Messari x Bitazza: Curve Finance Report
By: François-Xavier Lord
The following report was written by Messari Hub Analyst(s) and commissioned by Bitazza, a member of Messari Hub. For additional information, please see the disclaimers following the article
Curve Finance is undoubtedly a pioneer of DeFi. At its launch, Curve disrupted the market with an innovative DEX that boasted an unparalleled level of efficiency for pegged asset trading. With a clear product-market fit, the protocol was able to bootstrap its growth with the introduction of its CRV governance token bringing a powerful token economic system into the mix.
Today, Curve transacts over $6B in monthly volume and more impressively, it has achieved the highest TVL out of any DeFI project, surpassing $19B. Nonetheless, with strong competitive forces brewing, many challenges remain.
This piece takes a look at Curve Finance and the key metrics behind its core AMM product and the CRV token.
About the project
Overview of Curve Finance
Curve Finance launched in January 2020, roughly two months after the publication of Michaele Egorov’s “StableSwap” whitepaper on November 10th, 2019. The vision for the project was born out of Egorov’s recognition that decentralized exchanges (DEXs) at the time did not provide an efficient medium of exchange for like-assets.
The introduction of Curve Finance sought to address this issue with a decentralized exchange algorithm optimized for low slippage swaps between stablecoins or similar assets that peg to the same value (e.g. wBTC / renBTC). The protocol is designed around an Automated Market Maker (AMM) system purposefully built for low slippage trading and steady revenues for liquidity providers (LP). It achieves this in part by employing a unique combination of both constant sum and constant product functions.
At first, Curve only generated minimal traction with deposits reaching $2M and a daily volume of $1M in its first few days after launch. The introduction of CRV, Curve’s native governance token, in August 2020 marked a significant inflection point for the protocol. Curve witnessed a 3x increase in TVL from $137M to $413M in the first week following the release of its CRV token. Since then, Curve has amassed $19B in TVL making it today’s largest DeFi protocol in terms of deposits.
Up until recently, Curve focused solely on pegged asset trading pairs with top pools devoted to maintaining stablecoin, BTC, and ETH pegs. On June 9th, 2021, Egorov published a whitepaper for an AMM system with a dynamic peg system. This sparked the expansion of Curve into non-pegged assets in what is dubbed as “Curve V2”.
At the time of writing, Curve now offers over 40 different official liquidity pools with some of the most popular being the tricrypto2 (USDT / wBTC / WETH) and 3pool (DAI / USDC / USDT). Note, however, that pegged assets trading remains core to the protocol and accounts for the majority of daily trading volume.
CRV Token Uses
CRV is the governance token for the Curve protocol and it is primarily used to incentivize liquidity to the protocol. Curve benefits from the increase in capital as it provides more trading liquidity, which reduces the slippage for end-users.
The CRV token can be used for voting, staking, and boosting rewards. Voting gives the ability to users to participate in community and official DAO votes. Staking allows depositors to receive 50% of all trading fees generated by the protocol. Boosting allows LPs to boost their CRV rewards by up to 2.5x.
To access all of those functionalities, tokenholders are required to lock their CRV in Curve for vote-escrowed CRV (veCRV). The longer CRV is locked in Curve, the more veCRV is generated. For example, 1,000 CRV locked for a period of one year will generate 250 veCRV, but the same amount locked for four years will generate 1,000 veCRV. As such, the longer the lock-up duration, the higher the voting power and rewards are for the user. This is to align tokenholders with the protocol’s long-term success.
CRV Token Supply
CRV launched with an initial supply of around 1.3B, which represents 43% of the total maximum supply of 3.03B. This initial distribution was allocated to the various groups as follows:
- 5% to pre-CRV liquidity providers with 1-year vesting;
- 30% to shareholders (founders and investors) with 2-4 year vesting;
- 3% to employees with 2 years vesting; and
- 5% to the community reserve.
