Decentralized finance (DeFi) platforms and the returns that come with them have earned a unique reputation in traditional finance and even the broader crypto market as risky, unsustainable, and even Ponzi-esque. Where does the yield come from and why is it 100 times higher than the interest offered by bonds, certificates of deposit or savings accounts?
A handful of protocols essentially created peer-to-peer lending, trading, and insurance protocols, eliminating a middleman like a bank, exchange, or insurance company and allowing smaller users to take their place. Here are some examples at a very basic level:
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Uniswap and Curve allow any user to create a market and earn trading fees through token swaps.
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Aave and Compound allow any user to make secured loans to other speculators and earn a chunk of the lending interest.
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Maker allows any user to create their decentralized stablecoin, DAI, by providing crypto as collateral.
Aside from offering low trading and lending fees, DeFi protocols have been generous in giving away their “governance tokens.” These native tokens often hold rights to a small percentage of protocol revenue, much like a company might pay dividends to shareholders.
Additionally, some of the most well-known protocols have given token holders a share of the responsibility of controlling the future plans, upgrades, and offerings of the project themselves. Curve DAO and its native token CRV are examples of this governance model, with the token playing an important role in the protocol and the broader DeFi universe.
Introduction to Curve DAO
Until recently, Curve has been extremely under-discussed given the important role it plays in DeFi across blockchains. Recent shifts in tokenomics caused its native token, CRV, to become net deflationary; Subsequently, the price has increased by 122% since the token became deflationary. Understanding the inner workings of Curve is almost essential to understanding DeFi yields. So what does Curve do and how does it do it?
The story goes on
Curve is a decentralized exchange known for its swaps involving tied assets such as fiat-pegged stablecoins or assets traded at a 1:1 ratio. With over $3 billion in deposits, Curve’s largest pool is known as 3pool and includes DAI, USDC and USDT. The stablecoin pools have gained traction, offering high liquidity and low fees (0.004%) as Curve uses its native token to reward liquidity providers instead of higher swap fees. Below are the results of the $75 million USDC to USDT swap on Curve, Sushi and Uniswap, with Curve optimizing the swap with significantly less slippage than its competitors. Slippage is the difference between the expected and executed price on a trade, or how far from the market price the trade is executed.
CRV tokenomics
CRV holders can “stake” their tokens on the platform and lock them in for set periods ranging from one week to four years to determine their voting weight. Depending on the amount of Curve locked and the duration of the lock, stakers will receive an adjusted amount of Curve in Trustee (veCRV). veCRV owners can then vote on how CRV rewards are distributed across Curve’s pools by assigning a weight to the “pool ad” that reflects their financial interests. The gauge is a tool to measure which pool is most heavily weighted with rewards, and gauge votes are bi-weekly via Snapshot.
As a result, a system of bribing veCRV holders to vote for specific gauge weights has emerged. Projects like Abracadabra pay veCRV holders in their native token for weekly bribes to boost the yield of their decentralized stablecoins and drive demand for their own project. Abracadabra has paid the equivalent of $1.9 million to veCRV holders willing to vote for their stablecoin pool in the past two weeks alone, and is now giving their pool 32.5% of the relative gauge weight.
veCRV holders also earn a portion of the protocol’s revenue via swap fees. According to Curve’s documents, “a community-led proposal introduced a 50% management fee on all trading fees. These fees are collected and used to purchase 3CRV, the LP token for the TriPool, which is then distributed to veCRV holders.”
veCRV’s dynamic capabilities have kept demand for CRV strong even during inflation to meet demand for maximized returns and low-fee swaps. However, as seen below, the issuance schedule has slowed down due to the end of early adopter rewards. Demand for blocking CRV has also increased, causing the net of assets to become “deflationary”. The vote locked CRV is not considered part of the token supply as it is illiquid and the majority is locked for the next three to four years.
