFi projects, specifically DeFi Lending protocols with a high total value locked (TVL).
As TVL grows, so does the price. That’s just what it does these days. Price follows TVL, period.
But what happens when tokens meet gravity and trade on valuations? Does a high TVL justify a high token price?
According to Christanto, she’s doubtful that’s the case because the reality is, there’s just too much supply over demand for these types of services on the market.
Take Aave for instance, there is $1.8B sitting in AAVE waiting to be borrowed. But get this, a whopping 70% of it is just sitting there. It’s not being used, and it's resulting in a lower average APY % for lenders.
The same goes for Compound. The platform has more than $8B in deposits available for lending yet more than half of it is just sitting there, making the TVL look big while lowering the APY % for lenders.
That said, when valuing crypto why do we really care about TVL when there’s no actual demand for it? When you look at it from this perspective, suddenly you realize that there’s more at play here.
I think that soon, people will realize that TVL is no longer the sole metric they should look at when evaluating a project, but also the utilization rate.
Again, take Aave for instance:
Since 70% of Aave’s deposits are not being used, a massive chunk of it might flee to other protocols seeking better returns. When this inevitably happens, Aave’s TVL will drop and its price will eventually follow as value leaves Aave to be utilized and accrued elsewhere.
Therefore, while getting a huge TVL inflow is great and all, what really matters is offering strong incentives to keep it there. If the incentives are weak or simply dry up, then the question is; will depositors stay or will they flee?
My bet is they’ll flee and Messari has data to support that’s already beginning to happen. As seen in the image below, DeFi Lending platform Alpha Finance has siphoned about 10% market share from the DeFi Lending kings, Compound and Aave.
2020 Was a Year of Incentivised Capital
For all you in the know about DeFi, you probably remember $COMP incentives in June 2020, when the DeFi boom started. People were able to put their idle, post-winter crypto assets to work and finally make some money off them through interest and $COMP token rewards for lending and borrowing (this campaign is now over, it lasted ~2 weeks).
It was a huge success and really put DeFi in motion. More and more DeFi projects began incentivizing usage with token rewards and their TVLs went up as a result. There’s now more than $64B TVL in various DeFi protocols and this number keeps on growing week after week, month after month.
But now what?
We have loads of liquidity and capital out there, the DeFi incentives brought about in 2020 made sure of that. Now, however, much of that capital is just sitting there, waiting to be put to work.
Therefore, we’re left with the question of, not how do we grow liquidity and capital, but how do we incentivize utilization of said capital.
That is the question… And I have the answer.
Keep on reading friends ;)
2021 Will Be The Year of Incentivised Borrowing
Lending and Borrowing are the essential parts of tradFi. This won’t be different in DeFi.
There’s a reason the top 3 DeFi protocols in terms of TVL (ie. Maker, Aave, and Compound) are all Lending protocols. But as described above, TVL alone can’t be used to value a Lending protocol. You need to combine it with the metric of utilization. Only then will you have a powerful valuation model that should hold up during times of fear and uncertainty.
That said, as a Lending platform how do you ensure your deposited capital gets utilized? It’s simple really, you just need to provide more incentives to get that capital working. If the incentives are there, it will happen.
This is something Aave has begun to realize, so they laid out a proposal on February 5, 2021, stating that they plan to launch a liquidity mining program that not only incentivizes lending but also borrowing too.
The proposal states:
“With almost every major DeFi protocol launching a liquidity mining program, we believe it would be advantageous for Aave to utilize part of the Ecosystem Reserve to drive lending and borrowing activity across markets. Distributing $AAVE to borrowers and lenders acts as an added incentive to attract more capital.”
It’s interesting to see that Aave plans to incentive borrowing in addition to the usual incentivized lending (earning interest on deposited capital). If borrowing is incentivized, more people will be inclined to borrow which will put unused deposited capital to work.
Yield Credit Beats Aave to the Party
Yield Credit Dapp Interface (Source)
While Aave is just starting to think about incentivized borrowing, there’s this lesser-known DeFi Lending project called Yield Credit which was built with an incentivized borrowing mechanism from the get-go.
Yield Credit is a decentralized, non-custodial, peer-to-peer (P2P) lending platform with an incentivized borrowing & lending mechanism baked-in to the protocol using its native cryptoasset $YLD as rewards.
Yield Credit took the existing DeFi Lending model and completely revamped it to ensure its TVL was actually being utilized. You see, unlike other lending platforms such as Compound and Aave, Yield is an individualized lending and borrowing platform (ie. Peer-to-Peer, not pooled).
This key fundamental difference changes the DeFi lending game as it opens up the door to things like fixed, guaranteed interest rates for lenders and incentives for borrowers to maintain healthy loans and repay on time to earn $YLD token rewards.
That said, not only are lenders incentivized by earning interest (as per usual), but it’s even better because they earn guaranteed fixed interest rates. But the biggest game-changer here is that borrowers are also incentivized to maintain healthy loans and repay on time as they can earn up to 350 $YLD token rewards for doing so.
Aave and Compound can’t implement these things in the same way because they use a money-market model where deposited funds get added to a pool with everyone’s funds, and from this, borrowers collateralize some of the deposits and borrow from this pool.
This interplay of “supply” and “borrowing” from a single pool affects how rates are determined. There are no guarantees and rates are not fixed, which increases the risk for borrowers if rates go up and is unfavorable to lenders if rates go down.
With Yield, however, Lenders don’t have to worry about market dynamics causing the rates on their active loans to trend to ~0%, and borrowers don’t have to worry that their interest rates will rise at all. Instead, lenders and borrowers are in full control. When you create a lending offer or borrow request, you can choose anything from 2% up to 12.5% interest with any duration.
Since Yield loans are individualized, you can lend or borrow any ERC-20 token. If there’s a demand for a specific asset, you’ll be able to create a lending offer for it. If you desire a specific asset, you’ll be able to create a borrow request for it. The fact that any ERC-20 token is fair game is a true game-changer. It will open the floodgates to an immense amount of capital that couldn’t previously be lent out or borrowed with existing platforms.
All in all, Yield Credit is the pioneer of incentivized borrowing and once it launches on Ethereum mainnet, watch out. It’ll be a DeFi Lending protocol to keep your eye on.
I’ll leave you now with some further Yield Credit bullets points to take away:
- First platform to have $AMPL as collateral
- Any coin with a Chainlink feed can be used as collateral
- The most extensive list of collateral options from Day 1 (31 in total)
- Fixed rates from 2% to 12.5%
- 100% of fees used to buyback $YLD on the open market and burn it, thus reducing the total supply of $YLD.