The digital asset ecosystem is a breeding ground for innovation. Anecdotally, operators have explained to me that many of the world’s best developers are drawn into the space because of its open-source ethos and the “fun” that accompanies building on top of decentralized systems. As the market cycle pivots from bear to bull, some of the more ground-breaking projects launching are centered on improved user experience, scalability enhancements, decentralized physical infrastructure (DePIN), and crypto’s intersection with AI.
Tokens have a way of financializing projects, so in some ways, all developments are related to DeFi, which like the real-world economic system, underlies most of our activities on-chain. However, while the aggregate digital asset market cap is only a few percent from it’s all-time highs, Decentralized Finance as a percentage of the overall market is still within its bear market range.
DeFi Share of Total Crypto Market Cap
To be fair, a good portion of this phenomenon is due to BTC’s dominance in recent trading, leading the rally and accounting for such a significant proportion of the aggregate. Given that context, could it be just a matter of time before the profits earned through ETF flows and macroeconomic tailwinds look towards the DeFi applications which seemed to have found product-market fit during the last cycle? The on-chain lending markets remain significantly below historical peaks but have demonstrated steady loan growth for the past six months.
Active DeFi Loans (in billions, USD)
Naturally, as demand for credit rises, so too does the cost of borrowing, absent an influx of capital. Stablecoin issuance has grown about 15% off the lows, signaling some return of funds which fled the market after the collapse of 2022, but the yields earned by lending stablecoins to the institutional-sized pools on the battle tested DeFi protocols (as captured by Aquanow’s DeFi Funding Rate Index) remain particularly attractive.
Benchmark Yields in Traditional and Crypto Markets
Significantly, investors contributing capital to the digital asset ecosystem today can achieve the exceptional yields above, yet their funds are not bound by the conventional price-yield dynamics seen in traditional markets. Therefore, while the income earned on one’s capital deployed can fluctuate, the base value lent remains constant, and this makes for a very compelling return profile. Further, over-collateralization with clear liquidation policies serves as an excellent risk mitigant.
While much of the discussion around innovation in digital assets has centered on AI and DePIN, there are some fascinating DeFi-specific developments which will make for an even better user experience. Due to enhancements in bridging, cross-chain interoperability, and data access, capital can flow more easily across the still disjointed ecosystem, which helps iron out inefficiencies. I’d encourage you to check out what Chainlink and Lendvest are working on here. Neptune is a new money market on Cosmos which sets interest with algorithms based on the same technology that autopilot uses to balance a plane. Term Finance provides a platform for fixed rate, fixed term loans, unlocking desired functionality for both sides of the market and enabling the eventual development of derivatives. The analysis of on-chain activity continues to be democratized, which has some advantages, but not everyone wants their trades to be known. Hinkal Protocol allows institutions to interact with DeFi privately, while remaining compliant. They recently launched an incentive program for depositors enabling to generate yield on top of any token, including liquid staked assets.
It's a great time to be a lender in crypto. However, there are some areas of the landscape which are waiting for more innovation. Intent-based trading and automation can alleviate some of the frictions associated with established protocols and further enhance the programmability of capital. I’ve met teams, like Accountable, that are working on tech solutions to help reduce or eliminate the information asymmetry between borrowers and lenders, while others are tackling the idea of on-chain credit scoring. Advancements here should help improve capital efficiency over time, but I suspect we’re still a few cycles away from overcollateralization giving way to some of the other “Cs of Credit” in DeFi. The integration of Real-World Assets onto blockchains represents another area poised for growth, albeit gradually. Checker and StakeUp are making big strides in accelerating this movement. The promise of enhanced liquidity and transparency is significant, yet achieving widespread institutional engagement at scale may require more time to materialize. I think there’s one big catalyst that could help accelerate these developments and that’s a wholesale push towards KYC and compliance. Many in the space would disagree with me here, but I’m firmly in the camp that this presents the fastest path to institutional adoption.
Aquanow operates an investment management subsidiary, AQN Digital, which currently oversees two offerings. One is an early-stage venture fund where we seek-out intrepid developers who are building the products we believe can help shape the crypto landscape of tomorrow. The other is a market neutral yield fund where we seek to provide investors with exposure to the opportunities created in crypto’s dynamic and fragmented markets. While we like DeFi for all the reasons discussed above, some of its shortcomings have the portfolio tilted towards overcollateralized OTC lending where the rates are also compelling.
Asset Class Yields
We leverage Aquanow’s network, the team’s experience in credit analysis, and best practices in risk management to source a healthy pipeline of borrowers for our private lending book. This allocation is supplemented with DeFi lending, and other income-oriented strategies for diversification and yield enhancement. AQN Digital is actively helping institutions launch bespoke solutions around those capabilities, so please reach out if you’d like to discuss further.
Aquanow helps institutions find the signal through the noise in digital assets. Contact us to explore how our expertise can enhance your performance.
If you want to contribute to the web3 movement, Aquanow is on the look for curious and motivated folks to join our team. Feel free to reach out directly or check out the current openings here.