The remaining 57% of the total maximum supply is to be released progressively as incentives to future liquidity providers.
Despite the initial supply of 1.3B, the effective circulating supply of CRV at launch was of nil due to respective vesting schedules.
From this schedule, it is clear that inflation of released CRV is set to be significant in the coming years. As of October 31st, only 28% of supply is in circulation but this number is set to hit 2.27B in five years, a 2,700% increase. Note that this is higher than Uniswap’s 2,200% and Sushiswap’s 13% increase in circulating supply during the same period.
Circulating Supply & Convex Finance
The locking of CRV has significantly reduced its circulating supply, as veCRVs are non-transferable, illiquid tokens. At the time of writing, around 350M CRV tokens were vote-locked on Curve for an average period of 3.7 years, representing roughly 42% of the total released supply. This high lock-up rate of CRV tokens can be in part attributed to the launch of Convex Finance in May 2021.
Convex Finance is a protocol that allows Curve liquidity providers to receive boosted CRV rewards by leveraging deposits of other CRV tokenholders within Convex. Deposits on Convex are irreversible. However, users receive cvxCRV tokens as a receipt of deposit. cvxCRV has the differentiating characteristic of being freely tradable compared to veCRV, which is non-transferable. Users holding cvxCRV earn both their share of Curve’s trading fees as well as boosted CRV rewards. Additionally, they get the added bonus of earning CVX, Convex’s governance token. Currently, the platform accounts for more than 40% of all veCRV on Curve.
Prior to Convex, around 30% of daily token issuances to LPs were being vote-locked. After the introduction of Convex, and following a step-wise decrease in the daily inflation rate, this number has doubled to 63.7%. As such, Convex only strengthened the already powerful incentive to vote-lock CRV for users. Therefore, despite the relatively high projected inflation, the impact on the actual circulating supply should be relatively mitigated.
Recent Upgrades & Initiatives
Below are noteworthy recent updates to the protocol:
- Launch on Layer 2 Solution Polygon: In April 2021, Curve launched its first liquidity pool on Polygon, one of Ethereum’s main scaling solutions. This implementation was done to provide users with an alternative option for cheaper asset swapping compared to the standard Layer 1 manner. Despite not residing on the same chain as Curve’s DAO, LPs still benefit from CRV token rewards. Additionally, through a partnership with Polygon, Curve depositors on selected pools are also eligible to receive MATIC token incentives.
- Curve V2: In June 2021, Curve expanded its core stablecoin AMM to non-pegged assets with the introduction of Curve V2 and the tricrypto pool. The new formula of the protocol maintains the general form of the original StableSwap, but with some adjustments to accommodate for differently priced assets. This milestone has put Curve in a favorable position to compete in the broader traditional DEX market.
- Launch on Harmony: Curve’s proposal to launch on Harmony was passed in September 2021 and on October 12th, Curve officially launched on the smart contract network Harmony. Note that Harmony has allocated $2M in ONE token to bootstrap potential usage of Curve on its platform.
- Other Multi-Chain Launches: During 2021, Curve also launched on many other protocols such as xDAI, Avalanche, Arbitrum and Fantom. This is part of Curve’s overall strategy to make the protocol as widely available as possible and a core building block of every ecosystem.
Over the last 12 months, the total volume of decentralized exchanges has soared to $980B, up more than 11x YoY.
This growth was driven by sustained capital and user inflows into the crypto economy as well as surging asset values, with the total cryptocurrency market cap now reaching close to $3T.
Curve has been able to capitalize on this trend, increasing its average monthly trading volume by 3.8x in 2021 ($6.5B) compared to 2020, making it the third most popular DEX by this metric with a current market share of 8%.
In addition to its growing volume, Curve managed to become the most important DeFi protocol in terms of TVL. As of October 31st, 2021, Curve’s TVL has reached an impressive $19.3B, representing a more than 13x increase since the beginning of the year.
