Was there a value trade on in Crypto?

Shortly after this note was written, crypto went on to stage a rather dramatic downward move, likely driven by the happenings in global macro that have buffeted markets this week. That’s par for the course in crypto. More importantly, that doesn’t detract from the key message here: that we are seeing signs of increasing maturation in the crypto markets, allowing for the emergence of dispersion, rather than the indiscriminate “everything up only”/ “everything down only” that it used to be known for.

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It would be relatively safe to say that the stock markets have started 2022 with not so much a bang as a screaming screech, as the market rotated sharply from the high growth, low profit favourites of 2020 and 2021, squarely into value territory.

The distinction between growth and value in the world of stocks is a well-established one, even if the lines may sometimes get blurred. It follows that the world of crypto, given its overarching reputation as being jam packed with speculative projects with long-dated cashflow expectations, should be at the highest end of the growth spectrum, arguably even more so than unprofitable tech.

It follows that by this conventional wisdom, if growth equities are getting politely shown the door, then cryptos must have already been defenestrated from most portfolios in a repeat of past bear markets.

We wrote about half a year ago about the propensity for dispersion to start showing up in the world of crypto, as the easy money of a market that used to be “up only” quickly faded away. To some extent, the sideway “crab market” that took hold since the middle of last year has very much been in place, although that hasn’t precluded the meteoric rise of some outstanding price performance, especially with the likes of Avalanche, Solana and Luna, along with a couple of Metaverse plays where we had previously noted a bit of a bubble.

If these were the only assets on your crypto watchlist, along with Bitcoin and Ether, you’d be forgiven for believing that the mantra of conventional wisdom is holding true, that rightly, in a rising rate environment faced with tightening liquidity conditions, crypto is in a full-blown bear market, just like high growth profitless tech. The skeptics would say they’re the same thing.

But as always, things are not what they seem beneath the surface. Look one level down, and there are signs that a bull market – albeit in a very specific sector – could be brewing.

The list of prospective outperformers might look like a blast from the past.

Hello again, DeFi

We’re usually our toughest critics, so we’ll be the first to admit that about a month or so ago, we wrote a note suggesting that most of DeFi 1.0 may be “old news”. Looking under the hood, one actually finds that in the midst of widespread bear market, DeFi (not necessarily just DeFi 1.0) MAY be staging a bit of a comeback.

Now, one could call it a dead cat bounce, especially after the extent of the drawdowns DeFi has had from its highs. That could well be the case. But the fact that they are outperforming, at least in the past few weeks, suggests that there is a rotation going on. A rotation from the growth themes of “SoLunAvax” et al. to the “cheap” valuations and established track records of on-chain necessities like Sushiswap and Curve, as well as some of the DeFi 2.0 cohort like Alchemix.

On one level, we’d argue that the very fact we see a specific collection of names outperforming in the same way a sector rotation happens in the world of equities already testifies to a maturation of the crypto market, from generalised correlation across everything (i.e. “all up only” or “all down only”), to diverse but positive correlations (i.e. “up only, but some up more than others” or “down only, but some down more than others”), to actual signs of negative correlations where there are ups and down at the same time, in the same market state.

Of course, this maturation is an ongoing process, so it would be safe to say that if one day Bitcoin hypothetically found itself at US$20k again, it is HIGHLY likely that everything else would be looking at pretty serious losses. But the progress is encouraging.

The reality nonetheless remains that we are seeing rotation and dispersion. The question is why.

One reason could be that it’s just another market play – a race to safety, as crypto traders hide in assets with low valuations and high cashflows/earnings. That may be true, although we’d be skeptical: crypto managers aren’t like traditional investment managers. If they need safety, there are stablecoins to hide in; but in most cases, their mandates and their clients’ expectations are that volatility and drawdowns are par for the course.

So, if this isn’t a tactical rotation, then could the underlying reasons actually be one that constitutes a fundamental growth narrative, the very same narrative that fuelled “SoLunAvax” and the Metaverse theme?

Gotta bridge ‘em all

To be clear, when we say that “DeFi” is having a bit of renaissance, it isn’t a sector-wide resurgence the same way a rise in, say, copper price automatically drives a move in all copper miners. There is always a method to the madness, and the challenge is to work it out.

One of the big developments in the world of crypto, not coincidentally brought forth by the rise of “SoLunAvax”, alongside other alternatives to Ethereum such as Arbitrum (and other L2 rollups), Polygon (as a side chain) and other alternative L1s like Fantom and Harmony, was the need for cross-chain solutions. Regardless of the technicalities of how, the fundamental fact is that all of these alternative blockchains/rollups/sidechain solutions promise one common benefit: faster and cheaper transactions than executing on Ethereum itself.

As a result, the nightmares of high Ethereum gas fees dissipated: everyone could now use the decentralised web without going bankrupt through fees, and developers could deploy their decentralised apps on chains that make their applications usable. Even Ethereum users were better off because the smaller transactions got taken off the main blockchain, freeing up capacity and lowering costs for those who chose to remain.

