Could DeFi 1.0 be… old news?
Photo by Annie Spratt on Unsplash
As far as unpopular opinions go, this could potentially rank close to the top. Some might even say it borders on blasphemy, certainly as something expressed only a year after DeFi summer. After all, how could the fundamental building blocks of one of the most critical segments of the decentralised web be “old news”?
To be clear, the concept of Decentralised Finance is alive and kicking. A second generation of DeFi protocols, aptly termed DeFi 2.0 and comprising the likes of Alchemix, Olympus, Abracadabra Money and Tokemak (the former two of which we’ve written about before), has arisen, building strategies that make the benefits of DeFi available not just to individuals, but to entire protocols – including other DAOs.
Olympus Pro is a clear example of how this works, allowing entire protocols to benefit from the same incentive design that powers Olympus, effectively offering protocol design as a service. Another example is Tokemak, which allows staked single-name tokens to be deployed as liquidity provisions for DEX AMMs like Uniswap and Sushiswap on a dynamically adjusted basis (and even centralised exchanges, too) – we haven’t written about Tokemak in detail before, but their blog is a fascinating read for those who are interested.
To be sure, all of these new protocols build on the concepts made real by their predecessors: Uniswap and Sushiswap’s liquidity pool tokens receive the inflows from Tokemak; Yearn’s vaults, themselves built on Curve’s reward pools, receive inflows from Alchemix’s self-paying loans; and Abracadabra channels the basics of on-chain lending pioneered by Aave and collateralised stablecoins pioneered by Maker in its creation of DAI.
But the market doesn’t seem to be generous is showing gratitude to generations past: in fact, it has a reputation for doing quite the opposite. While the DeFi ecosystem has thrived, delivering for users the plethora of benefits it promised, reaching far beyond the borders of Ethereum into other chains like Avalanche and Solana, many of the champions of DeFi summer – let’s call them DeFi 1.0, the likes of AAVE, YFI, SNX, MKR or UNI – have remained close to their July 2021 lows, underperforming even their base protocol, Ethereum.
Of course, there are exceptions: CRV for example, after a long period of underperformance, is playing catch up. But it is the exceptions that prove the norm, and very much so in this case.
Is there a chance at salvation for these former champions, often considered as “blue-chips” in the crypto world? Or have they, for one reason or another, faded into disinterest, the “old” batch of “new” technology in the crypto world?
The legions of DeFi enthusiasts will probably be able to make a strong case for the former, so we’ll play devil’s advocate here and take on the other side of the argument.
Usual disclaimers: none of this is a solicitation to buy or sell anything, this isn’t financial advice, so please ask your advisors for advice - that’s what you pay them for. Additionally, we hold positions in some of the names mentioned across the realm of stocks and crypto.
Too many forks (aka the perils of an open-sourced world)
One possible culprit for the lacklustre performance of DeFi 1.0 is simply the presence of too many shiny new competitors which are largely forks of the original code, typically deployed on a different chain but operating on the same concept. Often, these new upstarts also come equipped with generous marketing budgets, paid out in the form of big incentives to entice new users, as they promise their investors a bigger, better and stronger version of the original, with their value proposition de-risked by the fact that there was a precedent in the market that showed product-market fit.
In the defence of the “originals”, it’s not that their product is inferior. In most case, the Lindy effect applies both in terms of credibility (perceived and realised) and in terms of robustness of code and governance. After all, communities take time to build, and good governance from the community isn’t something that happens overnight.
But this isn’t a discussion about a protocol’s fundamentals. Take one look on Token Terminal at any of these DeFi 1.0 protocols and anyone will see that they are doing well revenue wise. In fact, in many cases, protocol revenues are HIGHER now than what they were when these tokens were trading at their highs, making them even cheaper on a P/E or P/S basis.
Would these revenues, earnings and user count numbers be higher if it weren’t for the presence of competing forks? Most probably, although competition was naturally to be expected for a market built on the principles of open-sourced code.
Alas, fundamentals are but a fraction of the overall picture when it comes to price performance, and at the end of the day, between being right and making money, our preference must surely be for the latter. As a result, narratives matter too.
On the narrative front, therefore, the presence of many other shiny objects competing for the attention of the notoriously fickle crypto capital pot means that no single token receives the full dose of attention (and capital) it used to garner. AAVE might be the first fully-fledged decentralised lending platform, the bluest of blue chips – but it’s just not as sexy as being able to pledge cross-chain collateral, mint an algo stablecoin, move it across multiple chains, stake, wrap, re-post, re-farm, repeat.
It’s all DeFi, but some are more DeFi than others. And while choice is good for individuals, no longer being able to dominate the narrative as the champion of some segment of DeFi, be it decentralised lending, synthetic asset collateralisation, stablecoin issuance etc means that the protocols in question have simply lost a bit of the sex appeal they used to command.
When innovation becomes standard
More ominous than the market being fickle, however, is the possibility that the innovative features that made these protocols special in the early days are now just… standard. Or even worse, no longer necessary, thanks to some other innovative solution that was more recently developed.
