Ask Georges: DeFi Ecosystem Growth

By Andy Kangpan on May 5, 2022

2022 will bring explosive DeFi ecosystem growth in terms of total value locked (TVL), with many trends contributing to the inflow of new capital. However, we believe the most important force to watch is the fragmentation of the DeFi ecosystem across base layer chains outside of Ethereum, which includes the likes of Solana, Terra, Near, and many others.

We asked Georges Doribot, our AI team member and proprietary research tool that helps our team find new, innovative startups to back: which DeFi ecosystem has seen the most growth in the past 6 months?

Our team of engineers worked with Georges to dive deep into data available via DeFi Llama, a DeFi TVL aggregator. After sorting through this data, it’s interesting to see that many ecosystems have only seen very modest gains in TVL. Only a couple ecosystems have seen significant growth including Avalanche and Terra, with the latter being the clear winner in terms of TVL growth over the past 6 months (see chart below).

Key Drivers of Terra’s Growth

There are many factors we can point to. First, the organization behind the Terra ecosystem, Terraform Labs (TFL), is a force to be reckoned with. Led by its charismatic leader, Do Kwon, TFL has brought on unbelievably talented individuals who have championed a number of projects and initiatives that have driven the crypto market’s attention towards their emerging and we believe soon-to-be-dominant ecosystem.

Source: TSV Analysis, DeFi Llama Data

UST, for example, has become the dominant decentralized stablecoin in the crypto market in just a short period of time. UST is not backed by fiat currency, and its peg to the dollar is maintained by Terra’s native currency, LUNA. For every new UST that is created, $1 worth of LUNA is subsequently burned.

Terra’s Star Player Project in Terms of Driving TVL Growth

According to DeFi Llama data, the Terra project that has brought in the most TVL is Anchor (see chart below). A wildly popular and controversial protocol, Anchor offers users a stable and attractive rate leveraging a diversified mix of staking yields, money markets and token incentives. The current annualized deposit rate is ~18% APY, which is significantly superior to competitive “stable” alternatives such as the ~3-5% rates one can get on USDC deposits.

Source: TSV analysis, DeFi Llama

A big question facing the protocol is whether the rate it offers users can be sustainable over time. When the protocol is unable to deliver against its promised rate (known in the network as the “Anchor Rate”) due to fluctuations in available yield opportunities in the DeFi ecosystem, the project dips into its reserves to deliver on its promise. Recently, the community noticed that the protocol was burning through its reserves at a faster rate to deliver against the Anchor Rate. This was quickly followed up with an injection of $450M UST into the network (Bloomberg).

Skeptics of the Terra ecosystem pose reasonable questions about the sustainability of initiatives that have driven the ecosystem’s recent growth. However, what cannot be denied is the pace of innovation and success the Terraform Labs team and the Terra community has exhibited in opening up the crypto ecosystem to a broader user and capital base.

We spoke with SJ Park, Head of Special Projects, Terraform Labs, to get his take on the incredible growth of the Terra ecosystem over the past six months. SJ shares, “In addition to the rapid rise of Anchor’s TVL to date, the success of new protocols like Stader and PRISM (combined $1.5B in TVL) has been particularly exciting, as well as cross chain strategies that are effectively proliferating UST in other ecosystems such as Avalanche and Solana. We’re looking forward to more innovations in crypto and continued UST adoption everywhere.”

At Two Sigma Ventures, we are excited to invest in opportunities that have the potential to expand the “installed” capital and user base in the crypto ecosystem. In order for the market to mature, projects will need to address key pain points that are preventing large players from entering the market and develop new use cases that drive relevance for a broader subset of users.

This was in part the driving force behind our investments in projects such as Pyth, which is developing sophisticated pricing data that should enable more robust financial applications to be built in the DeFi ecosystem, and in Rally, which is empowering digital creatives to engage and monetize their audiences directly without the need for a centralized platform intermediating the relationship.

Opportunity Areas to Expand the Market

Looking ahead, we are focused on a number of themes that we expect will expand the crypto market.

Enabling infrastructure for institutional investors. Institutional trading volume will far surpass retail, as they do in traditional financial markets, in the coming years. We are in the early innings of this transition and we believe there are a number of opportunities that will benefit from this shift such as technology and services that drive capital efficiency, as well as compliance and regulatory technology that address the KYC/AML concerns of larger institutions.

Ease of use. The crypto user experience is lathered in friction. Even for users who are familiar with crypto native products, navigating the fragmented L1 landscape, adopting a diverse set of wallets, and moving money across bridges is a highly complex, frustrating experience. We are moving into an era where user experience will become a differentiated feature that will drive defensibility and attract new users into the ecosystem. We see a number of ways this theme can be expected to manifest, including embedded crypto experiences in Web 2 products, automated DeFi investment strategies, and consolidated platforms that unify the product landscape.

Gaming x Finance. The application of crypto in gaming titles represents a massive shift in how developers can monetize their creative IP, and the relationship that users have with their favorite games. Developers are using crypto mechanics to turn gaming assets (e.g., in-game currency, players, items, etc.) into financial assets that are owned by users. This opens up entirely new mechanics for developers to bootstrap user growth and engage users on an ongoing basis. We anticipate this will shift the industry from a primarily “free-to-play” to a “play-to-earn” model and over time, potentially introduce 3.24B gamers worldwide to crypto.

Stay tuned to Non-Standard Deviations and our blog for updates on how we are thinking about the Web 3 market, and if you are an entrepreneur building in this space we would love to connect!

*View all TSV investments here.

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