This surge in TVL is attributable to several factors, such as growing trading volume, generous LP rewards, strong vote-locking incentives, and increasing asset values. Moreover, the introduction of Curve onto other protocols/scaling solutions also had a positive effect on this metric. As of October 31st, 2021, those secondary markets account for roughly $2.4B, or around 12.2% of the TVL.
Curve can be valued on the profit-generating potential of its core AMM product using both a discounted cash flow as well as a comparative analysis.
CRV Supply for Valuation Purposes
Although only vote-locked CRV tokens receive the cash flows from the protocol, the valuation is based on the total outstanding supply since free-floating, un-staked CRVs possess the optionality to receive trading fees at any time. This represents an effective base of 841M tokens at the October 31st, 2021 valuation date.
Discounted Cash Flow Analysis
The discounted cash flow analysis is based on the 5-year projected growth of the protocol. In this case, the model values the portion of cash flows generated from the trading volume that are attributable to token holders. This represents 50% of total trading fees.
Projected Trading Volume
Evidently, trading volume is the key driver of value for Curve as it directly drives the fees collected from the protocol. In an effort to provide a range of potential CRV values under different market conditions, this report forecasts three distinct volume growth scenarios.
For each, the total DEX trading volume for 2021 is used as the starting point on which an annual growth rate is applied. The annual growth rate decreases annually by a factor of 2.5 over the forecast period (2022 to 2026).
To obtain the trading volume of Curve, the protocol is assigned a constant market share of 9% on the total DEX trading volume. Below is a summary of the projected volume for Curve under each scenario:
- Low Growth Scenario: Curve’s trading volume increases at a rate of 100% in 2022 gradually decreasing to 3% in 2026, resulting in a total trading volume of $312B in 2026. This scenario represents a slowdown in the growth of the crypto ecosystem and/or a decrease in the overall usage of DEX in favor of CEX.
- Moderate Growth Scenario: Curve’s trading volume increases at a rate of 200% in 2022 gradually decreasing to 5% in 2026, resulting in a total trading volume of $744B in 2026. This scenario implies a continuing growth of DeFi and/or a rising adoption of trading on L2s / other smart contracts.
- High Growth Scenario: Curve’s trading volume increases at a rate of 300% in 2022 gradually decreasing to 8% in 2026, resulting in a total trading volume of $1.47T in 2026. This would represent an extremely optimistic growth of Curve. For example, this scenario could represent a successful implementation of ETH 2.0 that would drastically decrease gas prices and trigger a significant shift away from CEX to DEX.
To provide perspective, the total volume on all DEXs has reached around $979B in the last 12 months, with Curve’s share representing $69.7B. Additionally, the total transactional volume on Binance, the world’s largest centralized exchange (CEX), has reached over $7.7T in 2021. DEXs represent roughly 7 to 9% of total CEX volume at the time of writing.
Below is a visual representation of the projected trading volume on Curve under each growth scenario:
The discount rate used for the 2022 to 2026 cash flows is set at 20%, based on a perception of the risks and progress of the protocol to date. At the end of the forecast, a terminal exit multiple of 15x is applied to 2026 forecasted free cash flow, which is in line with the price-earnings ratio of publicly listed traditional exchanges.
This report compares the valuation of Curve Finance to some of its closest competitors: Uniswap, Sushiswap, and Balancer. The metrics assessed for each project are the Price-to-Sales multiple (P/S) and the Dividend Yield.
The Price-to-Sales multiple is based on the total trading fees generated by each protocol on its trading volume. This includes both the portion of fees paid to liquidity providers and the portion paid to token holders.
The annual trading volume used was computed by annualizing the volume of the last six months for each project. This was done to provide an up-to-date perspective given the rapid growth of DEXs in the last year.
The estimated weighted average trading fee is applied to the volume based on recent protocol activity. The rates used are 24bps for Uniswap, 30bps for Sushiswap, 6bps for Balancer and 5bps for Curve (see model for source).
