Health, Wealth, and Happiness

February 8, 2023

“History provides a crucial insight regarding market crises. They are inevitable, painful, and ultimately surmountable.”

- Shelby M.C. Davis

"Same with crypto winters."

- Bitcoin Market Journal

In today's issue:One of the best use cases for blockchain is decentralized exchanges (DEXs) where users can buy, sell, or trade their crypto with each other.

The top five players have a combined market cap of over $6 billion, making them among our favorite investments in crypto. We think they're not only here to stay... They're growing.

In today's newsletter, we'll give you a state of the union on the DEX market. Read on.

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Must Read

Today's most important story for crypto investors.

One Step Closer to Shanghai Upgrade(The Defiant)

The Ethereum development team recently launched the Shapella fork, a significant step toward the next major Ethereum upgrade which will allow staked ETH withdrawals for the first time.

If you're just joining us, last year's Ethereum upgrade -- The Merge -- allowed you to begin staking (or locking up) ETH to earn staking rewards (like earning interest). The catch? You still can't withdraw your staked ETH.

With the Shanghai upgrade, scheduled for later this year, all that's about to change. You'll be able to freely withdraw staked ETH at any time.

(Blockchain is cool. You can seelive transactions on the testnet here.)

Investor takeaway: When users are able to withdraw all that ETH, we expect the price of ETH to drop considerably. After things stabilize, we expect ETH prices to gradually increase, buoyed by another successful upgrade.

Blockchain believers like us stick to a long-term, buy-and-hold strategy, but be forewarned... Prices are likely to go down before they go up.

Sector Report: Decentralized Exchanges in 2023

by Anatol Antonovici

Centralized crypto exchanges like Coinbase and Binance have contributed to the rapid adoption of digital currencies, but decentralized exchanges (DEXs) have introduced a new approach to trading. Users buy, sell, and trade digital assets from each other.

This article will explore the emerging DEX industry to see whether it can continue its growth in the coming years.

Industry Overview

After lending, DEXs are the second major use case to emerge in decentralized finance (DeFi). They're part of a proven model that's here to stay, enabling users to trade cryptocurrencies with each other in decentralized environments.

One of the most important features of a DEX is the automated market maker (AMM) model, which replaces centralized order books and market makers. An AMM relies on smart contract-powered pools for each trading pair, where liquidity providers lock their tokens in exchange for rewards from trading fees.

The prices of a pair are dictated by algorithms based on the supply/demand dynamics of the related pool. This model is far more efficient that the traditional order book and market maker approach (read more on the old model here).

Unlike centralized exchanges (CEXs) such as Coinbase, DEXs are non-custodial, i.e., they don’t hold user funds. This enables them to provide trading services without KYC (know your customer) verification. This makes them easier for new users. Just connect your crypto wallet and start trading.

While trading volumes on DEXs remain considerably smaller compared to CEXs, they've gained traction during the DeFi boom that started in 2020. As of this writing, DEX trading accounts for about 15% of all trading volume.

Image via The Block

However, all DEXs have seen declining volumes since the beginning of 2022 amid the "crypto winter." SushiSwap has been among the worst performers, with its native token -- SUSHI -- losing about 87% (light blue line on the bottom):

Nevertheless, the two-year performance tells a different story. The DEX industry has had several ups and downs since early 2021, but DEXs like Curve (red) and Uniswap (light purple) saw their tokens gain over 60% during this period:

DEXs are still an emerging market. They only began gaining wider adoption in 2020. The DEX sector has great potential to expand in the future thanks to its promise of non-custodial trading at low costs.

Investment Thesis

There are two ways for investors to gain exposure to DEXs:

Buying the token: DEXs are fueled by their native tokens. Although the tokens may have other use cases like governance, staking, and rewards, the tokens' performances are generally impacted by exchange trading volumes. We view them like buying "stock" in the DEXs with high trading volumes and great potential for future growth.

Liquidity mining: Another approach for investors is participating in its ecosystem by providing liquidity to one or more pools. In a classic model, a pool requires a 50/50 balance for each pair. Users have to lock both tokens of a pair (say, ETH and UNI), and liquidity miners are rewarded with percentages of DEX trading fees.

DEX tokens have been negatively impacted over the past year, but user activity has been increasing. This suggests healthy fundamentals that should support a rebound in the coming months.

The collapse of the FTX exchange has also worked in favor of DEXs. Shortly after FTX went bankrupt, one familymoved over $1 million worth of crypto to DEXs, choosing not to trust centralized exchanges with their assets.

Even though DEXs have no risk of hacking attacks as they don’t hold user funds, loopholes in the smart contracts may persist. The most notable attack points are bridges used to connect different blockchains.