The basis for DeFi
The dynamic capabilities of the CRV token and ecosystem have made the project an attractive building block for several other DeFi projects, namely Yearn and Convex. The two projects can be viewed as “yield optimizers”, rotating assets between curve pools and removing the complexity of using the CRV token efficiently. Both protocols allow users to deposit Curve liquidity positions (LPs) or CRV in their vaults, which then reap rewards – both topping up the LP position and reinvesting in CRV to optimize returns.
Born out of the “DeFi summer,” Yearn quickly began acquiring large stakes in veCRV, holding almost 10% of the supply when Convex launched. However, in a few months, Convex was able to swallow over 35% of the veCRV supply. The competition for control of Curve’s Gauge Voting and Yield Boost has been dubbed “Curve Wars” and some in the DeFi community believed the projects were playing a zero-sum game. Bankless HQ has highlighted where the two protocols differ and how each gains its competitive edge.
“There are three main differences between Convex and Yearn:
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On Convex, users must manually invest their rewards back into the various vaults to complete them, rather than doing it automatically on Yearn
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Convex has a lower fee structure as it retains 16% of profits in the form of a performance fee, while Yearn charges a 2% management fee along with 20% of profits
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On Convex, users can “farm” CVX, which can also be reinvested back into the various vaults.
The two protocols undoubtedly compete on some level, but their combined presence seems to add to the Curve pie as a whole. In fact, Yearn is probably one of the largest depositors in specific Convex strategies, with $724 million in Covex’s SETH strategy and $586 million in the usdn3crv strategy.
While Convex supporters have pointed out that the protocol now owns a much larger share of veCRV than Yearn, Yearn developer @bantg suggests that Yearn’s responsibility for a large portion of Convex’s CRV holdings and the total locked value (TVL ) make simple metrics less valuable for comparing the two products.
Over time, Yearn and Convex appear to be symbiotic and nice to each other. What is clearer, however, is the positive effect they both have on Curve and CRV. If the demand for stable yields continues to grow, the battle for maximum boosts on Curve has only just begun. Yearn and Convex will continue to buy CRV to keep up with their rising TVL and provide the highest possible return.
Early adopter bonuses are also coming to an end, meaning CRV emissions are peaking. The graph below shows a very clear trend:
The Importance of Curve in the DeFi Ecosystem
Over the past six months, Curve has only earned $34.1 million in swap fees despite having $16.5 billion in TVL on Ethereum’s main network and has kept its trading volume consistently high. Curve and its liquidity providers earn $0.40 per $1,000 in trade volume compared to another popular decentralized exchange, Sushi, which earns $3 per $1,000 in trade volume for its liquidity providers. Oftentimes, liquidity would migrate to exchanges with higher fee tiers for higher returns, yet Curve has the lowest fees and more tied-up liquidity than any other exchange. The real secret of the project is to subsidize liquidity with the CRV token and keep yields high enough for liquidity providers to stay in their pools.
Curve now has nearly $18.8 billion in TVL across seven different ecosystems, making it the second-largest decentralized application, or dapp, behind Aave and giving the project 11.4% of Ethereum’s total DeFi TVL. According to Curve’s release schedule, approximately 113 million CRV tokens were released to the community in Q3. At the current price and TVL, that equates to a 12% annual return percentage for stakers and liquidity providers, not counting swap fees and incentive programs from alternative chains like Polygon and Avalanche.
Providing such massive liquidity rewards has earned Curve a reputation for being the backbone of all DeFi earnings. A surge in CRV price usually signals a “risk-on” DeFi market, with yields falling across the ecosystem.
Stablecoin swaps are not the only source of DeFi earnings. Aave and Compound both offer relatively attractive yields on stablecoins and crypto assets for providing secured lending. However, the demand for swapping stalls is an integral part of lending rate arbitrage, or the transfer of funds between protocols and exchanges. Curve has established itself as a focal point for large swaps and passive returns, as well as a testing ground for decentralized stablecoins like DAI or MIM and tokenized assets like staked ether.
DeFi TVL hitting all-time highs most likely signals a growing hunger for yield. Large funds or high net worth individuals will use Curve, Yearn and Convex for non-volatile returns, making the “curve wars” as important as ever.
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