The Dividend Yield represents the cash flows generated by the protocol that is directly attributable to token holders. This metric is computed by dividing the annualized trading fees to token holders by the total market cap. The applicable percentage, applied to the trading volume, varies from project to project.
- For Curve, half of all trading fees go to veCRV holders, which represents 2.5bps.
- For Sushiswap, 5bps of trading volume is paid to xSushi holders.
- For Uniswap, the protocol currently does not pay a portion of fees to tokenholders
but UNI governance has the option to turn on this feature. As such, for the purpose of this analysis, a protocol fee paid to UNI holders of 5bps is assumed, similar to Sushiswap.
- For Balancer, the protocol also does not currently pay a portion of fees to token holders but the protocol’s governance may vote to introduce a protocol fee. For the purpose of this analysis, the same rate as Curve is applied due to the similarities between the two projects.
From the table above, it appears that Curve is trading at a significant premium in terms of P/S multiple. This is partly attributable to the significantly lower fee structure on trading volume compared to Uniswap and Sushiswap (5bps vs. 30bps).
In terms of dividend yield, Curve trades lower than Uniswap and Sushiswap, which could again be explained by the lower token fee on volume. Note that when lowering the rate of UNI and SUSHI to match Curve, the dividend yields fall to 0.8% and 1.9% respectively.
Curve does appear to be trading in line with Balancer and both protocols have very similar fee structures and products.
CRV Token Valuation
Discounted Cash Flow Analysis
Below are the results from the DCF analysis for each of the three scenarios:
According to the DCFs, the fair value of CRV is $0.86 under the Low Growth Scenario, $1.97 under the Moderate Growth Scenario and $3.80 under the High Growth Scenario. At equal weight, this gives an average price target of $2.21 per CRV based on the present value of projected cash flows to token holders. Readers are invited to adjust the model to their own estimate.
DCF Valuation Sensitivity
The table below lays out the various implied pricing of CRV depending on an array of market share and first-year growth rates. The scenarios used in the valuations are highlighted in blue.
The following presents the price per CRV based on the P/S Multiple and Dividend Yield of the current comparables. These metrics are applied to the fees collected based on the annualized volume of the last six months.
Using this valuation method, the implied average price per CRV is $1.7 based on the P/S Multiples and $2.0 based on the Dividend Yields.
Comparable Valuation Sensitivity
The table below presents a range of CRV implied values based on a set of P/S Multiples and Dividend Yields. The scenarios used in the valuations are highlighted in blue.
CRV Valuation Premium
Curve appears to be trading at a significant premium based on the valuation methods detailed in this report. The following presents some potential explanations that could be taken into consideration by the market when valuing CRV:
- Limited Circulating Supply: At the time of writing, around 42% of the released supply of CRV has been vote-locked in Curve for an average period of 3.7 years. This significantly reduces the amount of CRV in circulation and therefore might contribute to a higher price per CRV given current demand. Note, however, that the introduction of Convex has reduced this effect, as cvxCRV tokens are freely transferable whereas veCRV are not.
- Demand for Voting Power: The ability of token holders to vote on the allocation of liquidity rewards has created a very strong demand for CRV, with many sets of opposing stakeholders competing for control over incentive distribution. Demand for this purpose has become so substantial that it has even given rise to the monetization of veCRV voting power. Indeed, in August 2021, Andre Cronje, founder of Yearn, launched a vote-bribing platform that allows token holders to be compensated for supporting particular gauge weights. For example, a veCRV holder could receive a certain amount of MIM, FTM, or CREAM by allocating his voting power to support pools corresponding to those protocols. This illustrates the non-negligible value and significant demand for the voting power associated with the CRV token.
- Boosting Feature: As shown by Curve’s very high TVL compared to its trading volume, it is clear that the community is valuing Curve’s token rewards more than its core trading fees. The boosting and voting features of CRV to earn additional rewards on liquidity have not been valued in this report. However, they likely represent the most important driver of demand for CRVs at the moment.