To be clear, we’re in no way underplaying or undermining the brilliance of the innovations of DeFi 1.0. In some cases, these innovations have become the lynchpin of much more complex systems: for example, Uniswap’s pioneering of the constant product AMM model alongside Curve’s stableswap model (the possible applications in the world of equities of which we wrote about here) underpin most decentralised trading systems in existence today. The same can be said of on-chain synthetic instruments pioneered by Synthetix, the concept of which went on to birth protocols like Perpetual and DyDx; or of Aave’s flash loans being used to swap collateral and facilitate trades on DEXes. The list goes on.
But it is precisely because of their ubiquity and the lightning speed of innovation in the crypto world that these brilliant innovations are now pretty much seen as a basic requirement of any new protocol that wants to be taken seriously.
Whereas a traditional company would have launched into a patent battle in an effort to claim royalties, an open-sourced protocol with code that is publicly available accepts the copy/paste of their innovation as fair game. The hope was always that the first mover advantage, alongside the strong community built around these protocols, would continually provide the critical mass of users that would make the “original” the protocol of choice for any user that is just getting involved in the ecosystem.
As it stands, however, despite all the loyalty and allegiance of the founding communities around these pioneering protocols, broader interest in owning these tokens appears lacking. Users come and go, and they pay their fees, but in the cutthroat world of DeFi, user loyalty isn’t something to be taken for granted.
In many cases, these DeFi 1.0 protocols remain essential building blocks for new projects in DeFi 2.0, allowing them to continue to grow earnings and continue to grow as a business. In others, the need for a DeFi 1.0 building block isn’t so clear, especially when the concept itself can be replicated without necessarily using the original DeFi 1.0 protocol.
Let’s illustrate this with an example: Alchemix (DeFi 2.0) continues to utilise Yearn vaults and Curve liquidity pool gauges (DeFi 1.0) to generate the yields that power its self-paying loans. There is an ongoing shift towards Convex (we’d call it DeFi 1.5 as it’s kind of halfway in between) but the general idea is that we have a DeFi 2.0 protocol that is built directly upon protocol-level utilisation of DeFi 1.0 protocols.
On the other hand, consider something like DyDx, which is a decentralised derivatives exchange which allows users to trade synthetic instruments and take long and short positions. The concept is similar to what Synthetix pioneered – but does DyDx need to utilise SNX as an underlying building block? Not at all, just the concept.
Take another example, of Abracadabra Money: its stablecoin, MIM (aka Magic Internet Money) is a cross between an algorithmic stablecoin (like Ampleforth) and a backed asset (like DAI). Does it use any of its predecessors in constructing its offering? Not at all. Just the concept.
There’s composability, and then there’s copy/paste
DeFi enthusiasts (including ourselves) often use the word “composability” to describe how a decentralised system permits developers to combine different existing technologies to form new products and services, what is these days called by many of the more illustrious commentators than us, “Money Lego”. That is absolutely true, but the question is “whose Lego blocks?”.
The most fundamental Lego blocks in DeFi are those that are provided within the compiler of Ethereum’s programming language, Solidity. DeFi 1.0 was built on this same code, even if upgrades can happen over time. As we have now seen, there is very little standing in the way of a new developer, with a completely clean sheet, copy-pasting the publicly available code of multiple projects and patching it together to build something new.
The only time a developer would NOT do that, and instead use a pre-built code library or execute code built by an existing project, is when it is MUCH easier to just plug and play. Put differently, for a DeFi 1.0 protocol to remain viable over time, it needs to be complex enough to be a waste of time to replicate but also be able to offer something that a developer cannot simply write up from scratch code: locked funds, privileged access to certain functions, a committed user community etc.
On the flipside, one could ask the question: why don’t these DeFi 1.0 protocols evolve and upgrade themselves, and offer users all the fantastic new functionality that they want since it’s all built on their innovations anyway?
It’s a great question for the founders of these protocols, but we can take a guess at their answer: it likely has to do with focus, and making sure that as an essential part of the DeFi infrastructure (remember the ubiquity), their core offering does not even glitch one bit.
Such are the pains of being big, established and systemically important. The responsible thing to do is to keep the machinery running smoothly, rather than chase after the next big thing. After all, as long as revenues and earnings are growing (albeit at a slowing pace thanks to a massive base), the business can continue to run itself. Innovations can be pursued as long as they don’t risk toppling the boat.
As for the token price, that’s a decision for investors to make on their own.
Sounds like something you’d hear from a bank CEO? Perhaps it could be that running a bank on the decentralised web isn’t that different from running a bank in real life.
The devil, as always, is in the detail: DeFi 1.0 may not be dead (although some protocols may well be on the decline), but they have certainly grown up since DeFi summer.
And by the way, the same will eventually apply to DeFi 2.0. And 3.0, 4.0 and so on. Because one thing’s for sure, a new wave of innovation ALWAYS comes to challenge the old – faster, more secure, bigger and better.
Because one day, even the “new” news will become “old” news.