Who’s Investing: Institutional Backing

The DeFi boom has attracted institutional investors who have poured hundreds of millions of dollars into DEXs. Many DEXs implement the decentralized autonomous organization (DAO) governance model, but some are still backed by centralized entities that maintain the protocol.

For example, Uniswap is backed by Uniswap Labs, whichraised $165 million in a Series B funding round in October 2022. The round was led by Polychain Capital and was joined by other institutional and venture capital investors like a16z crypto, Paradigm, SV Angel, and Variant. Uniswap Labs is valued at $1.66 billion.

In August of the same year, 0xraised $70 million in a Series B round led by private equity firm Greylock Partners. Other participants included Pantera, Sound Ventures, OpenSea, Coinbase, and A.Capital.

At the end of 2021, 1inch secured $175 million in a Series B round from Amber Group. It was joined by about 50 investors including VanEck, Fenbushi Capital, and Jane Street.

A recentreport from blockchain intelligence firm Chainalysis shows that institutional investors also increased transfers from CEXs to DEXs during times of market volatility like after the fall of FTX.

Top DEX Projects

As of this writing, here are are a few of the bigger DEXs to watch:

Uniswap (UNI)

Uniswap was founded in 2018. It focuses on Ethereum-based tokens and enables users to swap ERC-20 tokens almost instantly. It's the largest DEX by trading volume. Uniswap is also one of the oldest DEXs, and it thrived well before the boom of DeFi in mid-2020.

The annualized trading volume on the exchangeis nearly $400 billion. During the last 12 months, traders also paid over $430 million in fees. Uniswap attracts over 45,000 daily active users on average.

Uniswap is backed by its proprietary token UNI. The total market cap is nearly $5 billion as of this writing, making it the 18th largest cryptocurrency.

The total value locked (TVL) in Uniswap’s pools is about $4 billion. Uniswap is the sixth-largest DeFi protocol by TVL and the second-largest DEX by TVL after Curve.

Uniswap’s status as a market leader will likely support its further growth. When the crypto market is recovering, UNI could be among the first tokens to benefit.

Uniswap raised over $160 million at the end of 2022, suggesting large institutional investors have high expectations of this DEX and the DeFi market in general (read more in our Uniswap Revenue Report).

Synthetix Network (SNX)

Synthetix Network is not a classic DEX, though it also enables users to swap different tokens. The Ethereum-based protocol acts like a decentralized synthetic asset platform that enables traders to get on-chain exposure to real-world assets like fiat currencies, commodities, stocks, and indices.

For those unfamiliar, synths are tokens that track the value of real-world assets and act as derivatives. On Synthetix, anyone can create synths by locking the native token (SNX) as collateral. For example, sUSD tracks the US dollar, while sBTC mimics the price of bitcoin. Synths rely on decentralized price oracles to track the performance of underlying assets. Therefore, Synthetix users can trade various synths in a trustless environment.

The annualized trading volume of Synthetix is over $4.4 billion. The annual revenue from fees exceeds $13 million. Today, over $400 million worth of cryptocurrency is locked on Synthetix. This helps it maintain its position in the top 30 DeFi protocols by TVL. The protocol hosts over 2,000 daily active users.

Synthetix used to be one of the largest DeFi projects by TVL and trading volume. Despite the dramatic decline from its 2021 peak, the project still has much to offer thanks to its unique business model.

SushiSwap (SUSHI)

SushiSwap is an Ethereum-based DEX launched in 2020. The DEX was created by copying the open-source code of Uniswap, so it works just like Uniswap. The promise of Sushi was to give users more decision-making power, so the native token (SUSHI) acts as a governance token.

While Sushi made waves shortly after the launch, it's lost ground and is smaller than Uniswap. Sushi’s annualized trading volume is $6.5 billion. The annualized trading fees reach $20 million. Sushi hosts less than 4,000 daily active users on average.

SUSHI has been the worst performer across DEXs during the crypto winter. It remains to be seen if it will recover.

Investor Takeaway

The DEX ecosystem has been struggling since early 2022, but the need for secure, decentralized trading infrastructure is likely to recover and grow.

The collapse of FTX, preceded by the fall of other centralized crypto projects, is helping support the case for DEXs. Decentralized exchanges boast a unique business model we believe will stay relevant in the years to come.

Some DEXs that were popular in the early days of the DeFi boom, like Sushi, may not recover. Still, there are exchanges with billions of TVL that may continue to dominate (i.e., Uniswap, Balancer, Curve, and PancakeSwap).

Be sure to check out our Future Winners portfolio, which has UNI as one of our four crypto picks.

ICYMI