Messari x Bitazza: Curve Finance Report

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.

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

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

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.

Comparable Analysis

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.

Price-to-Sales Multiple

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).

Dividend Yield

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.

Benchmark Results

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.

Comparable Analysis

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:

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.