Winners all around – with one problem: most assets were still sitting on Ethereum itself. There was not only a need to bridge those assets over to the plethora of new chains (most of the chain developers provided a bridge contract for users to bring assets over), but more importantly, after they got there, many realised that there was a lack of the basic infrastructure which everyone took for granted on Ethereum.

For these new chains to realise their full potential, they had to be kitted out with the same tooling for users to utilise as the main Ethereum chain itself. Unfortunately, not all DeFi protocols heeded that call. But of those that did, one stands out in terms of its cross-chain presence: Sushiswap.

Where the crypto world previously dreamed of one single chain that could span a multi-chain world, it seems like the winning strategy is actually to have the same application span multiple chains. The instantaneous brand recognition of Sushi as an exchange across 15 different chains has put it way ahead of the predecessor it famously copied-pasted its base code from: Uniswap still operates only on Ethereum, Arbitrum and Optimism, and is conspicuous in its absence everywhere else.

Curve ball

The same can be said of Curve, the beating heart of the DeFi ecosystem in not just Ethereum, but across 7 different chains.

The best part about Curve (notwithstanding a user interface that looks like the days of MS-DOS) is that it has no competition: there is NO OTHER DEX that specialises in swaps between assets of equal value.

What do we mean by that? Take a look at the largest liquidity pools in Curve on the Ethereum main chain:

With the exception of the tricrypto2 pool, which is a three way pool between USDT, wBTC and WETH, all their other pools are largely between assets of equal value. Note: 3Crv refers to the Curve 3pool, which is a pool of the three major stablecoins: DAI, USDC and USDT.

Most of Curve’s pools are between USD equivalent assets, with two major pools of ETH and staked ETH. In both cases, they’re equal in value – swapping between them is a Curve specialty. Of note, too, is that the 2nd largest curve pool is MIM + 3Crv, where MIM (Magic Internet Money, yes it’s actually called that) is the algorithmic stablecoin minted by the Abracadabra.money protocol, a stablecoin that spans 6 different chains.

Why is this important? In a cross-chain world, Curve is critical infrastructure, because only certain assets are set up to be “bridged”, since moving an asset across a bridge isn’t actually a “move”, more like a lock-up of the “original”, and a minting of a “new” but equivalent value asset on the other side, like a back-to-back cross-currency loan. That means that on the other end is a need to do another swap of different assets with equal monetary value, a Curve speciality.

Furthermore, specific to Curve is the emergence of what is being called the “Curve wars”. The short story here is that the projects which deposit liquidity into Curve are rewarded for providing that liquidity with CRV tokens (where did you think all of that “yield” going into Yearn etc was coming from if it wasn’t lending?), which can be either 1. Sold and monetised as “yield” for depositors or increased liquidity for a stablecoin; 2. Staked and locked up to exercise a governance vote in Curve.

What does this governance vote entail? Effectively, it is a weekly vote that decides for the coming week how the weekly emissions of new CRV tokens are to be distributed across all of the liquidity pools (or “gauges”). Whoever swings the vote gets to dictate which pools get the rewards.

In the early parts of 2021, Yearn was the largest single holder of CRV tokens (specifically, their locked form veCRV aka “voting escrowed CRV”). Then in the middle of 2021, a project called Convex popped up – their sole purpose was to launch a targeted attack to hoover up as much CRV as possible in the market and seize control of the Curve gauge vote. It helped their cause, that CRV emissions were extremely high at the time, and the constant monetisation of the CRV rewards meant that CRV was constantly being sold into the market, keeping prices low.

Convex has since moved to dominate almost an absolute majority of the CRV vote:

In that process, CRV has gone over the past year from being an over-inflated supply token to one of the most desired raw materials in the DeFi world, from facing constant selling pressure to constant buy pressure because without CRV, the stablecoin economy wouldn’t have the liquidity it needs – ever more so in a cross-chain world.

Value trade or narrative shift?

What we’re seeing unfold in the world of crypto is likely to be both of the above: to some extent one could argue that the shift of narrative to seeking out a fundamentally profit-driven story as opposed to “so and so token is going to take over the world and moooooon!” is already somewhat “defensive” in nature.

And there is some truth in the assertion that there is a “value” factor in play, especially with Sushiswap being perennially named as one of the most “deep-value” DeFi protocols in terms of earnings multiples. But it is probably no coincidence that its profitability as a single protocol is a function of is capabilities and presence across multiple chains.

We’ve touched on Curve and Sushi in greater detail here, but other recent outperformers like Alchemix, Spell (Abracadabra.money) and even Yearn (aka YFI) share some, but not all, of the above characteristics.

The “value” element certainly exists, in that these have been relative underperformers for some time now. But reversing chronic underperformance requires a growth narrative – and it is very likely the potential presence of such a narrative that is the accompanying reason for a prospective DeFi renaissance.

Either way, the dispersion is certainly welcome – and long may it last.