- Third-Party Token Rewards: Through partnerships with other protocols, many pools on Curve offer additional token incentives. This results in higher APYs for liquidity providers and might represent a valuable competitive edge.
- Community Fund: The initial distribution of CRVs allowed for a protocol reserve of around 150M CRVs to be used for community-led incentives. Currently, this account holds around 124M CRVs, worth around $479M.
The DEX market has progressed radically over the past year and has continued to become increasingly competitive. Below is the evolution of the market share of the top competitors in this space:
In terms of percentage of total volume, Curve’s market share declined during 2021, dropping from around 10% in January to 8% in October. Conversely, Uniswap has continued to grow its dominance in the sector, increasing its market share by 18% from 49% to 67% during the same period.
While Uniswap certainly benefited from its network effect as the most established and widely used DEX, most of this continued success can be attributed to the technological innovation brought by the Uniswap V3 protocol. Launched on May 15, 2021, this new iteration of Uniswap introduced the concept of concentrated liquidity, giving LPs the ability to create markets within customized price ranges. This targeted approach to liquidity provision (similar to Curve) results in far superior capital efficiency as deposits are deployed on the most used portions of asset pricing curves. As such, it allows Uniswap to compete directly with specialized DEXs such as Curve who target trading pairs with narrow price ranges.
Moreover, on October 29th, 2021, Uniswap added in a unanimous poll a 1bps fee tier that allows the protocol to compete even more effectively on stablecoin pairs through lower fees. Looking at the exported USDC / USDT volume on the 1inch DEX aggregator, it appears to have had an immediate impact on the routing of volume on that platform.
In the month of October, Uniswap’s share of the exported volume averaged 2.6%. Following this implementation, its share has risen to well over 50% in the most recent days. This example highlights the very competitive nature of the stablecoin trading market, with razor-thin margins and price-sensitive users.
As such, Curve faces very strong competitive forces from other DEXs such as Uniswap, which are continuously innovating to provide more efficiency and better pricing.
The following are some of the key risks that are facing Curve Finance in the short to medium term:
- Mounting Competition: As explained in the previous section, one of the most significant risks for Curve is the growing competition from other DEXs. As Curve attempts to challenge others on non-pegged assets with the introduction of Curve V2, competitors like Uniswap are improving their protocols to compete even more effectively on both non-pegged trading pairs and stablecoins.
- Relatively High Inflation: In the next five years, the released supply of CRVs is set to increase by a factor of 2.7x. Although those rewards are necessary to attract and retain liquidity, it is considerably higher than both Uniswap’s and Sushiswap’s projected inflation. This will inevitably have a dilutive effect on token holders. Note,
however, that this risk is partly mitigated by growing vote locking of CRV on Curve.
- Governance: As veCRV holders have the power to vote on liquidity rewards, many users and groups have attempted to purchase large stakes of CRV to increase the incentives on selected pools. This has the potential to be detrimental for the Curve ecosystem as token rewards are diverted from high-volume pools to other less relevant pools. Recently, Mochi, a controversial stablecoin protocol, launched a governance attack on Curve by exploiting this feature. This required the protocol’s developers to activate the Emergency DAO to cut rewards to Mochi in order to
prevent a spiraling feedback loop.
Curve’s potent token economics have driven a surge of TVL in the last year, with users pushing demand for CRV to leverage and extract more value out of the protocol’s reward system. On the other hand, while trading volume has grown, the protocol is experiencing strong competitive headwinds on its core AMM product and is currently losing market share to competitors like Uniswap. This situation highlights an apparent disconnect between the cash generating potential of the protocol’s core AMM product and its current trading price.
Nonetheless, with the introduction of non-pegged asset trading and several integrations with scaling solutions and emerging smart contract protocols, Curve has shown its will to continue to innovate and be at the forefront of the fast-moving DeFi ecosystem.
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